SEC Officials Say Rule 2a-7 Changes Possible

WASHINGTON - The Securities and Exchange Commission staff is considering whether to remove any explicit references to "nationally recognized statistical rating organizations" from its money market fund and other rules, top SEC officials said yesterday at a conference sponsored by the Securities Industry and Financial Markets Association.

Also yesterday, the National Federation of Municipal Analysts released a two-page paper on credit ratings, expressing concern that "recent statements by public officials advocating radical and sudden changes to the municipal rating scale," such as making municipal bond ratings mirror corporate ratings, "could threaten the restoration of a smoothly functioning market."

The NFMA said that the push for similar ratings has been based in some cases on misleading and inaccurate information.

The remarks by SEC officials come as the commission has registered nine credit rating agencies as NSRSOs, whose ratings can be used to comply with such rules as the commission's Rule 2a-7 on money market funds, which generally limits those funds to securities that have ratings or double-A or higher.

The staff reconsideration of including NRSRO references in commission rules was requested by SEC chairman Christopher Cox, who wants to avoid creating a so-called moral hazard by bestowing the government's endorsement of registered credit rating agencies, which are private firms, the SEC officials said.

"We're very cognizant of trying to strike a balance between a moral hazard that gets injected by ... anointing a particular kind of agency that is after all just crafting an opinion [versus] the efficiency that rises from allowing people to rely on those opinions and not having to redo all the work themselves," said Erik Sirri, director of the SEC's trading and markets division, who spoke at the SIFMA conference.

Meanwhile, Andrew Donohue, director of the SEC's investment management division, said the commission had already planned to review provisions of 2a-7 that require money market funds to conduct a special analysis of a security if it is downgraded by a rating agency. With the growth in the number of registered credit rating agencies, any time one rater downgrades a security, the downgrade has a "cascading effect" within the money market funds, he said.

"The rule was drafted when there were only a few NRSROs. I think there's nine now and there could easily be 20," Donohue said. "So we have been asked by the chairman to go back and look at where rating agencies have been embedded in our regulations to see whether or not it's appropriate or whether there's an alternative approach to the same thing."

The rule review comes as Cox has said the commission this summer will propose rules designed to, among other things, boost the disclosure and competitiveness of the rating agencies.

But any changes to 2a-7 and other rules that reference the agencies are much further off, an SEC source said after the conference.

The source said it will be difficult for the SEC to eliminate references to the raters in 2a-7 without eroding the commission's credit standards.

"The hard part will be coming up with something that captures securities that are of the same level of creditworthiness without using ratings," the source said.

Some market participants who spoke at the SIFMA conference expressed skepticism about the commission's plan for proposing rating agency rules, contending additional rules are unnecessary. They argued that the rating agencies are taking actions on their own to improve their ratings and ratings processes, which critics have blamed for contributing to the credit crunch.

"There's a lot of market pressure to evolve," said Alan Anders, deputy director of finance for the New York City Office of Management and Budget.

Yet Anders appeared to support changes to 2a-7 that would remove the explicit references to the rating agencies. He said that many issuers are "frustrated with the inflexible limits" on money market funds, and that the fund managers he has talked to would prefer to do the credit analysis themselves.

Karen Weaver, managing director and global head of securitization research at Deutsche Bank Securities Inc., said criticism of the rating agencies' failure to accurately rate structured mortgage products is "misguided." She said raters have a good historical track record and argued that investors should never purchase securities without first conducting research on their own.

"I don't think it's sufficient to say, 'Well, it was triple-A rated by two or three rating agencies and so it should have been fine,' " Weaver said. "The ratings are a starting point for someone whose job it is to select securities. That's all they are. They are a quick easy blunt instrument."

Meanwhile, the NFMA paper cautioned against knee jerk reaction and urged market participants to engage "in a thoughtful dialogue to discuss some key questions regarding the short and long-term impact of ... changes" to credit ratings.

The group's paper outlined four major topics for debate, including whether muni issuers should be rated similar to corporate issuers when disclosure requirements are far looser in the muni market?

"The stakes of this debate are extremely high and the NFMA believes that the loudest voices should not be permitted to drown out that have yet to be heard," the group said in its paper.


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