06/03/2011

SEC Rating Rule Fails to Achieve Results

The SEC is taking another look at a much-maligned rule designed to promote unsolicited ratings of structured products.

The year-old rule, known as 17g-5, requires issuers to simultaneously share data on new deals with all 10 nationally recognized statistical rating organizations via secure websites. The idea was to give smaller rating firms a crack at market leaders Moody’s, S&P and Fitch, and thereby spur more accurate grades for investors. But issuers have chafed at the rule right from the start, citing the trouble and expense of setting up the websites — not to mention the obligation of disclosing private communications with the rating agencies they hire.

It’s unclear what kinds of changes the SEC is contemplating to 17g-5. What is clear is that the rule has failed to generate unsolicited ratings. Indeed, since it went into effect June 2, 2010, virtually none of the websites set up by bond issuers have registered more than a handful of hits.

“Tens of millions [of dollars] to set up, and only a couple of looks,” one securitization professional complained.

The SEC presumably is considering ways to increase traffic to the websites — and thereby spur more rating firms to analyze deals. The agency’s official line is that the review is part of a longer-term effort to implement the so-called Franken Amendment to the Dodd-Frank Act, which envisions a wholesale transformation of the ratings process. Specifically, the amendment requires the SEC to study the feasibility of creating an official body that would assign firms to grade each bond offering. A key question is whether 17g-5, either in its current or amended form, is effective enough to obviate a more radical approach.

Under the Franken Amendment, the SEC has until July 2012 to complete its study of the ratings process.

The SEC crafted 17g-5 in response to widespread criticism of the rating agencies during the credit crisis. In particular, Moody’s, S&P and Fitch were blamed for handing out triple-A ratings to countless mortgage securitizations and collateralized debt obligations that later experienced significant losses.

The rule imposes a high degree of transparency on bond issuers, including the sharing of e-mails and phone conversations between an issuer and any rating agency it hires to grade a deal. This, issuers complain, has had a chilling effect on their communications with ratings analysts.

Why the smaller rating firms haven’t taken more advantage of the access isn’t clear. One reason might be the obligation to rate a minimum of 10% of the deals they view via the secure websites — or at least one of every 10 they look at. The rating agencies seem to be carefully avoiding viewing too many websites so as not to trigger the 10-deal threshold.

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