Editor: David Reiss
Brooklyn Law School

March 29, 2013

Rating Agency Reform

By David Reiss

Emily McClintlock Ekins and Mark A. Calabria have recently posted a policy analysis to SSRN, Regulation, Market Structure, and Role of the Credit Rating Agencies.  They argue, as others have before them, that the major rating agencies are an oligopoly.  And like others, they argue that references to ratings should be weeded out from financial regulations.  The main value of their analysis, at least as far as I am concerned, lies with their analysis of other options.  They review three alternative regimes:

  • Open Access
  • Licensing
  • Licensing with captive demand

They define an open access regime as “an industry specific regulatory framework not stipulated by the state.” (24) With a licensing regime, “the state would stipulate that credit risk analysis be used to either require or incentivize investors to purchase high quality financial instruments.” (25) And with a licensing regime with captive demand, the state would, in addition to licensing,  also “stipulate, or ‘designate,’ whose credit risk analyses would be eligible to be used to meet requirements or incentives when purchasing financial instruments.” (26) They reject other reforms, such as (i) having the government take on the role of the rating agencies, (ii) holding the rating agencies liable for their ratings and (iii) banning ratings of overly complex financial instruments.

While I do not take a position on their reform agenda (other than finding the analysis of the open access option to be overly optimistic), it is important that people are thinking about what life would be like without the NRSRO designation for rating agencies that grants them the power to act as gatekeepers to the capital markets.  While many have criticized, few have come up with real alternatives to the system we now have.  Much more thought needs to go into creating a real alternative, and this analysis is part of effort to come up with one.

(As a side note, they have some interesting charts and tables, including Figure 5 which shows the increase in rated RMBS by Moody’s and S&P from 2002 to 2006.  Bottom line:  they more than doubled.).

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