Thursday, March 28, 2013

In Letter to SEC, House Oversight Leaders Urge Full Implementation of Dodd-Frank Provision Mandating Removal of References to Rating Agencies

In a letter to SEC Chair Elisse Walter, House Financial Services Committee Chair Jeb Hensarling (R-TX) and Capital Markets Subcommittee Chair Scott Garrett (R-NJ) emphasized that the repriortization of SEC Dodd-Frank Act rulemaking to crafting regulations under Section 939F rather than completing the work under Section 939A would further entrench the status quo of the Big Three credit rating agencies rather than reforming their structures. Section 939A requires federal agencies to remove from their regulations any reference to, or requirement of, reliance on credit ratings. The House oversight leaders asked Chairman Walter to respond by April 5, 2013 and detail the Commission’s progress in finalizing the Section 939A mandate and tell the Committee when Congress can expect to see this provision fully implemented. Congress expects the SEC to refocus its efforts and complete its regulations implementing Section 939A before taking any actions to implement Section 939F.

More broadly, the House leaders noted that the global financial crisis exposed serious deficiencies in the performance of Nationally Recognized Statistical Rating Organizations (NRSROs), commonly known as credit rating agencies. As the crisis unfolded, investors become increasingly, and sometimes solely, reliant on the use of credit ratings to determine the safety and soundness of their investments. Congress enacted Section 939A to address these deficiencies by ending the federal government’s apparent endorsement of the ratings issued by credit rating agencies and investor over-reliance on such ratings by requiring every federal agency to review any of their regulations that use credit ratings to assess creditworthiness. At the conclusion of this review, each agency must report to Congress on how the agency modified these references and replaced them with alternative standards of appropriate creditworthiness.

Chairmen Hensarling and Garrett noted that, although the SEC has not yet fully complied with Section 939A, the Commission nevertheless announced that it would convene a Credit Ratings Roundtable on May 14, 2013 to examine the SEC staff report of December, 2012, issued pursuant to Section 939F, relating to the feasibility of a system under which a public or private utility would assign an NRSRO to determine credit ratings for structured finance products. Rather than convening this Credit Rating Roundtable, the House Chairs urged the SEC to heed recent remarks by Commissioner Daniel Gallagher expressing frustration with the SEC’s inability to fully implement the Section 939A mandate to remove all references to SEC-registered credit rating agencies, formally referred to as nationally recognized statistical rating organizations, from all agency regulations. (see remarks by SEC Commissioner Daniel Gallagher, Jan. 16, 2013, before the U.S. Chamber Center for Capital Markets Competitiveness, Washington, D.C.)

In contrast to the goal of Section 939A to reduce investor reliance on credit ratings, encourage investor due diligence and increase competition among rating agencies, observed the FSC leaders, Section 939F(d)(1) has the potential to create a new financial crisis by cementing the dominant market position enjoyed by Standard & Poors, Moody’s Investor Service and Fitch Ratings and further entrenching the federal government in the ratings process. The oversight chairs reasoned that only by removing what they called the ``Good Housekeeping seal of approval’’ bestowed by the government can competition among rating agencies be increased and investor reliance on credit ratings be lessened. In turn, this will reduce the likelihood of a future financial crisis based on fundamentally flawed credit risk analysis.