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

  • 1. 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
  • 2. 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
  • 3. 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?
  • 4. 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
  • 5. ABCP Structure
    • Wason (2008)
    Seller ABCP Conduit Investors assets asset cash securities cash Asset return Bank liquidity Rating Agency
  • 6. 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
  • 7. 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
  • 8. 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
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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
  • 13. 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
  • 14. 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
  • 15. 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
  • 16. 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
  • 17. 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
  • 18. 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
  • 19. 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
  • 20. 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
  • 21. 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
  • 22. 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
  • 23. 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
  • 24. Comments? Questions? [email_address]