CDO’s, RMBS and new regulation of rating agencies?

A spectacular proof of the adage not to come back ‘till St Leger Day, or systemic failure of the market systems? Plenty of comment this month in the wake of the subprime disasters on the latter. Especially when it comes to new regulation.

Recent downgrades on residential mortgage-backed securities and collateralised debt obligations, and subsequent hedge fund failures and market turmoil, have led many to blame ratings agencies for the market mess. Both the European Commission, in reviewing its OECD-created voluntary code, and the House financial services committee in the US, promised hearings into ratings agencies. And CESR, which has been consulting on whether/ how to regulate ratings agencies, has extended its consultation period, to allow more comment.

The business model of ratings agencies has changed quite substantially in recent years. From charging investors a fee, through recognition by regulators as an essential part of the regulatory compliance by debt issuers, and hence to charging a fee to issuers for creating a rating, the agencies have won a privileged status.

However the ratings agencies are quick to point out that their job is not to manage risk for investors; theirs is simply to provide an analysis. Despite this, many believe that this understates their influence. Unlike other analysts, ratings agencies are more protected from loss of business, as issuers must have ratings, even if some investors think they are ‘inaccurate’. Regulators have given regulatory functions to the agencies.

And from an IR perspective, rating agencies are a special case. The rating agency analysts tend to be treated rather differently – especially since the company is paying their fees!. They usually come under the responsibility of the Treasurer or FD of the company. Given their influence on a company’s cost of capital, agencies are often given much more detailed access to the management forecasts and are afforded management access.

So if regulators are now considering more ‘regulation’ of rating agencies, IRO’s will want to listen. But what sort of controls will there be? Possibilities may include regulation of the way in which agencies create ratings. Changes to the grade system would require investors to think through – rather to assume from computer models - risk metrics more effectively. And there could be greater transparency surrounding the processes of reaching their analysis, and the means of assessing risks.

As regulators get to work, companies’ interaction with ratings agencies will be looked at carefully.

Making the Transparency Directive work – across the EU

In past posts, this blog has pointed out the uneven application of the Transparency Directive. This has included the variable guidance on Interim Management Statements, on differing standards of major shareholding notification, and in the reach of inside information across the EU.

Now we all have our opportunity to have our say. The Committee of European Securities Regulators has called for evidence on all of the above – and asked whether it should get involved in ensuring a similar standard of implementation of the rules at national level.

So what are the challenges? For IMS (you will recall that this was the compromise agreement between full blown quarterly reporting and a trading statement), companies across Europe are still working out their best approach. Since January when the new rules were introduced, we have seen around one fifth of companies produce a report.

The content is highly variable, and one wonders what the consumer of the news makes of it. IRO’s have had – in the absence of guidance – to work out what the rules mean, and of course to watch what best practice is evolving. The result ranges from a substantial financial update, to a report on sales performance in the last quarter. Would IRO’s welcome some more substantial guidance from their regulators? Probably.

Another area that CESR plans to look at is in whether to make ‘derivatives’ material for disclosure of major shareholdings. If there is one subject on which our side of the capital raising fence guarantees to raise interest, it is surely this. Now is the time to speak out, as regulators are still casting about for a good solution for all sides. There seems to be some agreement that the process of ensuring that votes are not influenced by holders of a CFD is not working, however many will still argue that this does nothing to clarify who is behind block trades.

CESR also asks for comment on whether the dissemination of news is working. I suspect that most UK listed companies will say it is; those with multiple listings may differ, as the requirements in different countries vary hugely, and complying is not the easy process envisaged. Investors are therefore receiving a patchy update of news.

And finally CESR asks whether there is a role that it should play in creating a European storage system. This is the idea of a “European EDGAR” where companies would be obliged to file their news and other disclosure materials into a central database. For the moment, most regulators have set up web- based retrieval of documents, and filing is a simple matter of providing it to your PIP, who will do it for you.

The CESR idea seems to go beyond that, and foresees a Europe-wide mandated system, with the advantage that investors can easily retrieve standard materials. The obvious concern is who should pay for it; inevitably the costs would fall on the issuer in some form or another.

The CESR call for evidence is open for comment on their website www.cesr-eu.org. Now is the time to comment.

Still more changes for issuers: a summer update from the EU and the US.

Back from the beach (and jolly nice it was too, thanks for asking). Meanwhile regulators have continued to be busy on both sides of the Atlantic, proposing and finalising changes to the way in which companies report and to the markets.

There is considerable frustration among regulators that the Transparency Directive, law since the 20th January, has still not been implemented in some countries in Europe. Some of the laggards are now making progress. The Italian government passed the laws needed to create a compliance regime for Italian companies this month, but Spain and some others are still not compliant.

A second aspect is the differences in implementation; requirements for quarterly reporting (Interim Management statements), for disclosure of shareholdings, and the means by which news is disseminated, continue to vary widely. In fact the Committee of European Securities Regulators is consulting at the moment on whether to get involved. It proposes to start working directly with national regulators to create so-called “Level 3 standards”, to ensure coherence between the member states.

A hot topic - of concern to many IRO’s in the US Europe – is the disclosure obligations of CFD’s and other cash settled derivatives. At the moment, this disclosure is outside the scope of the rules; holders do NOT have disclose their positions. The causes problems for issuers, where as much as 30% of their holders remain invisible.

So CESR and individual regulators such as Consob are examining urgently how to treat CFD’s for disclosure purposes. Should ‘materiality’ include derivatives such as CFD’s?

Meanwhile, in the US, the SEC has been very active. The requirement for foreign companies to reconcile their IFRS numbers to US GAAP is on the way out, triggering US companies to ask why they can’t use IFRS as well.

This together with content, frequency and timing of corporate reporting, as well delivery, are the basis for the new committee formed by the SEC, which met for the first time 2 weeks ago. The panel members Advisory Committee on Improvements to Financial Reporting and its terms of reference suggest that this is a root and branch re-examination of how investors (of all kinds) receive and use fundamental data from companies.

Meanwhile, Sarbanes Oxley is starting win better press. Costs of compliance are less than expected, and research from the University of Texas has concluded that SOX has improved both the quantity and quality of corporate disclosure. This in turn encouraged the SEC to say that implementation of auditing requirements for smaller and foreign firms will NOT be delayed.

A fast update on key issues – ho hum, heads down for the autumn.