PrefBlog

The Securities and Exchange Commission spent 2010 busily entrenching the practice of selective disclosure with respect to the credit quality of investible intruments.

In 17 CFR Parts 240 and 243 “Amendments to Rules for Nationally Recognized Statistical Rating Organizations”:

Under the re-proposed amendments: (1) NRSROs that are hired by arrangers to perform credit ratings for structured finance products would have been required to disclose on a password-protected Internet Web site the deals for which they have been hired and provide access to that site to non-hired NRSROs that have furnished the Commission with the certification described below; (2) NRSROs that are hired by arrangers to perform credit ratings for structured finance products would have been required to obtain representations from those arrangers that the arranger would provide information given to the hired NRSRO to non-hired NRSROs that have furnished the Commission with the certification described below as well; and (3) NRSROs seeking to access information maintained by the NRSROs and the arrangers pursuant to the new rule would have been required to furnish the Commission an annual certification that they are accessing the information solely to determine credit ratings and would determine a minimum number of credit ratings using the information.

So the SEC acknowledges – and, in fact, emphasizes – that it is difficult, if not impossible, to asset the credit quality of a structured-finance instrument without acess to material non-public information.

Currently, when an NRSRO is hired to rate a structured finance product, some of the information it relies on to determine the rating is generally not made public. As a result, structured finance products frequently are issued with ratings from only one or two NRSROs that have been hired by the arranger, with the attendant conflict of interest that creates. The amendments to Rule 17g-5 are designed to increase the number of credit ratings extant for a given structured finance product and, in particular, to promote the issuance of credit ratings by NRSROs that are not hired by the arranger. This will provide users of credit ratings with more views on the creditworthiness of the structured finance product. In addition, the amendments are designed to reduce the ability of arrangers to obtain better than warranted ratings by exerting influence over NRSROs hired to determine credit ratings for structured finance products. Specifically, opening up the rating process to more NRSROs will make it easier for the hired NRSRO to resist such pressure by increasing the likelihood that any steps taken to inappropriately favor the arranger could be exposed to the market through the credit ratings issued by other NRSROs.

… and only NRSROs are granted access to that information. Investors (or “Investor Scum”, as I believe they are generally known to regulators) must be made dependent upon NRSROs for assessments of credit quality – this will, of course, make it easier to blame them for that dependence when – as will inevitably happen in a competitive economy – things go pear-shaped.

Later, in an exemption to address extra-territoriality the SEC repeated:

Rule 17g-5(a)(3), among other things, requires that the NRSRO must:

• Maintain on a password-protected Internet Web site a list of each structured finance product for which it currently is in the process of determining an initial credit rating in chronological order and identifying the type of structured finance product, the name of the issuer, the date the rating process was initiated, and the Internet Web site address where the arranger represents the information provided to the hired NRSRO can be accessed by other NRSROs;
• Provide free and unlimited access to such password-protected Internet Web site during the applicable calendar year to any NRSRO that provides it with a copy of the certification described in paragraph (e) of Rule 17g-5 that covers that calendar year;12 and
• Obtain from the arranger a written representation that can reasonably be relied upon that the arranger will, among other things, disclose on a password-protected Internet web site the information it provides to the hired NRSRO to determine the initial credit rating (and monitor that credit rating) and provide access to the web site to an NRSRO that provides it with a copy of the certification described in paragraph (e) Rule 17g-5.13

… and DBRS confirms that every single particle of information that they use to rate structured finance wil be on these semi-seqret websites:

To ensure compliance with the Representation Agreement, DBRS requests the Arranger not provide new information orally to DBRS. Rather, the Arranger should post all new information on its website at the same time as it provides it to DBRS. Discussions between the Arranger and DBRS about the application of DBRS methodologies that do not relate to a transaction or a potential transaction would not need to be posted.

I have long argued that Regulation FD (and the corresponding Canadian National Policy 51-201) must be repealed; instead, it is being entrenched. One wonders when the first scandal regarding leakage of passwords will occur.

This entry was posted on Sunday, January 9th, 2011 at 1:51 pm and is filed under Regulation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.