Measuring Trust: US SEC Votes Markets Must Reduce Reliance on Embarrassed Rating Agencies

The failure of private ratings agencies like Moody's and S&P to alert investors to the shortcomings inherent in mortgage-backed securities and other exotic financial products was commonly cited as one of the causes of the financial crisis. The SEC has now voted to remove references to the ratings of these agencies in their documents so investors will not be gulled into thinking the ratings are meaningful. The core problem, which has not been resolved, is that the companies issuing the securities pay the rating agencies for the service so the agencies have a strong incentive to provide what the issuers desire, rather than protecting investors. The essential element of trust was damaged by the market participants' behavior. No replacement rating system has emerged, which is both a capital markets' concern - and a business opportunity.

Sarah Lynch from Reuters reports on the SEC vote:


"U.S. securities regulators on Wednesday moved to scale back markets' reliance on credit rating agencies, after the financial crisis laid bare the industry's shortcomings.

The Securities and Exchange Commission voted 5-0 to propose that several of its key documents for securities offerings no longer include ratings references designed to give investors confidence in the quality of the securities.

The proposal would affect the use of ratings from firms such as Moody's Corp, McGraw-Hill Cos' Standard & Poor's, and Fimalac SA's Fitch Ratings, but is not expected to deeply cut into the industry's revenues.

The proposal predates the financial crisis, but it lost steam when global financial markets started going into panic mode.

In 2009, the agency stripped some requirements for rating references from regulations, saying it was concerned about undue reliance on them, but the removal of all ratings references was not mandatory.

The Dodd-Frank financial law, however, changes that by requiring government agencies to go through their regulations and remove such requirements.

On Wednesday, the SEC resuscitated a similar plan it proposed in 2008, in its first move to remove ratings from its regulations since the Dodd-Frank law was enacted in July.

Credit-raters have often been blamed for helping fuel the crisis by giving overly positive ratings to loans backed by toxic subprime mortgages.

Dodd-Frank mandates some credit-rating reforms, such as mitigating conflicts of interest, holding credit-raters accountable for their ratings and reducing investor reliance on them.

But credit-raters are not facing the same sweeping overhaul as banks and mortgage lenders, largely because lawmakers could not come up with a good alternative to what they offer.

The lack of a good alternative has even caused some financial regulators to worry that Dodd-Frank goes too far, especially those that rely on ratings providers to assess the risk associated with a bank's capital