SEC Releases Report on Credit Rating Standardization as Required under Dodd-Frank | Practical Law

SEC Releases Report on Credit Rating Standardization as Required under Dodd-Frank | Practical Law

The SEC staff published a report to Congress on credit rating standardization, as required under the Dodd-Frank Act.

SEC Releases Report on Credit Rating Standardization as Required under Dodd-Frank

Practical Law Legal Update 5-521-3273 (Approx. 4 pages)

SEC Releases Report on Credit Rating Standardization as Required under Dodd-Frank

by PLC Corporate & Securities
Published on 11 Sep 2012 • USA (National/Federal)
The SEC staff published a report to Congress on credit rating standardization, as required under the Dodd-Frank Act.
On September 7, 2012, the SEC staff published a report to Congress, Credit Rating Standardization Study, required under Section 939(h) of the Dodd-Frank Act, on the feasibility and desirability of:
  • Standardizing credit rating terminology so that all credit rating agencies issue credit ratings using identical terms.
  • Standardizing the market stress conditions under which ratings are evaluated.
  • Requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations under standardized conditions of economic stress.
  • Standardizing credit rating terminology across asset classes, so that named ratings correspond to a standard range of default probabilities and expected losses independent of asset class and issuing entity.
On December 17, 2010, the SEC issued a request for comments from the public as part of its preparation of this study (see Legal Update, SEC Seeks Comments on Credit Rating Standardization Study under Dodd-Frank). Commenters, including nationally recognized statistical rating organizations (NRSROs) and other market participants, raised concerns about the feasibility and desirability of standardization and most did not feel that it would result in higher levels of accountability, transparency or competition in the credit rating agency industry.
Among other things, the SEC staff found that:
  • Although standardizing credit rating terminology may result in fewer opportunities to manipulate credit rating scales to give the impression of accuracy, this level of standardization may not be feasible due to the number of unique rating scales and differences in credit rating methodologies used by credit rating agencies. Requiring standardized credit rating terminology may reduce incentives for credit rating agencies to improve their credit rating methodologies and surveillance procedures.
  • Standardizing market stress conditions under which ratings are evaluated may prevent tailoring of stress conditions to a particular type of credit rating and the reevaluation or updating of stress conditions as needed.
  • Requiring a correspondence between credit rating categories and a range of default probabilities and loss expectation could lead to greater accountability among credit rating agencies. However, NRSROs do not provide this correspondence because they base their credit ratings on a range of qualitative, as well as quantitative, factors.
  • Dodd-Frank rulemaking initiatives designed to increase transparency regarding the performance of credit ratings and the methodologies used to determine credit ratings may be more feasible and desirable than the standardization that is the subject of this study.
Based on its findings, the staff recommended that the SEC not take any further action at this time with respect to credit rating standardization.
Instead, the staff stated its belief that it would be more efficient to focus on the Dodd-Frank rulemaking initiatives designed to promote transparency in the performance of credit ratings and the methodologies used to determine credit ratings. For a discussion of these rules proposals, see Legal Update, SEC Proposes Rules on Credit Ratings by NRSROs and Creates New ABS Due Diligence Requirements.
For more information on credit ratings and credit rating agencies, see Practice Note, Credit Ratings and Credit Rating Agencies.
For more information on the key provisions of the Dodd-Frank Act relating to credit rating agencies, see Practice Note, Summary of the Dodd-Frank Act: Credit Rating Agencies.
For more information about rulemaking by the SEC and federal banking agencies under the Dodd-Frank Act, see Practice Note, Road Map to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Credit Rating Agencies.