Alert September 18, 2012

SEC Submits Credit Rating Standardization Study to Congress

In response to a mandate in the Dodd-Frank Act, the SEC submitted to Congress a study prepared by its staff on the feasibility and desirability of standardizing certain elements of credit ratings and their underlying methodologies.  As directed by the statute, the study examines the viability and practicability of: (i) standardizing credit rating terminology; (ii) standardizing the market stress conditions under which ratings are evaluated; (iii) requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations (under standardized conditions of market stress); and (iv) standardizing credit rating terminology across asset classes.  The SEC staff solicited public comment regarding the mandated topics, and reviewed publicly available information on the subject of standardization in credit ratings.  The study sets forth a number of findings, as follows:

  • Standardizing credit rating terminology may facilitate comparison of credit ratings across agencies and could result in a decrease in the opportunities for manipulating credit ratings, although this may not be feasible given the number and uniqueness of rating scales and the variances in methodologies used by credit rating agencies. 
  • Requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations could lead to greater accountability; however, such correspondence may not always exist because credit ratings are also based on qualitative factors. 
  • Most credit rating agencies believe it is desirable to have standard credit rating terminology across all asset classes; however, credit ratings have not historically been comparable across asset classes. 
  • Transparency in credit ratings may be more achievable and more practicable than implementing standardization.

Based on these findings, the SEC staff recommended that no further action be taken with respect to: (i) standardization of credit rating terminology; (ii) standardizing the market stress conditions under which ratings are evaluated; (iii) requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations (under standardized conditions of market stress); and (iv) standardizing credit rating terminology across asset classes.   In addition, the staff concluded that it would be more efficient to focus on the rulemaking initiatives mandated under the Dodd-Frank Act with respect to credit ratings, which, among other things, are designed to promote transparency with respect to the performance of credit ratings and the methodologies used to determine credit ratings.