In mid-June, the SEC issued several proposed rules relating to rating agencies, designed to increase transparency and avoid conflicts of interest in the credit ratings process. Nationally recognised statistical rating agencies (NSROs) will be required to be registered and certified annually by the SEC. In the aftermath of the subprime crisis, NSROs have been widely criticised for inaccurate initial ratings of mortgage-backed and asset-backed securities and poor transaction surveillance. Critics have also pointed to conflicts of interest that they perceive to have resulted from the practice of NSROs providing structuring advice to issuers and financial intermediaries, as well as the practice of NSROs being paid directly by issuers or their underwriters.
The SEC did not provide any information in its releases that link ratings problems with actual conflicts of interest. However, whether or not these new conflicts rules and disclosures are necessary or useful, they do no apparent harm and are not likely to be controversial. In many respects, they resemble those put in place for research analysts. The proposals relating to the content, timing and public disclosure of information provided to NSROs and used in determining an initial rating are likely to provoke comment and engender controversy. The proposals require public disclosure of all information provided to NSROs by issuers, underwriters, sponsors, depositors or trustees used in determining initial ratings and in performing rating surveillance. These disclosure requirements extend well beyond the current Regulation AB mandated disclosures and would impact practices for registered and private securities offerings. At the moment, issuers, underwriters and their advisers make determinations on the information that is or would be considered to be material to investors. In effect, the proposals would result in a lot of additional information being made available with little regard to materiality or usefulness. Investors will be awash in information: but to what end?
The SEC proposals characterise rating agency participation in structuring transactions as a "conflict of interest". Given the iterative nature of product development, the proposed regulations will stifle innovation. Rather than encouraging market activity, they will have the unintended effect of bringing it to a complete halt.