Credit raters face new rules

Tara Perkins Financial Services Reporter

From Wednesday's Globe and Mail
Published on Wednesday, Jul. 14, 2010 2:00AM EDT

Regulators are moving to oversee credit rating agencies in Canada, widening the mandate of the watchdogs and slapping national rules on the sector for the first time.

The Canadian Securities Administrators, an umbrella group of provincial regulators, is expected to announce Friday new measures to toughen the accountability and transparency of the agencies, which came under fire after securities that investors believed were safe bets became frozen during the financial crisis.

The plan is the latest in a series of moves globally to toughen regulation of the financial sector, from banks to securities firms. Oversight of ratings agencies was one of many pledges made by the Group of 20 countries, along with reforms such as new capital rules for banks.

Regulation would give securities watchdogs the authority to review and demand changes to the way agencies such as DBRS Ltd., Standard & Poor’s and Moody’s Investors Service operate, industry sources said. The agencies would also have to sign on to a code of conduct that would deal with issues such as potential conflicts of interest.

The proposed rules are expected to be subject to changes after a comment period. In some cases, provincial bodies might require new powers by law.

Influential business voices including Canada’s top banking regulator and a number of Bay Street chief executives have pointed a finger at rating agencies for the role they played in the financial crisis. For their part, ratings agencies have said they have already improved their ratings systems and boosted their degree of transparency in light of market changes.

The prime example in Canada was the $30-billion-plus market for asset-backed commercial paper that was not sponsored by banks. It seized up during the credit crisis in 2007, leaving many investors without access to their money. Canada’s homegrown DBRS took heat for being the only agency to rate the paper, much of which received top ratings.

Similar situations occurred with other structured credit products and other agencies in the U.S. and elsewhere. Rating agencies have become engrained in the financial system because of laws that refer to them or require their ratings.

Canadian authorities first recommended regulating the agencies more than 18 months ago, and received feedback from the industry in early 2009. But they took time to see what other jurisdictions decided before making their move, and observers suggested the CSA has also been weighed down by the effort to create a single national securities regulator.

“We look forward to reviewing the proposed regulatory framework when it is published later this month,” DBRS said in an e-mailed statement Tuesday. “In the meanwhile, we have been consulting with investors and regulatory bodies, and have implemented policies that are consistent with global best practices including the IOSCO [International Organization of Securities Commissions] code of conduct for rating agencies.”

In a letter to the CSA, Moody’s said it was in favour of a regime that is governed more by broad principles than specific rules. “A prescriptive, rules-based regime that provides for a significant degree of day-to-day supervision by securities regulators could inadvertently create the perception that such approved [credit rating agencies] and their ratings are ‘fail-proof’ because they have a regulatory ‘seal of approval,’ ” the agency said.

Authorities have generally backed away from seeking major changes to the rating agencies’ business models, and are instead looking to bolster oversight. Shortly after the financial crisis, the European Union adopted a law requiring that rating agencies be registered, and the financial reforms that the House of Representatives recently approved in the United States will give the Securities and Exchange Commission new powers over rating agencies.

Since the 1970s, rating agencies have been charging companies and other issuers of debt fees for ratings. Critics charge that it’s a conflict of interest for agencies to be taking fees from companies that they rate, and argue that their revenue models should instead rely on payments from the investors who use the ratings.

In a comment piece published by American Banker last month, Standard & Poor’s president Deven Sharma argued that “the issuer-pays model allows us to publish our ratings for free on our website, whereas the subscriber-based model creates information haves and have-nots in the marketplace.” He said S&P is doing a top-to-bottom review of its ratings and making some changes to its procedures. “For instance, we have made changes to our criteria for rating mortgage securities so that it will be much more difficult for such a security to receive a triple-A rating.”