Increased competition amongst credit rating providers, and some limited regulation, are essential to protect the interests of issuers and users alike, according to ACT comments on the recent US Securities and Exchange Commission (SEC) concept release on the role and function of credit rating agencies.
In its response to the consultation, the ACT expresses concern that issuers generally have no effective economic power in agreeing contracts and tariffs with rating agencies for solicited ratings, comparing rating agencies to “utility operators with a local monopoly”. Issuers also have no economic leverage to ensure that agency reports deal fairly with their situation. These circumstances are exacerbated by the fact that, where there are only a minute number of practically useable rating agencies, anti-competitive collaboration between agencies is not necessary to prevent price competition. The ACT recommends that, at the very least, unnecessary barriers to entry to new agencies should be avoided.
Furthermore, the ACT contends that unsolicited ratings must be clearly distinguished from ratings based on confidential, non-published information and discussions with management. Published ratings usually fall into three main categories, namely:
For regulatory capital requirement assessments, while for large diversified portfolios ratings in the first category may be appropriate, for narrow portfolios the ACT considers only ratings in the second and third categories should be used. For investment purposes, of course, the last category should be superior. Therefore, the ACT is of the opinion that the current practice whereby the basis on which a rating has been prepared is only indicated on its initial release is inadequate and that this information should be available whenever and wherever rating are published or quoted. This would also prevent unacceptable pressures being brought to bear on issuers to engage a ratings provider following the publication of an unsolicited rating.
Whilst the introduction of adequate competition and issuer choice into the ratings arena was a key objective for corporate treasurers, the ACT response also made recommendations in relation to improved transparency, comparability of published ratings and the conduct of agencies in relation to confidential information.
The ACT would not be in favour of regulation which would prescribe methodology or drive harmonisation of approaches across different agencies. However, it would be strongly supportive of moves to require ratings providers to publish detailed methodologies and to establish systems which would ensure that these were understood and followed. There is also a strong belief that any particular published methodology (and compliance with it) should produce comparable ratings in what ever country the related work was carried out. A common basic rating scale amongst the various providers would also facilitate comparability – particularly if the number of recognised rating agencies was to increase. This should not stop ratings providers from issuing additional ratings classifications to further refine their opinion.
The ACT calls for greater regulation of rating agencies in relation to their handling of confidential issuer information. The ACT points out that credit analysts with unique access to management and information are in a very privileged position and are regarded as “insiders” to the business. Accordingly, rating agencies need to have in place systems to ensure confidential treatment of this information, including restriction on relationships with other parts of the same agency (or related businesses) which might deal with equities and with journalists and other outsiders (including ratings subscribers). Analysts and other rating agency staff who have had access to confidential information about an issuer which would potentially give them an advantage should also be prohibited from working in related areas such as relevant securities markets for a reasonable period.
In addition to their general comments on the role of ratings agencies, the ACT also submitted detailed responses to specific questions posed by the concept release.