Law and Regulation
Geoffrey Yeowart, Robin Parsons, Edward Murray and Hamish Patrick
Chapter 1 provides an overview of the CRAs’ activities, as well as a map of the role played by ratings in the financial markets. It explores the CRA industry by taking into consideration the importance of improving disclosure and transparency ratings. This reflection identifies some key aspects, notably the extent to which the ratings industry can reduce conflicts of interest and investors’ over-reliance. This chapter further addresses the need to enhance the organizational and governance rules of CRAs. The overriding proposition is that CRAs should be liable for the issuance of inaccurate ratings. The analysis delineates the contours of the legal aspects of the credit ratings market before addressing the major questions regarding a CRA’s modus operandi.
Chapter 2 focuses on the reliability of CRAs, since this has been questioned following the mis-evaluation of the default risk attaching to certain financial products—such as subprime mortgages and derivatives—that adversely affected the stability of securities markets. The CRAs have become major players in the financial markets yet their reputations have been tarnished by certain assessments issued during the 2007–09 financial crisis. This chapter provides evidence into aspects such as: (1) the motivation of CRAs to issue solicited or unsolicited ratings; (2) the discretion of CRAs to bring into play evaluation models and to control the treatment of information; and (3) the assessment of rating agencies’ responsibility. The results are interpreted with regard to the standard of rating activity, evaluating positive and negative effects of adopted regulation. This analysis offers significant implications with regard to an applicable normative framework. There is therefore a clear need to regulate the practice of the highly influential, though at times inaccurate, ratings of these agencies.
Chapter 3 examines the regulatory framework of CRAs, with particular attention being paid to the existing legislation at the international level. However, methods for securing more cooperation among global regulators, with a system of integrated controls are also considered. Such methods could require the disclosure of all aspects of the ratings activity, with an emphasis on the evaluation methods and the transparency of information. Although the task force launched by the global regulators produced significant results a hard law approach was still necessary, in fact the 2007-09 financial crisis has demonstrated that a more explicit reference to a hard law regime and legally binding measures would have been desirable.
Chapter 4 examines the US system of authorization and recognition of CRAs as Nationally Recognized Statistical Rating Organization (NRSRO). The importance of this discussion lies in the significant role authorized by the NRSRO in allowing the use of ratings within the regulatory framework. By conferring on ratings the power to determine the credit risk of assets, the NRSRO incautiously placed much reliance on CRAs’ activities. This chapter also addresses the major issues that the system of the NRSROs brought into being within the ratings industry. These included barriers to entry, poor competition and overreliance by regulators. It is argued that the creation and development of an NRSRO system has provided ratings with the status of special label for the quality of debt instruments.