Ratings Agencies Back in the Crosshairs

US lawmakers have taken aim at the major credit ratings agencies as they continue shaping financial industry reform legislation—but buy-side managers remain on the hook in terms of ensuring better internal tools to gauge creditworthiness of their investments.

In the Senate, legislators have approved two amendments in response to how agencies including Moody's Investors Service, Standard & Poor's (S&P) and Fitch Ratings may have fueled the global credit crisis, according to Reuters, The New York Times and other sources.

The first proposal would omit any mention of credit rating agencies in US financial laws such as the Investment Company Act. This would break up what one lawmaker referred to as a "government-sponsored monopoly" enjoyed by the agencies, and require federal regulators to rely on other standards in order to assess creditworthiness.

The second proposal would establish a board run by the US Securities and Exchange Commission (SEC) that would randomly assign ratings agencies to investment products in order to assess them. This would both prevent conflicts of interest caused by securities issuers selecting which credit agencies to work with, and open up competition between the big three agencies and smaller players, according to amendment sponsor Sen. Al Franken.

Both S&P and Moody's have issued less-than-favorable reactions to these proposals—a sign, perhaps, that legislators are on the right track. However, one of the key lessons of the recent economic crisis was the need for more effective internal capabilities among investment managers to determine the creditworthiness of their instruments. That lesson should remain front and center for any manager pursuing credit-related strategies, regardless of how deservedly tight a grip US regulators end up exerting on the big three credit agencies.