Saturday, May 15, 2010

LeMieux-Cantwell Amendment Ends Federal Endorsement of Credit Ratings, Orders SEC Study

The approved LeMieux-Cantwell Amendment (SA 3774) to the Senate financial reform bill eliminates statutory protections and references to national credit ratings agencies in a number of federal acts, including the Exchange Act and Investment Company Act, thereby essentially removing the federal government's seal of approval from investment rating agencies. The effect of this action will be to force federal regulators to develop more diverse and accurate measures of credit worthiness. According to Senator Cantwell, it is critical that federal regulators use their discretion to come up with appropriate standards of creditworthiness and not rely on the monopoly of the rating agencies. Press release of May 13, 2010.

The Amendment also requires the SEC to evaluate and make recommendations to Congress within one year regarding how credit ratings can be standardized and better utilized as one of many tools for evaluating general investment risk. The study will be very granular. For example, the SEC must determine the feasibility of standardizing the market stress conditions under which ratings are evaluated, and requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations under standardized conditions of economic stress. The study must also examine the feasibility of standardizing credit rating terminology across asset classes so that named ratings correspond to a standard range of default probabilities and expected losses independent of asset class and issuing entity.

Section 6009 of the House financial reform legislaiton is virtually the same in its provisions removing federal statutory references to credit ratings as the Senate bill, with the difference that the House provisions would become effective six months after enactment, while the Senate provisions would take effect one year after enactment. Also, the House version does not direct the SEC study ordered by the LeMieux-Cantwell Amendment.