Skepticism Greets US Senate’s Rating Agency Proposal

Reactions in some quarters to the US Senate's proposal to vest greater authority in the Securities and Exchange Commission (SEC) to regulate credit rating agencies have been lukewarm.

The Senate's rule, part of a larger financial reform effort still making its way through Congress, would establish a committee within the SEC to randomly assign credit rating agencies to new investment products in order to assess their creditworthiness. The move comes in response to conflict-of-interest concerns among investors that security issuers paid agencies to rate their products favorably even though the instruments' underlying characteristics proved less than stellar—a major factor in the global credit crisis.

According to some buy-side industry sources, however, the Senate proposal may have gone too far in the other direction.

"Getting the SEC involved is a bit much," says Michael Levas, chief investment officer at hedge fund and wealth management firm Olympian Capital Management. He argues that stronger auditing of rating agencies, both internally and externally, would be a more effective remedy.

"Yes, there was a conflict of interest and that's not right, but this is overreaction," he says. "These firms should get neutral, smarter boards together and establish better auditing processes."

John Jay, senior analyst at financial technology consultancy Aite Group, sees the Senate's proposal as highly problematic, and emphasizes the need for investment managers to take on more direct responsibility for credit analysis functions.

"For the buy side, managers have already started doing their own credit work, now more than ever before. But now this is more explicitly placed on them," Jay says.

"Investors now have to look after their own economic interests and follow the economics of their particular transactions. Both on the institutional as well as the retail level, there has to be a greater appreciation on the buy side for its own responsibilities."

CalPERS, the largest US pension fund manager that filed suit against Moody's, Fitch and Standard & Poor's last year alleging inaccurate structured product ratings leading to $1 billion in losses, declined to comment on the Senate proposal. A CalPERS representative, however, reiterates what the manager itself has advocated in terms of rating agency reforms.

Components of CalPERS' reform proposal include payment to the agencies from end-users of their services rather than from securities issuers, support of SEC steps to assert greater authority over the agencies, elimination of the agencies' exemption from liability from misrepresentation of creditworthiness, and stronger disclosure rules for methodologies agencies use to rate products.