By Amanda Maine, J.D.
The SEC’s Office of Credit Ratings (OCR) has published a pair of reports on Nationally Recognized Statistical Rating Organizations (NRSROs) outlining trends in the industry and findings from the staff’s examinations. According to a press release, the examination report shows that NRSROs have made some improvements in response to the staff's examinations. The congressionally-mandated annual report on NRSROs discusses several aspects of the industry, including the state of competition and barriers to entry.
Report to Congress. The staff’s 2019 report to Congress on NRSROs includes information about registered credit rating agencies and an overview of certain SEC and staff activities relating to NRSROs. During the report period, there were nine registered NRSROs, including three “larger NRSROs” (Fitch, Moody’s, and S&P) and six “smaller NRSROs” (A.M. Best, DBRS (which added Morningstar as a credit rating affiliate in 2019), Egan-Jones, HR Ratings, Japan Credit Rating Agency, and Kroll Bond Rating Agency).
The latest statistics indicate that while Moody’s, S&P, and Fitch continue to account for the highest percentages of outstanding ratings, smaller NRSROs have gained market share in certain asset classes, according to the report. S&P accounted for 49.5 percent of outstanding credit ratings during the report period, followed by Moody’s at 32.3 percent and Fitch’s at 13.5 percent. The report points out that while the larger NRSROs account for over 95 percent of all the ratings outstanding as of December 31, 2018, the share of outstanding credit ratings that were issued by the larger NRSROs decreased in each category, most significantly in the asset-backed securities category.The report noted in particular that A.M. Best dominated the insurance category. A large proportion of the aggregate credit ratings were in the government securities category, the report states.
The report also describes NRSRO staffing levels and revenue. One of the report’s findings is that while smaller NRSROs in the aggregate employ only approximately 15.4 percent of all credit analysts employed by NRSROs, this percentage has increased steadily in recent years. Total revenue NRSRO revenue for fiscal year 2018 was approximately $7 billion. Moody’s and S&P both experienced a decline in revenue, while Morningstar experienced a sharp increase.
According to the report, some of the smaller NRSROs have gained market share in the asset-backed securities rating category, especially those backed by discrete asset types. These include “newer or esoteric asset types” such as securities backed by unsecured consumer loans and securitizations backed by aircraft-lease receivables.
The report also finds that barriers to entry continue to exist in the rating agency industry. For example, some fixed income mutual fund managers, pension plan sponsors, and endowment fund managers have historically relied on the larger rating agencies by name, the report explains. Cost is also a barrier to entry, including costs associated with complying with the statutory provisions of the Rating Agency Act and the Dodd-Frank Act.
Examinations findings. The report on NRSRO examinations, generally encompassing the period between January 1 through December 31, 2018 (the review period), includes a list of the staff’s “essential findings,” which were included with one or more recommendations in an examination summary letter sent to an NRSRO but did not necessarily constitute a “material regulatory deficiency.” The staff found that in certain instances, some smaller NRSROs did not adhere to their policies and procedures relating to information disclosed with credit ratings, including the failure to publicly disclose the methodological approach in assigning a credit rating or the modification of press releases based on issuer comments.
The staff also found instances in which both larger and smaller NRSROs did not publish Rule 17g-7(a) information disclosure forms when taking rating actions. For example, one larger NRSRO did not publish an information disclosure form when converting a preliminary rating to a final rating as required by Rule 17g-7(a) and the NRSRO’s own policies and procedures. Other Rule 17g-7(a) findings related to information disclosure forms, including the failure to include the assigned rating in the information disclosure form and the failure to sign the attestation form. One NRSRO did not comply with format requirements when it issued a single information disclosure form that applied to multiple ratings and was hundreds of pages long, the report described.
Other essential findings identified in the report included the failure of NRSROs to address a finding and recommendation from the previous year, failure to adhere to policies and procedures related to rating file documentation, and the failure to consistently apply security patches to IT systems under a defined schedule. In some cases, NRSROs did not provide complete, current, or accurate records to SEC staff upon request. In addition, some NRSROs did not conduct sufficient reviews and remediation of analysts’ non-adherence to their own internal policies and procedures or to SEC rules.
The report also outlines the staff’s findings related to conflicts of interest. These included the failure to disclose or appropriately manage a conflict of interest or adhere to policies and procedures related to certain prohibited conflicts of interest. The staff also found that analytical personnel participated in sales or marketing or were influenced by sales or marketing considerations.
Regarding essential findings pertaining to internal supervisory controls, the staff found that some internal controls were unclear or inconsistent, as well as weak internal supervisory controls related to disclosing or documenting errors in determining credit ratings or related to material, non-public information. The staff also identified certain NRSROs that did not adhere to existing methodologies in determining credit ratings or developing and implementing new or revised procedures and methodologies.