In a comment letter filed today with the Securities and Exchange Commission (SEC), the Securities Industry and Financial Markets Association (SIFMA) cautions against proposals to remove references to credit ratings in regulations, which the SEC issued with the intention of avoiding overreliance on credit ratings and promoting independent analysis.
SIFMA’s Credit Rating Agency Task Force does not believe the possibility of undue reliance on credit ratings supports the deletion of references to and use of credit ratings in regulations. Moreover, the Task Force finds that the incorporation of credit ratings in regulations in many cases provides an appropriate independent minimum threshold, and is an important data point that should be retained as part of an investor’s overall credit analysis. Removing these references may increase apprehension among market participants faced with the challenge of complying with new, vague standards, increase uncertainty among investors who rely on the protection and transparency the ratings provide and increase confusion among market participants subject to competing regulatory frameworks.
The letter also notes that determining the appropriate degree of reliance on credit ratings is less of a regulatory issue and more of a best practices one. Finally, the Task Force stresses that credit ratings and the ratings process itself will be more transparent once the SEC implements Part 1 of its recent credit rating agency reform proposals and recommends that the SEC focus its efforts on ensuring that the proposed rule amendments in Part 1 achieve their stated objective.
“While we support the promotion of due diligence and independent investment analysis by market participants, we believe removing references to credit ratings from securities regulations will not achieve that objective,” said Deborah Cunningham, chief investment officer at Federated Investors and co-chair of SIFMA’s Credit Rating Agency Task Force. “Credit ratings provide an important data point that is a useful component in an investor’s risk analysis process and offer an objective minimum threshold in bright-line, rating-based compliance standards. Rather than undertake a sweeping regulatory reform which may potentially destabilize the market and harm investors, the Task Force encourages the SEC to instead continue to pursue its efforts to improve investor confidence in ratings.”
The SEC proposal would amend portions of the Investment Company Act, the Investment Advisers Act and the Securities Exchange Act. In several instances, the proposals would remove an objective, ratings-based component of specific rules under these Acts and replace it with subjective standards. In its letter, SIFMA notes the potential for uncertainty, decreased transparency and market disruption caused by the new discretionary standards.
For example, Rule 2a-7 of the Investment Company Act limits a money market fund’s portfolio investments to those securities that have received a short-term rating in one of the two highest categories from “the Requisite NRSROs” (or have been determined to be of comparable credit quality to such securities) and have been determined by the fund’s board of directors (or its delegate) to present minimal credit risks. Among other changes, the proposal would eliminate the first requirement and rely solely on a fund’s board of directors (or its delegate) to make minimal credit risk determinations. SIFMA strongly opposes this proposal.
“Removing the objective, rating-based standard under Rule 2a-7 increases the possibility that different funds will apply varying standards of risk assessment and has the potential to decrease the confidence investors have in the money markets,” said Ms. Cunningham. “Rule 2a-7 has worked remarkably well for 25 years and we believe removing a valuable floor for assessing credit risks could have negative consequences for investors.”
The SEC proposal would also amend Rule 15c3-1, commonly known as the net capital rule, under the Securities Exchange Act, by substituting two new subjective standards for the rating-based standards currently used to determine the haircut on commercial paper and non-convertible debt securities or preferred stock. A commercial paper instrument would have to be subject to a minimal amount of credit risk and have sufficient liquidity such that it can be sold at or near its carrying value almost immediately. For non-convertible debt securities or preferred stock, the instrument would have to be subject to no greater than moderate credit risk and have sufficient liquidity such that it can be sold at or near its carrying value within a reasonably short period of time. Brokers would be required to explain how the securities they use for net capital purposes meet the new subjective standards. SIFMA notes that broker-dealers have dependably relied on credit ratings under the existing rule and finds no substantial added benefit to the amendments, but does caution that the removal of a transparent and predictable standard creates uncertainty.
About the SIFMA Credit Rating Agency Task Force:
The Task Force is a global, investor-led industry member task force formed to examine key issues related to credit rating agencies. It is comprised of 37 individuals from the US, Europe, and Asia, and includes asset managers, underwriters, and issuers who are experts in structured finance, corporate debt, municipal debt, and equity securities. The Task Force has been designated by the President’s Working Group on Financial Markets (the “PWG”) as the private-sector group to provide the PWG with industry recommendations on credit rating matters. More information on the Task Force, including a roster of Task Force members, can be found at www.sifma.org/capital_markets/cra-taskforce.shtml.
