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.
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.
posted by Mark Hynes @ 10:57 am
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