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SEC fine no panacea for ratings risk

low ratings flavour
By Alexander Saeedy
30 Aug 2018

The role of rating agencies in contributing to the 2008 financial crisis should not be forgotten. Inflated ratings on securities that turned toxic played a major part in the build-up of the financial bubble that later burst with costly consequences.

The SEC’s recent fine against Moody’s for inaccurate ratings on RMBS and CLOs may be an encouraging sign of contemporary regulatory toughness. The $1m fine is small but marks the first application of the Universal Ratings Symbol requirement, embedded in the Dodd-Frank Wall Street Reform and Consumer Protection Act. It is a reflection of how major agencies have become more tightly regulated entities, so much so they have even been dubbed Nationally Recognised Statistical Rating Organisations in regulatory circles, and are subject to hefty Securities and Exchange Commission supervision.  

You know you've arrived as a threat to stability when you are given your own barely bureaucratic categorisation.

But the truth is that the incentives that spur a race to the bottom on ratings have not been realigned. Issuers still pay whichever agency gives them the ratings they find to be the best, and, obviously, issuers are going to like higher ratings which downplay credit risk and attract more capital to a securities offering. Higher rated securities also allow institutional investors to hold less capital against these securities.

It had been suggested that rating agencies ought to look more like a public utility. It had even been proposed in US Congress that the SEC could start assigning ratings to the different agencies. But those post-crisis proposals went nowhere.

So, for better or worse, we face the same jeopardy as we did in the early 2000s. We can only hope our eyes are open to it this time.

Rating agencies provide a valuable service helping investors to pick securities to match their risk preferences. Absent any other models for the industry, that means it’s up to the SEC to stay vigilant as a central regulator. Let’s hope they get it right this time.  

By Alexander Saeedy
30 Aug 2018