July 28, 2003
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: File No. S7-12-03
Dear Mr. Katz:
The Association for Financial Professionals (AFP) welcomes the opportunity to comment on the Securities and Exchange Commission's (SEC) Concept Release Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws. The SEC has asked for comments on a wide range of topics and issues surrounding the oversight of credit rating agencies. Our comments address only those issues on which AFP has expertise.
The membership of our Association includes approximately 14,000 financial executives employed by over 5,000 corporations and other organizations. Our members represent a broad spectrum of financial disciplines and their organizations are drawn generally from the Fortune 1000 and middle-market companies in a wide variety of industries, including manufacturing, retail, energy, financial services, and technology.
In September 2002, AFP surveyed senior-level corporate practitioners such as CFOs, vice presidents of finance, and corporate treasurers regarding the accuracy and timeliness of credit ratings, the role the SEC should take in regulating the credit rating agencies, and the impact additional competition may have on the marketplace for ratings information. We released the results of the survey in November 2002. Following the release, we presented the results to the SEC during a hearing that was held to gather information for its study on the role and function of credit rating agencies in the operation of the securities markets.
The survey found that many of our members believe that 1) the information provided by credit rating agencies is neither timely nor accurate, 2) the rating agencies are primarily serving the interest of parties other than investors, and 3) the SEC should increase its oversight of rating agencies and takes steps to foster greater competition in the market for credit rating information. The survey also found that the majority of respondents believe that increased competition will improve the quality and timeliness of credit ratings.
AFP believes that the credit rating agencies are vital to the efficient operation of capital markets and is pleased to present our views on the concept release. We hope that this process will lead to increased competition in the market for credit ratings and improve the quality of the information provided by rating agencies for the benefit of issuers and investors in the securities markets.
Question 1: Should the Commission eliminate the NRSRO designation from Commission rules?
AFP believes that rating agencies play an important role in the U.S. capital markets and global financial system. AFP's members support keeping a designation that recognizes agencies that provide credible and reliable ratings, and believe that the Securities and Exchange Commission (SEC) is the appropriate agency to grant that recognition. Fewer than one in five respondents to our survey believe that this is not an appropriate role for the SEC. In fact, more than ninety percent of survey respondents believe the SEC should take additional steps in its oversight of the rating agencies, including clarification of the recognition process and periodic reviews of existing nationally recognized statistical rating organizations (NRSROs).
Question 10: If, on the other hand, the Commission should continue to use the NRSRO designation in some Commission rules, could that designation be eliminated from other rules? If so, which rules?
The NRSRO designation should not be removed from other rules. Doing so would likely result in separate designations from the regulators responsible for enforcing those rules or the listing of specific, acceptable agencies in the rules. The creation of new designations of acceptable rating agencies would force agencies desiring recognition to seek approval from multiple regulators, while the listing of specific agencies would codify the competitive advantages enjoyed by those listed agencies. Either scenario is likely to increase barriers to entry and stifle rather than stimulate competition.
Question 11: Are the criteria currently used by Commission staff to determine whether a credit rating agency qualifies as an NRSRO appropriate? If not, what are the appropriate criteria? How should a determination be made as to whether a credit rating agency has met each criterion?
The criteria currently used are not appropriate and have created an oligopoly among recognized rating agencies. This oligopoly has resulted from recognition criteria that create significant artificial barriers to entry. The Commission should establish stringent but attainable criteria and clear procedures that will eliminate unnecessary regulatory barriers to entry into the ratings market.
The appropriate criteria should be based on whether an agency can consistently produce credible and reliable ratings, not simply on whether the market recognizes the rating agency's ability to do so. While market acceptance may be one measure of whether ratings are credible and reliable, quantitative analysis or other methods developed by the Commission may also be acceptable. The criteria should also focus on internal controls designed to protect against potential conflicts of interest and anti-competitive and abusive practices and to ensure the appropriate use of the non-public information to which rating agencies are privy through their Regulation FD exemption.
Question 12: Is it appropriate to condition NRSRO recognition on a rating agency being widely accepted as an issuer of credible and reliable ratings by the predominant users of securities ratings in the United States (e.g., underwriters, dealers, banks, insurance companies, mutual funds, issuers)? Would this general acceptance be verifiable through the examples set forth above (e.g., requiring verification through attestations from, and interviews with, authorized officers of users of securities ratings, as well as using statistical data to demonstrate market reliance on an applicant's ratings? As a more objective way of evidencing market reliance and credibility, should NRSRO recognition be conditioned on a credit rating agency documenting that it has been retained to rate securities issued by a broad group of well-capitalized firms?
The criterion that requires that a rating agency be widely accepted in the U.S. as an issuer of credible and reliable ratings by the predominant users of securities ratings is inappropriate, as it is difficult for a new firm to attain this wide acceptance absent the SEC's recognition. Many of the largest institutional investment portfolios, either through regulation or internal policy, require that investments be rated by one or more NRSRO. Therefore, an issuer hoping to have its securities purchased by one of these portfolios or an investor wishing to purchase a security have a powerful incentive to use only NRSROs. This requirement is perhaps the largest single barrier to entry for non-recognized rating agencies and the greatest impediment to realizing the benefits of increased competition.
As we already noted, the most important criterion should be whether an agency issues credible and reliable ratings, which can be evaluated through measurements including, but not limited to, market acceptance or quantitative analysis. Market acceptance may therefore be one criterion, but it should not be the only or predominant criterion.
Question 13: Should the Commission condition NRSRO recognition on a rating agency developing and implementing procedures reasonably designed to ensure credible, reliable, and current ratings? At a minimum, should each NRSRO have rating procedures designed to ensure that a similar analysis is conducted for similarly situated issuers and that current information is used in the rating agency's analysis? What minimum standards should the Commission use to determine whether the agency's ratings are current? Should each NRSRO use uniform rating symbols, as a means of reducing the risk of marketplace confusion? When reviewing a rating agency's procedures for obtaining information on which to base a rating action, should the Commission establish minimum due diligence requirements for rating agencies? How could these minimum requirements be developed? By the Commission? By the industry, with Commission oversight?
The most important criterion for determining whether a rating agency should be recognized is whether it is an issuer of credible and reliable ratings. This determination may be made through quantitative analysis, market acceptance, or other means determined by the Commission. The procedures used to assign these ratings should be documented, applied consistently, and be demonstrated to produce a similar rating when applied to issuers in similar situations.
The Commission should not stipulate the frequency with which ratings must be updated or reaffirmed, but should instead require that all ratings issued by an NRSRO include a disclosure regarding when the rating was last updated. If the Commission clarifies the process by which a rating agency becomes recognized in order to stimulate competition, market forces will determine the appropriate update frequency by rewarding those NRSROs that update ratings at the appropriate interval. In a competitive environment, market forces will also determine the acceptability of different rating symbols and the minimum due diligence required when issuing or updating a rating. Rather than establish uniform rating symbols, the Commission should require that each NRSRO annually disclose the definition and historic default rates for each rating symbol it uses.
Question 14: Should the extent of contacts with the management of issuers (including access to senior level management of issuers) be a criterion used to determine NRSRO status? Should the Commission limit the credit ratings that can be used for regulatory purposes to credit ratings that include access to senior management of an issuer? If so, why?
The extent of contact with the management of issuers should not be a criterion used to determine NRSRO status. If a rating agency can demonstrate that it is an issuer of credible and reliable ratings, its methodology in developing those ratings should not be a factor in determining recognition. If the rating agency issues credible and reliable ratings, has satisfactorily documented and publicly disclosed its process for developing ratings, and has in place the necessary internal controls discussed previously, the rating agency should be recognized as an NRSRO.
Question 15: To the extent a credit rating agency uses computerized statistical models, what factors should be used to review the models? Could a credit rating agency that solely uses a computerized statistical model and no other qualitative inputs qualify as an NRSRO?
If a credit rating agency that uses solely a computerized statistical model can demonstrate that it is an issuer of credible and reliable ratings and that it has the appropriate internal controls, the Commission should recognize it as an NRSRO. The models should be evaluated based on the quality of their output (credibility and reliability of ratings) over a meaningful period of time (e.g., at least one full business cycle).
Question 16: Should the size and quality of the credit rating agency's staff be considered when determining NRSRO status? Should the Commission condition NRSRO recognition on a rating agency adopting minimum standards for the training and qualifications of its credit analysts? If so, what entity should be responsible for oversight of qualifications and training? How could the Commission verify whether a member of a rating agency's staff is or was previously subject to disciplinary action by a financial (or other) regulatory authority?
Question 17: Should the Commission condition NRSRO recognition on an entity's meeting standards for a minimum number of rating analysts or a maximum average number of issues covered per analyst? For example, should the Commission question whether a single analyst can credibly and reliably issue and keep current credit ratings on securities issued by hundreds of different issuers? Or would this level of scrutiny involve the Commission too deeply in the business practices of rating agencies?
Question 18: Is a credit rating agency's organizational structure an appropriate factor to consider when evaluating a request for NRSRO status? Should the agency that seeks recognition consent to limiting its business to issuing credit ratings or could it conduct other activities, such as rating advisory services?
Question 19: Should the Commission consider a credit rating agency's financial resources as a factor in determining NRSRO status? If so, how? Should NRSRO recognition be conditioned on a rating agency meeting minimum capital or revenue requirements?
As with many of the questions posed, the issues addressed in questions 16-19 would be addressed by market forces if the Commission clarifies the recognition process for a rating agency, thereby enabling qualified agencies to compete with the existing NRSROs. We address the criteria on which recognition should be based in our answer to questions 12 through 15. If competition for credit ratings increases, rating agencies whose staffing, organizational structure, or financial resources are deemed inadequate will quickly be rejected by investors and issuers in favor of those who meet their expectations.
Question 20: Should a rating agency that confines its activity to a limited sector of the debt market be considered for NRSRO recognition? Should a rating agency that confines its activity to a limited (or largely non-U.S.) geographic area also be considered?
If a rating agency can demonstrate that it is an issuer of credible and reliable ratings for a certain industry or geographic region and that it also meets all other requirements of a recognized agency, the Commission should recognize that agency as a limited-purpose NRSRO. In some cases, that limited scope could allow for the development of more specialized expertise in an industry or region, resulting in more credible and reliable ratings. For regulatory purposes, the ratings of limited-purpose NRSROs should be acceptable only for issues in the industry or region of documented expertise.
Limited-purpose NRSROs would also have an opportunity to demonstrate that their methodologies can be applied to other industries or regions to produce credible and reliable ratings. In this case, the Commission could expand the scope of the limited-purpose NRSRO or grant it full recognition. This would result in additional competition with the expected benefits envisioned by respondents to our survey.
Question 21: Should the Commission consider a provisional NRSRO status for rating agencies that comply with NRSRO recognition criteria but lack national recognition?
Recognizing a rating agency as a provisional NRSRO would have little, if any, effect on the agency's ability to compete. The knowledge that NRSRO status may be removed during this provisional period would likely cause most investors to reject ratings from a provisional NRSRO. If the NRSRO designation was withdrawn, the securities purchased based on its ratings would no longer be permitted in many portfolios, forcing sales and causing a drop in the value of the affected securities. Creating a temporary, subordinate class of rating agencies is unlikely to bring any meaningful competition to the marketplace.
If the Commission determines that newly recognized NRSROs should be subject to an initial probationary period, the SEC should apply the same probationary status to all agencies that are granted recognition for the first time. Rather than label a newly recognized NRSRO as provisional, with the drawbacks discussed above, the Commission should increase the frequency with which it reviews these agencies to ensure that they continue to meet the criteria for recognition. The criteria for these reviews should be the same as those used for reviews of all other NRSROs.
Question 22: Should the Commission develop supplemental criteria to evaluate ratings quality that would be applicable to both rating agencies performing traditional fundamental credit analysis and those primarily reliant on statistical models?
All NRSROs should be held to the same standards. The most important standard should be whether an agency produces credible and reliable ratings. Using differing quality standards for firms using different methods to arrive at a rating could create the perception that the SEC prefers one method to another. The free market should determine which method(s) are preferred and accepted.
Question 23: Should the Commission consider other criteria in making the NRSRO determination, such as the existence of effective procedures reasonably designed to prevent conflicts of interest and alleged anticompetitive, abusive, and unfair practices, and improve information flow surrounding the ratings process?
As noted in our response to question 13, any recognized rating agency should have internal procedures to ensure that it issues credible and reliable ratings. To preserve market integrity and allow competition in the market for credit rating information to increase, those procedures should also include internal controls to prevent conflicts of interest and anti-competitive, abusive and unfair practices. Without such controls, NRSROs that have been recognized for many years could use their established position to unfairly stifle competition.
Question 24: Should the Commission expect NRSROs to follow generally accepted industry standards of diligence? If so, should the Commission encourage the establishment of a committee of market participants to develop those standards? Or should they be devised through other means?
If the Commission clarifies the process by which a rating agency can become recognized by the SEC, which will enable qualified agencies to compete with the existing NRSROs, market forces will address minimum standards of diligence. If competition for credit ratings increases, users of credit ratings will reject those agencies whose standards of diligence they deem inadequate and turn to the ratings of agencies that meet their expectations.
Question 25: Should recognition of NRSROs occur through Commission action (rather than through staff no-action letters)? Should the Commission establish an appeal process if the staff remains responsible for the recognition of NRSROs?
The Commission should take action to recognize new NRSROs. The current "no-action" letter process is based on the Commission's reliance on wide market acceptance as its primary criterion. Consistent with the more active role we recommend for the Commission in determining whether a rating agency is an issuer of credible and reliable ratings and has appropriate procedures and internal controls in place, the Commission should take unambiguous action to recognize new NRSROs. The Commission should also establish a clearly documented appeals process. In addition, firms that do not get recognized should have the ability to find out why they were denied recognition, what steps they need to take to secure recognition, and to demonstrate that these steps have been taken.
Question 26: Should the Commission publicize applications for NRSRO recognition, and seek public comment on the credibility and reliability of the applicant's ratings?
The Commission should publicize all applications for NRSRO recognition. Publicizing these applications would add transparency to the process and provide additional input into the Commission's decision. As previously stated, however, this public comment should not be the predominant determinant of whether an applicant will be recognized. A rating agency may be able to issue credible and reliable ratings, but have little or no public acceptance. In addition, a rating agency that issues credible and reliable ratings may invoke issuer criticism by assigning a rating that does not meet the issuer's own perception of its creditworthiness. The lack of wide acceptance or negative issuer or investor feedback should not automatically preclude a rating agency from being recognized as an NRSRO.
Question 27: Should the Commission establish a time period to serve as a goal for action on applications for NRSRO recognition? If so, would an appropriate time period be 90 days after all required information has been received, or a shorter or longer period?
After clearly defining the criteria for recognizing a rating agency as an NRSRO, the Commission should define a timeframe in which it will make its determination. Ninety days after the Commission receives all the required information seems to be a reasonable time period in which to make a decision. However, some flexibility should exist if circumstances arise and the Commission staff needs to conduct additional investigation.
Question 28: Should NRSRO recognition be conditioned on an NRSRO's meeting the original qualification criteria on a continuing basis? If so, should a failure to meet the original qualification criteria lead to revocation of NRSRO recognition? Should some other standard of revocation apply?
In AFP's survey, respondents clearly indicated that the Commission should undertake a periodic review of the NRSROs. The SEC should revoke NRSRO status for those rating agencies that fail continually to meet the same criteria used to determine whether to grant an agency initial NRSRO status. In order to restore investor confidence in the NRSROs, the Commission must periodically review the NRSROs and have the ability and willingness to revoke recognition of those agencies that cease to provide credible and reliable ratings. Because withdrawal of NRSRO status would have a material impact on a rating agency and the value of all securities it rates, the revocation process should be clearly defined and allow for an appeal by the affected NRSRO.
Question 29: What would be the appropriate frequency and intensity of any ongoing Commission review of an NRSRO's continuing compliance with the original qualification criteria?
In AFP's 2002 survey, respondents supported a periodic review of recognized rating agencies. The example given in the survey instrument was every five years. AFP feels that the Commission should review each NRSRO no less frequently than every five years. An NRSRO should also be reviewed following a material change in methodology or procedures, change in ownership or entrance into a new line of business.
Question 30: Should NRSRO recognition be conditioned on a rating agency's filing annual certifications with the Commission that it continues to comply with all of the NRSRO criteria?
All NRSROs should be required to certify on an annual basis that they continue to comply with all of the NRSRO criteria, and that no material changes have taken place in their methodology or procedures. Failure to comply with the criteria should trigger an immediate Commission review of a rating agency's NRSRO status. A material change in methodology or procedures should not necessarily result in the revocation of NRSRO status, as innovation is one of the many expected benefits of increased competition in the market for credit ratings. Instead, the NRSRO should be required to demonstrate to the Commission that it is still able to issue credible and reliable ratings under the new methodology.
Question 31: Should the Commission solicit public comment on the performance of each NRSRO, including whether the NRSRO's ratings continue to be viewed as credible and reliable? If so, how frequently should public comment be solicited (e.g., annually)?
Public comment should be solicited during each formal review of an NRSRO, which should take place at least every five years or following material changes in ownership, methodology or procedures, or the entrance to a new line of business. As part of its oversight of NRSROs, the Commission should establish procedures by which interested parties can communicate with it regarding recognized rating agencies. However, negative issuer or investor feedback should not preclude a rating agency from being recognized as an NRSRO.
Question 34: Should NRSRO recognition be conditioned on record keeping requirements specifically tailored to the ratings business? Should NRSRO recognition be conditioned on a rating agency's maintaining records relating to the ratings business, including those relating to rating decisions?
Recognition as an NRSRO should be granted based on a rating agency's ability to issue credible and reliable ratings (outputs) rather than the methodology or information (inputs) that led to these ratings. When a rating agency fails to meet the minimum standard of credibility and reliability, the Commission should revoke the NRSRO recognition rather than undertake a lengthy and costly investigation into why the methodology and procedures no longer meet the Commission's criteria.
Question 35: Are there minimum standards or best practices to which NRSROs should adhere? If so, how should these be established? By the Commission? By the industry, with Commission oversight? Should they be incorporated into the conditions for NRSRO recognition? Would it, or would it not, be a productive use of Commission resources to develop the expertise to review, e.g., issues related to the quality and diligence of the ratings analysis?
Minimum standards and best practices will be determined by market forces if the Commission clarifies the process for a rating agency to be recognized by the SEC, enabling qualified agencies to compete with the existing NRSROs. If competition for credit ratings increases, rating agencies whose standards are not acceptable to users of credit ratings will quickly be rejected in favor of those who meet expectations.
Question 37: Should the Commission condition NRSRO recognition on an NRSRO's agreeing to document its procedures that address potential conflicts of interest in its business including, but not limited to, potential issuer and subscriber influence? If so, what other potential conflicts should these procedures address?
Question 38: To what extent could concerns regarding potential conflicts of interest be addressed through the disclosure of existing and potential conflicts of interest when an NRSRO publishes ratings?
Question 39: Should NRSRO recognition be conditioned on an NRSRO prohibiting employees involved in the ratings process (e.g., rating analysts and rating committee members) from participating in the solicitation of new business and from fee negotiations? Would conditioning NRSRO recognition on a rating agency's establishing strict firewalls between employees in these areas and credit analysts address potential conflicts? Should the Commission also address the credit analyst compensation structure to minimize potential conflicts of interest?
Question 40: Should NRSRO recognition be conditioned on an agreement by a rating agency not to offer consulting or other advisory services to entities it rates? Could concerns regarding conflicts of interest be addressed by limiting or restricting consulting or advisory services offered by rating agencies?
Question 41: Should NRSRO recognition be conditioned on a prohibition on credit rating analysts employed by NRSROs from discussing rating actions with subscribers? If not prohibited, should the Commission adopt limits on contacts between analysts and subscribers? Or are existing remedies - antifraud, contractual, or otherwise - sufficient to deter inappropriate disclosures to subscribers?
Question 42: Should NRSRO recognition be conditioned on a rating agency having adequate financial resources (e.g., net assets of at least $100,000, or annual gross revenues of at least $1,000,000) to reduce dependence on individual issuers or subscribers?
Question 43: Should NRSRO recognition be conditioned on a rating agency not deriving more than a certain percentage of its revenues (e.g., 3%) from a single source to help assure that the NRSRO operates independently of economic pressures from individual customers?
Question 44: Are there other ways to address potential conflicts of interest in the credit rating business or to minimize their consequences?
Question 45: Should the Commission identify specific anti-competitive practices that NRSROs would agree to prohibit as a condition to NRSRO recognition? If so, what are those practices?
Question 46: Would it be sufficient to condition NRSRO recognition on the adoption of procedures intended to prevent anticompetitive, abusive, and unfair practices from occurring?
Question 47: Should NRSRO recognition specifically be conditioned on an NRSRO's agreeing to forbear from requiring issuers to purchase ancillary services as a precondition for performance of the ratings service?
Question 48: Should NRSRO recognition specifically be conditioned on an NRSRO's not engaging in specified practices with respect to unsolicited ratings (e.g., sending a bill for an unsolicited rating, sending a fee schedule and "encouraging" payment, indicating a rating might be improved with the cooperation of the issuer)?
The issues discussed in questions 37-48 present clear opportunities for biased ratings and for NRSROs to leverage their recognition for unfair advantage. While the vast majority of rating agencies and their staff can be relied upon to take ethical actions in their business dealings, the large-scale corporate frauds and investor deceptions that have been so well documented during the past two years provide clear evidence that investors must be protected by diligent oversight. The claim that the importance of a company's reputation alone will prevent the organization or its employees from committing criminal and unethical acts loses acceptance when some of America's premiere accounting and securities firms have recently been severely tarnished and even ruined by scandal.
One of the criteria used to determine whether a rating agency will be recognized should be the satisfactory documentation of procedures that address conflicts of interest and the prohibition of anticompetitive, coercive, abusive and unfair practices. Further, any evidence that an NRSRO has a conflict of interest or is employing any of these practices should result in an immediate review by the Commission. Additionally, the Commission should require that rating agencies disclose disciplinary actions that the Commission has taken against the agency's staff members in their annual filing referenced in Question 30.
If the Commission determines that an NRSRO engaged in any anticompetitive, coercive, abusive or unfair practices, or issued biased ratings, the Commission should revoke that agency's NRSRO status immediately.
Question 50: Specifically, should NRSRO recognition be conditioned on a rating agency disclosing the key bases of, and assumptions underlying its rating decisions? If so, should these disclosures be made pursuant to standards developed by the industry, or otherwise?
In previous responses, we have recommended that the Commission determine that a rating agency is an issuer of credible and reliable ratings, and that it has documented its process and internal controls before recognizing the agency as an NRSRO. Disclosure of additional information by an NRSRO, including the bases of and assumptions underlying ratings decisions will, improve transparency and efficiency in capital markets. However, market forces, not the Commission, should determine the appropriate amount and form of disclosures beyond the minimum criteria required for Commission recognition. If the Commission clarifies the process for a rating agency to be recognized, thereby enabling qualified agencies to compete with the existing NRSROs, rating agencies whose disclosures are not acceptable to users of credit ratings will quickly be rejected in favor of those who meet their expectations.
Question 51: Would it be advisable for the Commission to condition NRSRO recognition on a rating agency's agreeing to disclose performance information periodically? If so, what type of performance information would be most useful? How often should it be disclosed?
Credit ratings provide an estimate of the creditworthiness of debt issuers. The primary measure of whether a rating agency's credit ratings are credible and reliable is the historic default rate of issues that it rated in the various categories. In aggregate, higher rated issues should have a meaningfully lower incidence of default than lower rated issues. As a condition of NRSRO recognition, rating agencies should be required to provide historical default rates for all of its rating categories during the application process. Further, the NRSRO should be required to provide updates to this information annually. The most important criterion for determining NRSRO recognition should be whether the agency is an issuer of credible and reliable ratings. Initial and annual disclosure of historical default rates by category would be a meaningful source of information to assist the Commission and investors in determining whether an agency's ratings are credible and reliable.
Question 52: Should NRSRO recognition be conditioned on a rating agency's disclosing whether or not an issuer participated in the rating process? Or, could issuers be required to make such disclosures?
We have recommended that a rating agency be required to document its process for developing ratings prior to recognition as an NRSRO. The documentation of the process should include a required disclosure of whether issuers participate in the rating process. While not including the issuer in the process should not necessarily preclude a rating agency from becoming an NRSRO, nor prohibit an NRSRO from issuing a rating, this information is important to users of credit ratings and should therefore be disclosed.
Question 53: Concerns have been raised that certain credit rating agencies make their credit ratings available only to paid subscribers, and that it would be inappropriate to require users of credit ratings to subscribe for a fee to an NRSRO's services to obtain credit ratings for regulatory purposes. What steps, if any, should the Commission take to address these concerns? For example, should NRSRO recognition be conditioned on a rating agency's agreeing to public dissemination of its ratings on a widespread basis at no cost, as is currently the case?
The Commission should not involve itself in the determination of the pricing models used by NRSROs. This is another issue that will resolve itself through competitive forces if the Commission clarifies the process by which a rating agency becomes an NRSRO. In the enhanced competitive environment that would follow such a clarification, users of credit ratings will have additional choices for which ratings they use. If an NRSRO is perceived to issue ratings that are superior to those issued by other agencies, that NRSRO should be allowed to charge whatever price the market will bear. If the ratings issued by an NRSRO are not perceived to be superior, users of credit ratings will be unlikely to pay to access the ratings and will instead turn to NRSROs that publicly disseminate their ratings information. Further, companies whose debt is rated solely by an NRSRO that does not publicly disseminate its ratings will probably see their debt discounted by investors that either cannot access the ratings or must pay to do so.
Question 54: Should NRSRO recognition be conditioned on a rating agency's implementing procedures to assure public notification when it ceases rating/following an issuer. If so, what form of public notification would be appropriate?
The withdrawal of a rating by an NRSRO can have significant effects on a company's ability to access credit or issue debt, and can also have a negative effect on the value of the company's existing debt held by investors. There are many reasons why an NRSRO may cease to rate an issuer, many of which do not reflect any deterioration in the creditworthiness of the issuer (e.g., refusal of issuer to pay the NRSRO). To minimize the effects of an NRSRO ceasing to rate an issuer, recognized agencies should be required to issue a notice of withdrawal through the same channels that it issues its ratings. This notice should include a detailed explanation of the reasons why the NRSRO is ceasing its coverage of the issuer.
Question 55: What steps, if any, can the Commission take to improve the extent and quality of disclosure by issuers to rating agencies or to the public generally, and in particular, regarding: (a) ratings triggers in financial covenants tied to downgrades; (b) conditional elements of material financial contracts; (c) short-term credit facilities; (d) special purpose entities; and (e) material future liabilities.
During the past year, the rating agencies have independently taken steps to improve their analysis of issuers' alternate forms of liquidity. One NRSRO now issues Liquidity Risk Assessments, which specifically deal with many of the issues raised by this question. If the SEC clarifies the process for recognition as an NRSRO with a focus on whether an agency issues credible and reliable ratings, we believe that these issues will be resolved through market forces.
Question 56: Is it appropriate for the Commission to take steps to minimize the ratings "cliff" that has been represented to be particularly pronounced in the commercial paper market? If so, what steps should the Commission take?
We believe that companies, not the SEC, should take steps to minimize ratings cliffs. The ratings triggers that cause such ratings cliffs are one of many types of covenants that lenders and investors can request when structuring a debt agreement. Borrowers and debt issuers can negotiate the inclusion or exclusion of ratings triggers or other restrictive covenants in order to gain access to credit or to reduce the cost of credit.
We believe that rating agencies are critical to the efficient operation of the capital markets and that the SEC must provide prudent oversight that restores and ensures investor confidence. The SEC must improve its oversight by clarifying the criteria and process it uses to recognize a rating agency as an NRSRO, and requiring internal controls that reduce or eliminate potential conflicts of interest. By removing artificial barriers to market entry, the SEC will foster additional competition in the market for credit ratings, which will result in more accurate and timely ratings. Additional competition will also allow users of credit ratings to dictate acceptable standards for many of the issues discussed in the concept release. These actions will increase investor confidence in the ratings of current and future NRSROs and improve the efficiency of capital markets.
We appreciate the opportunity to comment on the concept release and urge your consideration of our recommendations. If you have any questions, please contact Jeff A. Glenzer, CTP, AFP's Director of Treasury Services at 301.907.2862.
James A. Kaitz
President and CEO