SEC, Frank Eye Rule Changes for Ratings Agencies

WASHINGTON The Securities and Exchange Commission plans to propose rules today that are designed to boost the transparency and accountability of the regulated rating agencies known as nationally recognized statistical rating organizations by, among other things, requiring the rating agencies to disclose the ratings history of each security they rate so that investors can then rank the accuracy of the ratings over time.

The SEC's proposed rules come as House Financial Services chairman Barney Frank, D-Mass., plans to introduce legislation in the next two weeks designed to put further requirements on the NRSROs by mandating that they rate municipal bonds, Treasuries, and corporate debt on the same scale.

Frank's legislation follows through on a threat he made in March to legislatively force the three major rating agencies to rate municipalities on a global-equivalent scale if the agencies did not do so voluntarily.

At a March hearing, Frank said he believed that separate rating scales for municipalities and corporate issuers were hurting muni issuers because municipalities historically have much lower default rates than other kinds of debt.

But as long as the separate scales exist, he said municipalities are forced to purchase insurance, which he described as an unnecessary expense that is dragging down the value of their bonds in light of the widespread downgrades to bond insurers. He called insurance "the lead life preserver" for bonds and said, "you'd be better off without the preserver."

Frank first announced his legislative plans in an interview with Bloomberg News on Friday, and a committee spokesman confirmed his remarks yesterday.

Rep. Michael Capuano, D-Mass., a member of the financial services committee who is helping to draft the legislation, said the only question the rating agencies should consider when rating bonds should be the likelihood of repayment.

“It’s the only question that bond rating agencies are supposed to be interested in,” he said, adding: “If they want to have 10 different scales [for 10 different markets] that’s fine by me, but every one of those scales should be based on the likelihood of repayment.”

Though the issue of a single global rating scale has found traction in recent months, no rating agency has yet embraced the idea. Standard & Poor's has said they already have a global scale which is used across all sectors, but some market participants dispute that assertion, while Fitch Ratings has named a top analyst to consider the possibility of "harmonizing" the corporate and public finance rating scales. Meanwhile, Moody’s Investors Service has said it plans to offer global-equivalent ratings, for a fee, in addition to its muni ratings.

Moody's and Fitch officials yesterday declined to comment on either Frank's pending legislation or the SEC proposal. Mimi Barker, a spokesman for Standard & Poor's, reiterated that the rating agency uses the same rating scale across all of the sectors it rates, including public finance.

"We strongly believe in the usefulness of our global rating scale because it is designed to serve as a common language for evaluating and comparing creditworthiness across all major sectors and geographies," she said in a statement.

Frank appears to have endorsed a proposal originally floated by California Treasurer Bill Lockyer to get the three major rating agencies to harmonize their municipal scale. Spokesman Tom Dresslar said that Lockyer would like to convince the rating agencies to voluntarily adopt a global scale that treats munis “fairly.”

“If we conclude that that’s not going to happen then we will join an effort to accomplish our objectives via legislative or regulatory mandates,” he said.

Susan Gaffney, director of the Government Finance Officers Association's federal liaison center here, said: "We appreciate chairman Frank's support for state and local governments and we'll be discussing this important issue at our upcoming annual meeting."

The GFOA meets next week in Fort Lauderdale, Fla.

In a March letter to Frank, the GFOA and five other state and local groups endorsed corporate equivalent ratings for munis and also urged Frank to consider legislation that would, among other things, change certain tax rules that would increase private sector investment incentives for purchasing munis.

A congressional source said that the bill Frank is planning may include more provisions beyond the global rating scale requirements, but he declined to elaborate because the committee had not yet decided what to do.

Meanwhile, SEC chairman Christopher Cox has said that the commission may consider rules that would require the rating agencies to make more detailed disclosures regarding past ratings, in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of the agencies' past ratings. Additionally, the commission plans to require that the rating agencies use different "symbology" to help investors distinguish between structured, corporate and municipal securities.

The SEC proposal will also aim to eliminate conflicts of interest between the agencies and the investment banks that pay them to rate the securities they issue. One proposal would ban the rating agencies from advising the investment banks on how to package securities to secure favorable ratings.

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