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U.S. Securities and Exchange Commission

Speech by SEC Staff:
NRSRO Proposal Opening Statement at March 3, 2005 Open Commission Meeting


Annette L. Nazareth

Director, Division of Market Regulation
U.S. Securities and Exchange Commission

Washington, D.C.
March 4, 2005

Good morning and thank you, Chairman Donaldson.

The Division of Market Regulation proposes today to define the term Nationally Recognized Statistical Rating Organization, or “NRSRO,” in proposed new Exchange Act Rule 3b-10.  In addition to defining the term, the Proposing Release also would include interpretations relating to each element of the definition. Since the mid 1970s, the Commission and broker-dealers have relied on credit ratings from market-recognized rating agencies for distinguishing among grades of credit risks.  Specifically, the Commission originated the use of the term "NRSRO" for the narrow purpose of permitting broker-dealers to use certain credit ratings to determine the capital charges on different grades of debt securities under the Commission's net capital rule.  To date, no-action letters have been issued for nine NRSROs, although there are currently fewer due to consolidation in the credit rating industry.

The proposed definition of the term “NRSRO” codifies what we believe are the most important factors to be considered in determining whether an entity’s ratings should be relied upon for purposes of the federal securities laws and rules. Adopting the definition in a Commission rule and publishing the related interpretations will substantially increase the transparency of the no-action process. This transparency should assist credit rating agencies who seek recognition.

Under the first prong of the proposed definition, an NRSRO must issue publicly available credit ratings that are current assessments of the creditworthiness of obligors regarding specific securities or money market instruments.  The majority of commenters who responded to the Commission’s recent concept release believed that the credit ratings of credit rating agencies that are used for regulatory purposes should be publicly available on a widespread basis at no cost, and the proposal reflects this viewpoint.

Commenters generally represented that the publication of credit ratings enhances the transparency and efficiency of the market, and that broad availability of credit ratings helps mitigate selective disclosure of potentially material information and allows for ratings comparability.

The proposed definition also requires that credit ratings are kept current – meaning that such ratings are actively monitored on a continuous basis.  Some credit rating agencies that review and update their credit ratings only on a periodic basis have sought NRSRO no-action relief.  The staff believes that credit ratings used for regulatory purposes should be actively monitored on a continuous basis and confirmed, upgraded, or downgraded, if and when necessary.

Because the Commission’s regulatory use of the NRSRO concept relates only to credit ratings on specific securities or obligations, the proposed definition of the term “NRSRO” is limited to firms that issue security specific ratings.  This is important because the risk of loss on a particular debt of an issuer can vary considerably depending on the particular type of security and the specific terms written into the security’s legal documentation.

The second prong of the definition would provide that an NRSRO is an entity that is generally accepted in the financial markets as an issuer of credible and reliable ratings, including ratings for a particular industry or geographic segment, by the predominant users of securities ratings.  

The Proposing Release provides guidance concerning how entities can demonstrate compliance with this part of the definition, including the use of statistical evidence or through attestations or interviews of key personnel at the predominant users of securities ratings.  In addition, the proposed definition explicitly recognizes that credit rating agencies that confine their activities to limited sectors of the debt market or to limited geographic areas may come within the definition of an NRSRO.

The final prong of the proposed definition would require that an NRSRO use systematic procedures designed to ensure credible and reliable ratings, manage potential conflicts of interest, prevent the misuse of nonpublic information, and have sufficient financial resources to ensure compliance with those procedures.  This prong is designed to ensure that a credit rating agency whose ratings can be used for regulatory purposes under the federal securities laws adheres to and is recognized by the marketplace for following sound business practices and for compliance with applicable laws.  NRSROs are recognized as entities that have sound procedures that are designed to produce credible and reliable ratings and that have processes for communicating to the marketplace how those procedures are followed.

As I indicated earlier, the scope of the proposal is limited to defining the term NRSRO. The proposal does not provide for ongoing oversight of the activities of the NRSROs, which we believe may require additional legislative authority. Given the critical role of the NRSROs in the marketplace, many have called upon the Commission to play a more active oversight role. To address these concerns in the absence of express Commission authority, the NRSROs, over the past few months, have sought to craft a framework for voluntary oversight by the Commission. Discussions are ongoing concerning the precise terms of a framework. It is not clear at this time what form that framework might take. The NRSROs have clearly articulated a willingness to abide by the IOSCO Code of Conduct, which sets forth how credit rating agencies can protect their analytical independence, eliminate or manage conflicts of interest, and help ensure the confidentiality of non-public information.

Finally, I note that today the staff will issue a no-action letter in connection with a new NRSRO – namely, A.M. Best. This acknowledgement of A.M. Best’s widely recognized role in the marketplace brings the number of NRSROs to five.

Thank you, Mr. Chairman.  I would be happy to answer any questions that you may have at this time.



Modified: 03/04/2005