AM Best and Fitch have both flagged up a significant concern with the Dodd-Frank Wall Street Reform and Consumer Protection Act – something that may have a profound effect on the ratings game.
Fitch has gone as far to say that it cannot consent to including Fitch credit ratings in prospectuses and registration statements “at this time”.
Could this be the start of real change to the established ratings process and business model that many people, still seething about the (perceived) part played by ratings agencies in the financial crisis, have been clamouring for?
Included among the Dodd-Frank legislation's market reforms are provisions aimed at enhancing regulation and transparency for credit rating agencies. AM Best says that while it believes that many of the provisions directed toward credit rating agency reform will benefit the capital markets as a whole, “the new law presents a host of new requirements and legal uncertainties that credit rating agencies such as AM Best must now address…
“AM Best is carefully examining its current practices in light of the new requirements in the Act and will explore ways to ensure that it can fully meet the needs of the marketplace while effectively mitigating its risks under the new law. If necessary, AM Best will take additional steps to mitigate any potential risks associated with the new law.”
The new law rescinds Rule 436(g), states AM Best, exposing credit rating agencies to "expert" liability if they consent to be named as such in registration statements and related prospectuses.
“AM Best will not consent to the use of its ratings in registration statements and related prospectuses. The Act also exposes credit rating agencies to a lower pleading requirement in government and private lawsuits and modifies the ability of credit rating agencies to receive certain information of a material, non-public nature from issuers."
Fitch meanwhile says that the unprecedented events of the last two years have changed expectations for credit rating agencies and Fitch has made a number of changes to its rating process to address these expectations. “Fitch expects to make a range of changes that will provide greater transparency, more rigorous processes and heightened verification of the information Fitch is provided by issuers and underwriters.”
But it too is ill-at-ease over rule Rule 436(g). Before repeal, Rule 436(g) provided that credit ratings assigned by a Nationally Registered Statistical Rating Organization (NRSRO) are not considered a part of registration statement prepared or certified by an 'expert', as described within the meaning of sections 7 and 11 of the Securities Act, and the NRSRO consent would not be required to include credit ratings in Securities Act registration statements and any related prospectuses.
Fitch says that historically, credit rating agencies have never been treated as experts under the Securities Act, appropriately so since ratings are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts.
“While Fitch continues to believe that it is not an expert under the plain meaning of sections 7 and 11 of the Securities Act, it is Fitch's understanding that, absent clarification by the US Securities and Exchange Commission (SEC), immediately after the Dodd-Frank Bill is signed into law an issuer will need to obtain Fitch's written consent to include a Fitch credit rating in a Securities Act registration statement and any related prospectuses. If Fitch provides its consent for ratings to be included into Securities Act registration statements or prospectuses, Fitch will be potentially exposed to 'expert' liability under section 11 of the Securities Act, liability to which Fitch is not currently exposed.
“Fitch is not willing to take on such liability without a complete understanding of the ramifications of that liability to Fitch's business and the means by which Fitch may be able to effectively mitigate the risks associated therewith. While Fitch will continue to publish credit ratings and research, given the potential consequences, Fitch cannot consent to including Fitch credit ratings in prospectuses and registration statements at this time.
In addition, the Dodd-Frank Act directs the SEC to remove the exemption for credit rating agencies from the SEC's Fair Disclosure Rule (Regulation FD) within 90 days of the enactment of the Dodd-Frank Act.
The exemption for credit rating agencies from Regulation FD permits issuers to provide the credit rating agencies with material non-public information without requiring public disclosure of such information.“To the greatest extent possible, Fitch will work with the issuer community to put in place appropriate mechanisms so that Fitch can continue to receive confidential information as part of the rating process.”