Then, the SEC went on to propose a second series of measures that raised alarm bells with investors and lenders. These would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds -- either through the use of different symbols, such as attaching an identifier to the rating, or by issuing a report disclosing the differences between ratings of structured products and other securities.
The are widespread fears that if rating agencies develop a separate category for structured securities it will further erode investor confidence in CMBS and RMBS and delay these markets' return. There has a growing drumbeat for the rating agencies to separate or at least differentiate its rating scale for structured securities for the last year, Dave Krohn, partner in DLA Piper's Corporate Finance practice, tells GlobeSt.com. Fitch, Moody's and S&P have all put out requests for comments about the pros and cons of doing so, he says. Also, similar proposals have been floated in Congress. But it is the SEC's proposal that is most likely to translate into actual regulation, Krohn explains, as the 2007 Credit Reform Act gave the SEC the necessary authority to push through these rules.
Many in the industry are eager to embrace the proposed transparency measured. "Any effort to introduce transparency invariably helps to create legitimacy for credit markets," Herb London, president, Hudson Institute and professor emeritus at New York University, tells GlobeSt.com. "One of the great problems associated with credit markets are the obscure and unknown factors that sometime militate against transactions."
"We think one of the key areas to restoring liquidity is to implement constructive reforms to the rating process," Clifton Rodgers, SVP of the Real Estate Roundtable, agrees. "Ultimately, the reforms will have to get us to the point where rating agencies provide investors with better tools for more accurately assessing the risks associated with specific securities," he tells GlobeSt.com. "Many market participants don't think that a bifurcated system like the one being suggested achieves that goal."
The reasoning behind these proposals to put separate securities on its own system is that corporate and municipal bond investors assume the risks are similar to CMBS and RMBS and do not very look closely at the deals within those issuances -- especially when the structured securities are delivering the same or better yield. Separate ratings for these asset classes, the theory goes, will flag that risk for investors.
Critics of the proposal, though, counter that a separate rating could bestow a misleading aura of invincibility around corporates and munis. "Right now, an AAA rating is the closest thing to a cashable investment that you can get," Jan Sternin, SVP of commercial/multifamily for the MBA tells GlobeSt.com. "It indicates that that investment has the least likelihood of having any kind of a loss."
Separate ratings, she continues, would lead to the perception in the marketplace that corporates and munis have an even higher level of insulation against loss -- and that structured finance may be even more prone to loss. "It would render all AAAs not created equal," she says. It would also lead to an exodus of capital from structured securities as investors would assume corporates and munis are safer.
Despite the groundswell of opposition, it is looking increasingly likely that changes are coming to the rating agencies. "The events of recent months have had a profound effect on our economy and our markets, and they have galvanized regulators and policymakers not only in this country but around the world to re-examine every aspect of the regulatory framework governing credit rating agencies," said SEC chairman Christopher Cox, says in a prepared statement when issuing the proposed changes. "This package of proposed rules would foster increased transparency, accountability, and competition in the credit rating agency industry for the benefit of investors."
However that doesn't necessarily mean a duel-track rating system is a foregone conclusion. "I think the SEC, by throwing out these options, is recognizing the potential problems and is asking for genuine feedback," Krohn says.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
