DealBook is reporting that “S.E.C. Removes Credit Ratings From Regulations” but that’s a bit of an overstatement. The SEC today issued final rules on short-form registration of debt securities. The old rules allowed certain investment grade issuers to use Form S-3 to register debt rather than the more time-consuming Form S-1; the new rules delete reliance on investment grade ratings and just allow issuers to use the short forms if they’ve issued enough debt ($750mm outstanding or $1bn in issuance over the last three years) or are qualifying subsidiaries of big public equity issuers.
This only sounds boring because it is. The registration rules are about disclosure, and there probably is less need for extensive disclosure and SEC review for an issuer with a huge high-yield complex than there is for a tiny investment-grade issuer. The rule never really made sense when it referenced ratings, because it never had anything to do with credit quality.
But that’s why it’s an exception: most of the regulatory references to ratings are about credit quality. When regulators think about capital haircuts for brokers or banks, or what money market funds can own, they actually care about whether the securities those brokers/banks/funds hold are likely to be paid back. Most systems of prudential regulation of financial institutions rely on somehow assessing how risky their assets are – preferably in a way that is more objective than just asking them to rate their assets themselves.
Or, for that matter, look at Europe, where S&P president Deven Sharma yesterday penned an FT column arguing that “reliance on ratings in determining regulatory and policy decisions may be encouraging excessive focus on rating agency opinions”:
For instance, the recent Greek debt rollover proposal from the French Banking Federation was made conditional on rating agencies determining whether it amounted to a default. Likewise, the European Central Bank has emphasised the need for any Greek restructuring initiative to avoid a default as defined by rating agencies. And it continues to consider independent ratings when determining which collateral it will accept and on what terms. Such behaviour places ratings into the heart of policymaking, a role that rating providers did not seek.
A better approach is to drop regulatory mandates to use ratings and avoid making ratings the sole criteria for policy decisions. That would reduce their impact on markets and on public policy. And it would free rating firms to compete entirely on quality.
You could reasonably question whether, in the absence of a regulatory monopoly, ratings agencies compete “entirely on quality” or on what you might call “sucking up to big repeat issuers” (as Freakonomics suggested today in slightly different words). But while Sharma’s article piously tells us that ratings agencies never wanted anyone to rely on them to assess credit quality, it doesn’t suggest much in the way of workable replacements – because they’re tough to craft, particularly in fast-moving crises. Which is why, for all its hatred of the American ratings agencies, Europe nonetheless continues to look to them in policymaking. And why, despite Dodd-Frank’s mandate not to, the U.S. is still doing the same thing.