By Joseph Neu
Rating agencies have been winning fewer and fewer friends over the years and in the wake of the financial crisis that trend has accelerated. The move by Standard & Poor’s to downgrade US government debt is unlikely to reverse this. Where S&P has won support with this move, it has far more political implications, especially for those who can use it on their side of the debate concerning the role and scope of government and government spending versus revenue growth. This is precisely the problem. S&P’s move has made it appear more like a provider of punditry and less an impartial arbiter of credit risk.
Avoiding liability
Aligning itself more with the punditry helps S&P’s liability defense. Rather than be held liable for ratings, S&P has never been shy (nor have its peers) about pointing to a free speech and editorial opinion categorization, rather than that of an expert advisor.
“S&P’s ratings are not statements of fact, but rather expressions of opinion about the likelihood that certain events will or will not happen in the future,” as S&P President Devan Sharma testified last month before US House Committee on Financial Services Subcommittee on Oversight and Investigations.
By expressing its opinion about the seriousness of US government debt reduction efforts in the way that it did, S&P arguably strengthened its case as a liability-free pundit as opposed to an expert to be held liable when making factual misrepresentations.
However, by failing to hold back on its opinion, at least for a while longer, S&P may have hurt its case for retaining a regulatory advantage for itself and its NRSRO peers with regulations referencing ratings and dwindling limits on recognized rating competitors. It may also have reopened the controversial provision in the Dodd-Frank Act to strike NRSRO exemption under the Securities Act from being a expert-certified part of an issuer’s registration statement.
Accelerating Reg Change
“Ratings firms fear litigation more than they fear regulation because past regulation efforts haven’t been that draconian,” Scott McCleskey, a former Moody’s compliance officer testified to this effect in Congress. This is about to change.
As International Treasurer noted in a July 27 post, US regulators have found themselves in something of a bind complying with the Dodd-Frank edict to remove any reliance on credit ratings in US financial regulations.
Despite the fact that the SEC came out with rules to displace ratings in the eligibility requirement of short-form registrations (see related story – “SEC Wash of Credit Ratings a Light Rinse”), most experts pointed to the need for an interim fix to get regulations such as for bank capital and liquidity requirements on track without figuring out how to strip them fully of rating references.
The convoluted nature of the short-form workarounds shows why.
Treasury Secretary Geithner’s reaction to the S&P downgrade, combined with Senate calls for an investigation (taking a page from our European policymakers’ book) suggest that rating stripping from regulation actions will be given a new political priority.
A fix that would have helped sustain regulatory support for the rating agencies’ business is no longer as likely.
The same could be said for the SEC’s continued indefinite suspension of enforcement of the Dodd-Frank provision allowing ratings to be referenced in registration statements, required for ABS issuance, without expert liability.
S&P’s Mr. Sharma said often that he supported, even encouraged, policymakers to eliminate regulatory and policy reliance on ratings. Still, the advantages in avoiding this scenario created a conflict of interest for his firm in assessing US credit risk at a time when significant rule changes impacting its business were being contemplated.
In hindsight this conflict of interest may have pushed S&P to take a harder line on US creditworthiness in order to avoid the appearance of conflict; or, the fear of litigation was simply much greater and drove S&P to remake its rating opinion as punditry.
The question for issuers then (and S&P is still an issuer-pays business model) is, are you willing to pay as much (or at all) for punditry; if you are no longer required to do so?