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Seven years on, ratings reform still needs work

By Max Adams
16 Sep 2015

Seven years after the crisis brought the reliability of credit ratings into question, parts of the sector are still in need of reform, issuers, investors and ratings officials told a standing room only crowd on day one of ABS East.

The rating agency reform panel played to a standing room only crowd as investors, issuers and rating agency executives debated the effects of previously implemented reforms and which parts of the sector still need reforming.

Topping the panel’s list of topics on Wednesday was the effect of disclosure rules and the internal controls that guarantee the integrity of an agency’s ratings methodology. The rules, implemented last September, dictate that rating agencies must have internal controls in place to show they have sufficiently reviewed any changes to methodology, extending accountability from the top all the way down to the analyst level.

“Overall, the reforms have gone a long way to addressing post-crisis concerns about quality and integrity of ratings,” said Calvin Wong, chief credit officer of Morningstar Credit Ratings, adding that there are still areas that the reforms have yet to address.

The CMBS market, for instance, is in deep dialogue over the comeback of ratings shopping, something that the current wave of reform says little about. Rule 17g-5, which says agencies must share information and was meant to encourage unsolicited ratings, never really worked as intended. The cost of rating a deal was found to be too prohibitive to issue what amounted to a pro bono rating of a transaction by an agency not selected by an issuer to rate it.

“The big three still dominate in most asset classes… That runs counter to the underlying rules that ratings agency reform said was intended to level the playing field,” Wong said.

From an investor perspective, the implemented reforms are a mixed bag. On the one hand, tighter controls and more adequate governance at the agencies themselves has so far averted a race to the bottom in ABS. 

On the other hand, the disclosure rules do not extend to all market participants. In CMBS, issuers disclose the ratings provided by an agency only for certain parts of the capital stack, while leaving other parts unrated. This has been common practice in the CMBS market for over two years now, but investors are still put off by it.

“There is really no alternative that we really see to what the Franken Amendment tried to do, which was level the playing field,” Francisco Paez, head of ABS and CMBS at MetLife, said, alluding to the amendment that would have possibly required issuers to rotate the agencies they used to rate deals. That legislation was ultimately abandoned.

Bob Behal, co-head of ABS and CMBS at Vanguard, said that it is hard to believe the topic of ratings shopping is still being discussed seven years after the crisis. But he conceded that if investors were given the choice, they would always choose the most conservative agency, reducing any incentive those agencies have to improve and adapt their methodology.

“That is the key to the dilemma at hand,” Behal said.

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By Max Adams
16 Sep 2015