Last week, IOSCO – the International Organisation of Securities Commisions – published its new code of conduct for rating agencies. Broadly speaking, it did little.
Which is why news of this deal – reported by the WSJ on Tuesday – is so significant:
The three major bond-rating firms are set to overhaul the way they collect fees as part of a settlement with New York state’s attorney general, Andrew Cuomo, that could be announced as soon as this week, people familiar with the matter said.
If a deal is reached, it could change the $5 billion-a-year bond-rating industry as fundamentally as Mr. Cuomo’s predecessor Eliot Spitzer did six years ago with his settlement with Wall Street firms over stock-research analysts whose recommendations were compromised by investment-banking ties.
The thrust of the deal tackles the issue of ratings shopping – the “iterative” process by which bond issuers glean indicative ratings from various issuers, before choosing the two best and running with them. Under Cuomo’s plans, the rating agencies will be required to charge a nominal fee for that preliminary process, thus somewhat rebalancing the revenue-led tendencies to overrate. Moreover, the rating agencies have agreed to disclose on a quarterly basis the fees they are paid for subprime MBS.
All this has the makings of something significant, but the key to it – as per – all will be in enforcement. The current mess, is afterall, a threefold problem: a drop in standards at the rating agencies, in turn ignoring a drop in underwriting standards, both in turn ignored by investors.
Thus for these proposals to work, while more transparency from the rating agencies is a good thing, it will need to be accompanied by a confident investor community willing to make use of it.
There is, of course, a less nebulous alternative. Wholesale change. Not something that anyone on Wall Street is comfortable with, but clearly something which less demure souls are willing to tackle. As Wednesday’s FT reports:
US insurance companies owning municipal bonds will soon be able to make investment decisions based on ratings provided by an industry body rather than those from credit ratings agencies, according to the National Association of Insurance Commissioners.
After structured finance, muni bonds are the second biggest rating market for most rating agencies. At Moody’s, one fifth of all revenues in 2007 came from muni bond ratings. Municipal bond issuers – local governments – are not plugged in to the Wall Street mainframe. There’s little love lost when it comes to ditching the likes of S&P, Moody’s and Fitch, especially considering the off-hand way the big rating agencies have treated local government issuers in the past.
And yet, back in the world of structured finance, though there are challenges – notably Egan-Jones – the rating agency issuer-pays business model is remarkably resilient.
The SEC, when it announces its new proposals later this month, is unlikely to go for anything sweeping. Moody’s, S&P and Fitch will persist as will ratings shopping – even if this time there are fewer bargains to be had.
Juvenal’s verse – disputed – is worth quoting more fully:
I know the plan that my old friends always advise me to adopt:
“Bolt her in, constrain her!” But who can ward
the warders? They keep quiet about the girl’s
secrets and get her as their payment; everyone hushes it up.
Related links
Moody’s error gave top ratings to debt products – FT Alphaville
Rating agencies agree to change charges – FT
D. IVNI IVVENALIS SATVRA VI – Latin