Still conflicted

Washington misses trick with rating agency reform

Washington has missed a trick with rating agency reform. On Wednesday, the US Securities and Exchange Commission finally approved new rules for judging the riskiness of asset-backed bonds. Some are modestly helpful. But measures like imposing unsolicited ratings on deals would offer more robust changes - and may foster much-needed competition for Fitch, Moody's and S&P.

The watchdog has put a lot of importance on internal controls. So rating agency chief executives will now have to certify that their processes are up to snuff - and that other business activities do not influence ratings.

These firms will also from now on need to review any ratings bestowed by analysts who then hop to a job either with issuers or investment banks. On top of that, analysts are prohibited from taking part in sales and marketing to companies they rate.

All of this is pretty obvious. It's also reminiscent of two other fixes: The 2002 Sarbanes-Oxley Act passed after accounting scandals at Enron and WorldCom; and then-New York Attorney General Eliot Spitzer's crusade to clean up sell-side equity research.

What's lacking in the new rules is meaningful reform to address the conflict of interest inherent to the business: Having issuers pay the agencies for their credit ratings. If a company looking to sell bonds reckons the rating agency it has hired is being too tough, it can simply employ another friendlier firm.

One idea would be for the SEC to convene a board comprised of market players whose role would be to assign a rating agency to each deal in addition to any that an issuer directly employs. Payment would still come from issuers - though perhaps from a kitty - so it might not work with just the big three raters vying for business. But such a model could foster competition by encouraging smaller firms which currently focus on corporate bonds, or even new entrants, to compete in securitisation. More players ought to help make the business more transparent and effective.

This idea, too, is not new. Senator Al Franken pitched something similar when Dodd-Frank was being drafted. It was effectively killed when relegated to a mere study. Nor would it remove conflicts entirely - that would require fundamental reform. But it would at least have been a more serious attempt to grapple with rating agency flaws than the SEC has managed.