WASHINGTON — As the House Friday approved the most sweeping financial regulatory reform legislation since the Depression, municipal issuers are debating the effectiveness of a little-noticed provision that would require rating agencies to rate municipal and other debt on the same scale and based on the likelihood of repayment to investors.
The House voted 223 to 202 to approve the massive bill, which would regulate over-the-counter derivatives for the first time, create a Consumer Financial Protection Agency, and establish a multi-agency council to monitor systemic risk as well as an orderly process for winding down large, failing non-bank financial institutions.
Obama administration officials were quick to praise lawmakers for passing the measure as lawmakers in the Senate work on their own version of the bill, which is expected to contain some different provisions. Treasury Secretary Tim Geithner said the House bill “moves us an important step closer” to meeting the objectives that President Obama laid out earlier this year in response to “last year’s financial collapse.”
Industry groups were far less enthusiastic. Tim Ryan, the president and chief executive officer of the Securities Industry and Financial Markets Association, said that while the House bill is “a significant milestone,” SIFMA has deep reservations about some of its provisions, including the framework for resolving failing non-bank institutions, which he said contains too much uncertainty for investors and creditors.
The bill includes several muni-related provisions, including one that would give the Securities and Exchange Commission oversight of municipal financial and swap advisers that is supported by groups representing dealer-FAs. Those groups have long called for a level regulatory playing field with currently unregulated, non-dealer FAs.
Michael Nicholas, chief executive officer of the Regional Bond Dealers Association, said RBDA strongly supports the FA provisions. But he raised concerns about separate provisions in the bill that would allow the government to shut down or break apart failing financial institutions that are systemically important.
“Instead, we prefer that the causes of systemic risk be addressed before a firm becomes too big to fail,” he said.
Another muni-related provision would change the composition of the Municipal Securities Rulemaking Board to require that a majority of its 15-members consist of public representatives. Currently the board is dominated by securities firms and banks.
While market participants generally are supportive of the muni-related provisions, there is debate among issuers about whether a section of the bill designed to require “uniform” ratings of municipal debt sold by states and localities will succeed in lowering their borrowing costs.
The idea of a uniform rating scale has been pushed by issuers and Democratic lawmakers who argue that munis are unfairly rated on a separate, more rigorous scale then corporate bonds even though their general obligation debt rarely, if ever, defaults.
Moody’s Investors Service and Fitch Ratings both committed to switching to a single scale last year, but halted their efforts citing the financial crisis. Standard & Poor’s maintains that it has long used a single global scale for its ratings.
Specifically, the House bill would require that the SEC pass rules requiring that each rating agency registered as a nationally recognized statistical rating organization, rate securities and money market instruments on the likelihood of loss to investors and that it apply those ratings consistently across all types of asset classes.
In addition, the SEC would be prohibited from adopting rules that bar NRSROs from considering credit factors “that are unique to municipal securities” or that prevents them from establishing “complementary” ratings to measure a “discrete aspect of the security’s or instrument’s risk.”
Tom Dresslar, a spokesman for California Treasury Bill Lockyer, who pushed for legislation requiring rating agencies to rate municipal securities on the likelihood of default alone, said the House bill represents a “giant step forward” toward achieving that goal. However, he said he is concerned about prohibiting SEC adoption of rules that would prevent NRSROs from considering credit factors unique to municipal securities.
“We kind of wonder what the purpose of that provision is,” Dresslar said. “It may be appropriate to consider unique factors, but those factors should have a demonstrated, clear relationship to the risk of default. Without that kind of clarification, we question whether that provision turns into a big loophole.”
Two market participants who asked not to be named said they are concerned that complementary ratings would confuse investors or at least not lower issuers’ borrowing costs.
“The net of it all will be the so-called global rating plus a rating that will consider other things, and I don’t know that the market is going to ignore the other stuff and focus on the uniform rating,” one of them said.
But Roger Anderson, the executive director of the New Jersey Educational Facilities Authority, said he is satisfied with the language and suggested the complementary ratings provision merely accommodates the additional ratings that at least one NRSRO, Standard & Poor’s, already provides. In 2004, the rating agency began providing ratings based on issuers’ derivatives profiles and this year it began providing ratings for financial entities based on the likelihood that the federal government would provide “extraordinary” aid to support them.
Meanwhile, Susan Gaffney, the director of the Government Finance Officers Association’s federal liaison center here, said her group is “very pleased” that the legislation includes the uniform ratings, as well as the regulation of FAs. She said the board hopes similar language is included in the Senate version.
It is not clear when the Senate next year will advance its own measure, which was unveiled as a discussion draft last month but is being rewritten by four bipartisan groups of Senate Banking Committee members.
Meanwhile, House Financial Services chairman Barney Frank, D-Mass., said in a television interview Friday that Senate Banking chairman Christopher Dodd, D-Conn., is working “diligently” to gain bipartisan support for the measure, which will likely need 60 votes to clear the Senate.
