What will happen to the rating agencies?

A major section of the Todd-Frank legislation is dedicated to the reform of the credit rating agencies.  Much of the momentum behind the drive to highlight this action as one of the major fixes to the US securities markets came from the obvious failures of Standard & Poor’s, Moody’s and Fitch Ratings in their ratings and surveillance of structured debt over the past decade.

The Todd-Frank bill provides for several areas of reform most of which are probably good ideas whose time had come. 

However, there is one section of the bill which has many industry experts very concerned.  That would be the section that eliminates statutory requirements for credit ratings in determining the eligibility of a security for certain investors.  These statutes may have applied to public pension funds and other similarly regulated investors.  Many felt that these statutes created a virtual oligopoly for the credit rating agencies or NRSRO’s, as they are known in the trade, essentially forcing issuers into securing a rating for their securities programs and generating fees for the rating agencies.

The hope of the new legislation is that issuers will now be less inclined to seek ratings for all their programs, as investors are “encouraged” to complete their own analysis of their investments both before they buy and while they own a security.  Some market analysts are predicting severe consequences for certain markets, particularly for securitization.

We don’t see it that way.

What we suspect will actually occur over the next several years is that the rating agencies will slowly rebuild their reputations and investors, possessing neither the time nor the resources, will once again lean heavily on credit ratings when making investment decisions.  They will recognize that the rating agencies are, in fact, experts in this area and are far better equipped to conduct the analysis across a broad array of security types, asset classes and individual issuers than any single investor might hope to be on its own.

This “investor demand”  for credit ratings will drive issuers to return to the credit rating agencies for all but the most exceptional cases.  While it may take some time, we believe the end result is inevitable.

About markferraris
Managing Principal Orchard Street Partners LLC

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