09/09/2011

ASF Angles to Block Franken Amendment

A much-maligned SEC rule designed to spur unsolicited grades on structured products ultimately could prove preferable to the transformation of the rating process envisioned by a controversial amendment to the Dodd-Frank Act.

That’s the position the American Securitization Forum will stake out when it submits a 25-page letter to the SEC next week commenting on the so-called Franken Amendment. Named for Sen. Al Franken (D-Minn.), the amendment requires the SEC to study the feasibility of replacing the current bond-rating system — in which issuers decide on which agencies get to rate their deals — with an official body that would assign firms to grade each offering.

Though the SEC has until July to complete the study, the deadline for submitting comments is Sept. 13. In its comment letter, the ASF will urge the regulator to fine-tune its ongoing reform efforts rather than abandon the current system altogether.

“Some issuers have expressed concern the Franken Amendment would be Russian roulette,” said ASF executive director Tom Deutsch. “The government would get more involved in the ratings process, which is something it said it doesn’t want to do.”

The best alternative in the ASF’s eyes: a new version of a year-old rule that has been widely criticized by issuers and investors alike. The rule, known as 17g-5, requires issuers to share deal data with all 10 nationally recognized statistical rating organizations — not just with the ones they hire. The idea was to give smaller NRSROs a crack at market leaders Moody’s, S&P and Fitch, and thereby spur more accurate grades for investors.

Issuers despise 17g-5 both because of added expenses involved and the fact that the rule requires them to disclose communications with the rating agencies they hire. Investors, meanwhile, say the rule has failed to achieve its goals. To wit: Since taking effect in June 2010, 17g-5 has yet to produce a single unsolicited grade.

Indeed, few rating agencies have even bothered to look at the secure websites. The reason: Under the rule, an agency has to issue an unsolicited rating for at least one of every 10 deals it examines — a potentially expensive proposition.

The solution, according to the ASF, is to improve the rule, not abandon it. Specifically, the trade group — with the support of six rating agencies — will recommend to the SEC that it allow NRSROs to issue “unofficial critiques,” rather than formal grades. This would still have the effect of providing investors with more information without being unnecessarily burdensome for the rating firms.

“It would be a significant improvement in that we don’t believe the rating is as important as the critical commentary,” Deutsch said. “We feel it would spur more rating-agency critiques of each other and create better competition.”

The ASF’s position is supported by Moody’s, S&P, Fitch, DBRS, Kroll and Morningstar.

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 losses.

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