Thursday, July 07, 2011

References to Credit Rating Agencies Stripped from Federal Tax Regulations per Dodd-Frank Mandate

As directed by Section 939A of the Dodd-Frank Act, regulations under the federal tax code were amended to remove any reference to, or requirement of reliance on, credit ratings and to substitute a standard of creditworthiness. Some changes involve simple word deletions or substitutions, while others are more substantive.

Tax regulations include rating agency fees in a list of non-exclusive examples of issuance costs. The regulations were amended to replace the reference to rating agency fees with fees paid to an organization to evaluate the credit quality of the issue. Under existing regulations, the credit rating of an issuer or obligation is one of the facts and circumstances used to determine how much of a repurchase premium is attributable to the cost of borrowing and not to the conversion feature of a convertible bond. Credit rating services is used as a means to determine the credit rating of an issuer or obligation. The regulations were changed to refer to credit quality and widely published financial information. Treasury also removed credit rating agency from an illustrative scenario of counterparty’s credit-worthiness based upon an industry standard of a certain credit quality.

Current regulations define a qualified reserve fund as an amount that is reasonably required to fund expenses of a mortgage-backed investment vehicle or amounts due on interests in the event of defaults on the underlying pool of mortgages. In defining the amount reasonably required, the regulations refer to the amount required by a nationally recognized independent rating agency as a condition of providing the rating for an interest in the mortgage-backed vehicle. Because an adequate alternative standard of reference is already set forth in the regulations, Treasury removed the rating agency alternative standard.

Current regulations provide for determining whether a modification of a debt instrument results in an exchange for federal tax purposes. An example in the regulations was revised so that the event that triggers an option to increase a note’s rate of interest is a breach of covenants in the note, rather than a specific decline in the company’s credit rating. Another example is revised so that the debt instrument described in the example allows a party to be substituted for the instrument’s original obligor on the basis of the party’s credit-worthiness, rather than the party’s credit rating

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