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    Credit Rating Agencies Regulation Across Countries: A ... Credit Rating Agencies Regulation Across Countries: A ... Presentation Transcript

    • Credit Rating Agencies Regulation Across Countries: A Critical Assessment of Reform Initiatives The Future of Credit Rating Agencies: Regulation and Accountability Capital Markets Institute - Toronto JUNE 25th, 2009 STÉPHANE ROUSSEAU
    • Context
      • American subprime crisis having profound consequences
      • Subprime loans made their way into asset-backed securities (ABS) through securitization: ABS experienced tremendous growth
      • Structured finance products widely held and incorporated into other securities: ABCP is a case in point
    • Context
      • Credit market turmoil : a « perfect storm » with all safeguards failing
        • Central role of credit rating agencies (CRAs)
        • Spectacular downgrading of ABS
      • Critiques of CRAs : calls for reforms
        • Regulatory interventions in the U.S., the EU, and Canada;
      • How to regulate CRAs?
    • Asset-Backed Commercial Paper
      • Introduced in Canada in the 1980s
      • Traditionnally backed by conventional debt: credit cards and trade receivables, leases, mortgages…
      • In the 2000s, synthetic assets such as RMBS and CDOs incorporated
      • 2000-2007: ABCP market doubles to $120 billion
    • ABCP Structure
      • Wason (2008)
      Seller ABCP Conduit Investors assets asset cash securities cash Asset return Bank liquidity Rating Agency
    • ABCP and the Credit Crisis: The Domino Effect
      • Delinquencies and foreclosures rates rise in the US
      • Property values plummet
      • Uncertainty about CDOs and RMBS losses
      • Liquidity crisis
      • Impact on ABCP:
        • Uncertainty with respect to underlying assets
        • Demand dries out
        • Liquidity facilities inoperative
    • ABCP Issues
      • Transparency
        • Lack of information on underlying assets
        • Ratings: primary source of information
      • Asset/liability
        • Long-term assets becoming predominant
        • Short-term notes
      • Liquidity facilities
        • Global style: banks acting as liquidity provider
        • Canadian style: general market disruption
        • Only DBRS rates ABCP with Canadian style liquidity facilities
    • Rating Agencies: Salient Facts
      • Concentrated industry: S&P, Moody’s, Fitch, DBRS
      • Ratings: assessment of creditworthiness/probability of default
        • Efficiency dimension:
          • Assist investors in their assessment of the risk and uncertainties associated with asset-backed securities.
          • ABCP: rating apply to the notes issued by the conduits
        • Regulatory dimension
          • Prospectus exemption for ABCP (short-term debt)
          • Investment grade vs speculative securities
    • Rating Agencies and ABCP
      • Canada: CRAs unregulated
      • U.S.: Nationally Recognized Statistical Rating Organization (NRSRO)
        • Prior to 2006, SEC No-Action Letter procedure
        • Credit Rating Agency Reform Act of 2006
      • IOSCO Code of Conduct
      • European Union: CRAs unregulated
    • Concerns: Quality of Ratings
      • Resources
        • Growth in the volume and complexity of structured finance products not matched by increase in CRAs staff
        • Impact on monitoring of ratings and timeliness of downgrading
      • Due diligence
        • Information provided by issuers taken at face value
        • Disclosure of lack of due diligence
      • Effectiveness of methodologies questioned
    • Concerns: Conflicts of Interest
      • Issuer pays model
        • CRAs paid only if retained to rate the product
        • Incentive to downplay risk/inflate rating
        • Particular problems with respect to structured finance products
          • Concentration in the underwriting business
          • Ratings structured finance products highly profitable
          • Unsolicited ratings difficult
      • Consulting services
        • CRAs advise issuers as to how to design the SPV in order to obtain the rating contemplated
    • Concerns: Transparency
      • Deficiencies in the disclosure of rating process, methodologies and criteria
      • Lack of verifiable and easily comparable performance data
      • Use of same symbols to rate traditional debt (corporate and municipal bonds) and structured finance products
    • Reform Proposals
      • Need for reform: strong consensus
        • “ We have agreed on more effective oversight of the activities of Credit Rating Agencies, as they are essential market participants”.
      • G20 Communiqué, April 2009
      • Wave of reform initiatives across countries
        • Securities and Exchange Commission
          • Amendments to rules governing NRSROs
        • International Organization of Securities Commissions (IOSCO)
          • Amendments to the Code of Condut
        • European Parliament:
          • Regulation on Credit Rating Agencies
        • Canadian Securities Administrators Concept Paper 11-405
    • Reform Proposals: Key Initiatives
      • Rating Process
        • CRAs should adopt reasonable measures so that the information it uses is of sufficient quality
        • Review periodically methodologies and models
        • Monitoring and updating of ratings: objectivity
        • Appropriate knowledge & experience: rating committees’ members
        • IOSCO Code of Conduct
        • EU Regulation
    • Reform Proposals: Key Initiatives
      • Independence and Conflicts of Interest
        • Compensation
          • Issuer pays model prohibited unless disclosure of information received by CRAs
          • Proposed SEC Rule
        • Fees
          • Prohibition to negotiate the issuer fees where rating the security.
          • SEC Rule
          • IOSCO Code
        • Consulting
          • Prohibition to issue a rating for a security where advice provided as to its structure
          • EU Regulation
          • SEC Rule
          • IOSCO Code
    • Reform Proposals: Key Initiatives
      • Transparency
        • Information of substantially material sources obtained for ratings
        • EU Regulation
        • Differentiate ratings for structured products
        • EU Regulation
        • IOSCO Code of Conduct
        • Ratings, and subsequent rating actions
        • Methodologies, models, and key rating assumptions
            • Verifications performed on the underlying assets?
            • Verifications of the quality of originators of assets?
        • Performance statistics
        • IOSCO Code of Conduct
          • EU Regulation
          • SEC Rules
    • Reform Proposals: Key Initiatives
      • Competition
        • Disclosure of information on asset-backed securities
          • IOSCO Code of Conduct
          • Proposed SEC Rule
        • Regulatory use of ratings
          • Remove reference to ratings in regulation
          • Proposed SEC Rule
          • Analyzing whether the approach taken by the SEC could inform its proposals to maintain, modify or delete references to credit ratings in Canadian securities legislation
          • CSA Concept Paper
    • Enhancing CRA Accountability and Effectiveness: Between State and Markets
      • Limited Effectiveness of Market-Based Instruments
        • Competition
          • Concentration: market- and regulatory-based barriers
          • Impact
            • Ineffective check on quality & integrity of ratings
            • Hampers reputational pressures
          • Solutions
            • Remove regulatory barriers
            • Natural barriers to entry will remain
        • Reputation: impact of market concentration
    • Enhancing CRA Accountability and Effectiveness: Between State and Markets
        • Restore Investor-Pays Model
          • Public good problem
          • Impact on information efficiency
            • Narrower dissemination
            • Limited public scrutiny
            • Uneven level playing field
            • Insufficient coverage of issuers
        • Self-regulation
          • “ Self-regulation has been tested since 2006 and the outcome is far from acceptable”
          • European Commission Staff, 2008
    • Enhancing CRA Accountability and Effectiveness: Between State and Markets
      • Uncertain Promise of the Regulatory Path
        • Government Utility Model
          • Attractions
            • Solves the public good problem
            • Ensures wide dissemination of ratings
            • Alleviates conflicts of interests
          • Issues
            • Scope of ratings services
            • Funding
            • Conflicts of interests: government bonds & policy objectives
            • Investor over-reliance
            • Accountability
    • Enhancing CRA Accountability and Effectiveness: Between State and Markets
      • Registration Model
        • Wide support: G20, US & EU Models
        • Attractions
          • Competition: facilitate entry by smaller agencies
          • Accountability: regulatory oversight
        • Issues
          • Competition: registration requirements as barriers to entry
          • Accountability: rules of conduct
            • Expertise?
            • Impact on innovation
          • Over-reliance on ratings
    • Enhancing CRA Accountability and Effectiveness: Between State and Markets
      • Disclosure-Based Model
        • Weak form of registration system
        • Attractions
          • Competition:
            • No substantive registration requirements
            • Clarify recognition criteria
          • Accountability:
            • Market: disclosure
            • Regulatory oversight
        • Issues
          • Natural barriers to entry remain
          • Reputational pressures
    • Closing Comments
      • CRAs, Credit Crisis and ABCP
      • What role for regulation?
        • Strong consensus for regulatory intervention:
          • CRAs failings
          • Limited effectiveness of market instruments
        • G20 favors registration system
        • Caution: avoid Nirvana fallacy
      • CRA regulation in Canada: disclosure-based approach
        • Supports & complements market-based mechanisms
        • Ensures regulatory coordination
            • US ABS market dwarfs the Canadian market: $2,480 billion vs $157 billion
    • Comments? Questions? [email_address]