Feds, Regulators, Congress Eye the Future of Credit Rating Agencies
The nation’s insurance regulators, Congress and the SEC have eyes on credit rating agencies and the standards they must follow in the future.
The National Association of Insurance Commissioners (NAIC) said it will hold a public hearing on Sept. 24 to discuss the past and future roles of Nationally Recognized Statistical Ratings Organizations (NRSRO), which include A.M. Best Co., Moody’s Investor Service, Standard & Poor’s and Fitch Ratings.
Representatives of credit rating agencies, insurance companies and pension funds will be invited to testify, as will regulators, consumer representatives, leading academics and industry experts on the role of these credit rating agencies in the insurance regulatory system and what changes may be needed in light of the financial crisis.
Insurance companies hold nearly $3 trillion in rated bonds and the insurance industry constitutes the largest sector of the financial services industry to rely on credit ratings to supervise capital asset adequacy. Insurance regulators currently mandate the use of credit ratings to determine capital reserves and other regulatory requirements for insurance companies.
The NAIC said that during the hearing, the working group will gather information from panels addressing:
- The historical reliance of insurance regulators on ratings and the impact of this reliance;
- Issues concerning ratings, particularly related to structured securities and municipal bonds;
- Recent systemic remedies or procedural changes enacted by NRSROs; and
- Recommendations and alternatives to NRSROs for prudential regulation.
Following the hearing, the working group will present a final report with recommendations for corrective action. The NAIC’s public hearing will take place during the NAIC Fall National Meeting at the Gaylord Convention Center in National Harbor, Md.
Congressional View
Congress is also considering the role of credit rating agencies and the standards they must adhere to in the future.
In a Reuters article, Representative Paul Kanjorski, a senior Democrat on the House Financial Services Committee, said reforms to promote better ratings quality could include exposing the agencies to greater legal liability.
“We must consider radical reforms aimed at improving accountability, reliability, transparency, and independence,” Kanjorski said at a hearing on changes to financial regulation in July.
Legislation also has been introduced in the U.S. Senate that would allow investors to sue credit rating agencies that recklessly failed to review key information in developing a rating. The bill aims to hold rating agencies liable when it can be proven that the firms knowingly failed to review data for determining a rating based on their methodology or failed to reasonably verify data.
Free Speech Protections
U.S. securities regulators are also chiming in on the issue. The Securities and Exchange Commission is planning to issue a general discussion paper that questions whether credit rating agencies should be regulated as “experts” under securities law, and thus subject to a tougher liability standard, according to a Reuters article.
Rating agencies are not considered experts but that may change. In the past, rating agencies argued that they are exempt from “expert” rules because they are only providing an opinion and are protected by free speech laws.
But in early September, in a case alleging that inflated ratings on risky mortgages led to investment losses, U.S. District Judge Shira Scheindlin ruled that ratings on notes sold privately to a group of investors were not “matters of public concern” deserving broad protection under the First Amendment of the U.S. Constitution.
The Manhattan judge said in the Reuters report that investors may pursue their lawsuit accusing Moody’s, S&P and Morgan Stanley, which marketed the notes, of issuing false and misleading statements about the notes, which were backed by subprime mortgages and other debt.
“This is potentially a very significant opinion,” Jonathan Macey, a professor at Yale Law School, told Reuters.
The SEC points out in the Reuters article that others such as auditors that companies use and cite in their public filings are considered experts and can be sued by investors.
The SEC’s general discussion paper, also known as a “concept release” among securities lawyers, can be the first step in the agency’s rulemaking process. However, some past discussion papers have been abandoned with no action.