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Remarks to the Securities and Exchange Commission Fixed Income Market Structure Advisory Committee

Nov. 4, 2019

Good morning, and thanks to all of you once again for joining us at today’s meeting of the Fixed Income Market Structure Advisory Committee (FIMSAC). Since my very first day on the Commission—when I began this job by attending my first FIMSAC meeting—I have been consistently impressed with the exceptional work of this Committee. I am grateful to each of you for your service to the Commission and the Nation’s investors, and as we meet for the last time this year I look forward to hearing from the Committee on today’s discussions about credit ratings and financial benchmarks. I also wanted to share two thoughts of my own as the Committee continues its work next year.

First, I want to highlight your work on an important issue raised in a previous meeting: the potentially abusive use of last-looks, or “pennying,” in bond auctions.[1] Auctions play an important role in centralizing liquidity, and a last look can be a way for dealers to avoid adverse selection—that is, losing money on bad trades. But there’s no free lunch in finance: if dealers are systematically abusing last looks to obtain free price discovery, that comes at the cost of fair competition and market efficiency. As in other markets where we have solved similar problems, I call on my colleagues at FINRA and on the SEC to collect data from trading venues to study this issue—and, if warranted, pursue rulemaking.

Second, I want to encourage thoughtful discussion about one of today’s agenda items: alternative compensation arrangements for credit rating agencies. Incentives play a powerful role in shaping our markets, and I am concerned that credit rating agencies lack the necessary incentives to produce reliable, unbiased ratings for systematically important markets.[2] Despite legislative and regulatory attempts to introduce transparency, oversight, and competition in these markets, we now risk repeating the tragic history of ratings shopping.[3] I very much look forward to hearing from the Committee on alternative ways we can produce the transparent and reliable ratings that American investors deserve.[4]

Thanks again to each member of the Committee for your continued engagement and hard work throughout this year. I very much look forward to continued conversations on these important issues.

[1] Securities & Exchange Comm’n, Fixed Income Market Structure Advisory Committee, Recommendations Regarding the Practice of Pennying in the Corporate and Municipal Bond Markets (June 11, 2019).

[2] Frank Partnoy, Rethinking Regulation of Credit Rating Agencies: An Institutional Investor Perspective (working paper July 6, 2009) (discussing policy proposals to address this issue, including regulation of rating agency practices, increased disclosure of ratings of all types—rather than a random sample of issuer-paid ratings—reducing regulatory reliance on credit ratings, and eliminating exemptions from liability).

[3] See, e.g., Cezary Podkul & Gunjan Banerji, Inflated Bond Ratings Helped Spur the Financial Crisis. They’re Back., Wall St. J. (August 7, 2019).

[4] One possibility is that, if we consider issuer-paid ratings to be economically equivalent to advertising rather than unbiased opinion, increased scrutiny of such ratings may be warranted.

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