US and EU Reduce Reliance on Credit Rating Agencies

In the wake of the global financial crisis, regulators in both the US and Europe are taking a more critical stance toward credit rating agencies (CRAs). These private entities – such as Moody's and Standard & Poor's – rate the financial worthiness of companies that issue debt obligations, like mortgage-backed securities. Many policymakers have criticized CRAs for giving excessively positive ratings to structured securities, thereby serving, in the words of the Financial Crisis Inquiry Commission, "essential cogs in the wheel of financial destruction." In the US, as part of the Dodd-Frank Act's reforms, the Securities and Exchange Commission (SEC) recently proposed to use ratings of creditworthiness other than those provided by CRAs. CRA ratings currently play a large role in SEC requirements; their elimination will likely result in far-reaching changes in securities practices. For instance, short-form registration requirements will likely change. Under the old rules, if a CRA rated a company highly, that company could qualify for short-form registration, an easier method of registering securities than through a public offering. The SEC now proposes allowing companies to qualify for short-form registration if they have acceptable recent histories of registering at least $1 billion in securities. SEC Commissioner Troy A. Paredes reportedly criticized this proposed standard for frustrating securities registrations. Eliminating references to CRA ratings will also likely affect money market funds, which the SEC regulates under the Investment Company Act of 1940. These funds will no longer be required to rely on CRA ratings of securities when deciding how to invest. In contrast, in Europe the European Commission did not react to the global financial crisis by eliminating references to CRA ratings. Instead, it began supervising these agencies more closely. For example, the Commission has instituted registration requirements for CRAs and created a government agency to oversee them. For regulatory purposes, the Commission will now only use ratings of registered CRAs. However, more recently, the Commission raised questions about the overreliance on even registered CRAs. It argued that the new registration requirements may lead to a false sense of security and thereby lead to unduly accepting reliance of the ratings of CRAs.

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