Securities and Exchange Commission advisory committee puts issue high on agenda for meeting in Washington on Monday following renewed calls by lawmakers for agency to tighten ratings industry controls credit.
The rally comes a week after four senators led by Mississippi Republican Roger Wicker wrote a letter to SEC chairman Jay Clayton asking why the agency has not proposed more restrictions on conflicts that may occur when bond issuers pay for ratings more than nine years after the SEC received broader control of the sector.
“We remain concerned about recent trends in note inflation and signs of continued rate buying,” the senators wrote in their letter to the SEC, which was reported earlier this week by the Wall Street Journal.
Bonds marked with the highest AAA ratings are expected to signal a relatively safe investment, while those with CCC ratings fall into a riskier category only a few steps above default. Prices and investor demand for these issues are influenced accordingly.
During the 2007-2008 global financial crisis, the highest ratings for billions of complex mortgage securities were downgraded after failing to meet their AAA status, which cast doubt on the merits of the pay-as-you-go model. transmitter.
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“This is an important time in the fixed income markets … potentially a price bubble and signs of liquidity difficulties.”
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The latest push from the legislator follows an earlier investigation by Senator Elizabeth Warren, a Democrat from Massachusetts, who is running for president in 2020 on a platform that includes wearing Wall Street in some regions. Warren identified a booming segment of the market where indebted business loans are grouped in marketable securities, dubbed “secured loan obligations” or CLOs, as “of particular concern”. Her On September 26, a letter to Clayton at the SEC asked for more clarity on his agency’s efforts to mitigate credit rating disputes.
While the broad Dodd-Frank law of 2010 gave the SEC more extensive oversight powers over credit rating companies, some lawmakers and investors have criticized the SEC for its slowness in ensuring that adequate controls are in place. sector.
The securitization market, which includes CLOs, has been blamed for triggering the latest financial crisis, while the credit rating industry has also paid billions of dollars in fines to settle allegations that it allegedly attributed overly rosy notes to complex bond transactions.
Meanwhile, the SEC’s credit ratings office asked for 20 minutes of speaking time at the annual securitization industry gathering in Las Vegas in late February, according to Michael Bright, CEO of the Structured Finance Association, the lead group commercial and industry conference. organizer.
Financial regulators, including the SEC, have attended previous industry meetings. It is this corner of the credit markets which, a decade ago, became synonymous with “Big Short” in subprime mortgage bonds, the famous financial implosion (and its winners) which inspired a bestseller of no. -fiction by Michael Lewis and a film.
“This is an important moment in the bond markets, [with], potentially, bubble pricing and signs of liquidity problems, “said Kurt Schacht, of the CFA Institute, chief executive officer of standards and advocacy at the World Association of Investors.
“Taking the pulse of scoring practices here is an important systemic control,” he told MarketWatch.
The Federal Reserve on Friday included the possibility of “significant volume of speculative note downgrades” in lower-rated corporate bonds as a potential risk to financial stability in its annual report to Congress on monetary policy.
The “big three” rating firms: Moody’s Investors Service
MCO,
S&P Global
SPGI,
and Fitch Ratings still dominate the ratings industry, while progress has been made by smaller players like the Kroll Bond Rating Agency and Morningstar Credit Ratings in more complex parts of the debt markets.
The SEC emphasized this point in its latest annual report to Congress, which established the total turnover of all credit rating companies at $ 7 billion for 2018.
S&P shared a written statement it submitted to the SEC commission before Monday’s panel, which underscores the industry’s belief that credit rating companies already comply with the “many requirements” imposed by Dodd- Frank.
Moody’s has also shared its letter to the SEC, which includes a section explaining why “rating shopping” in the securitization market needs to be addressed.
Fitch and Morningstar Credit Ratings did not comment on this article. KBRA did not immediately respond.
A key concern in the bond market is that problems may be slower to percolate (and less visible) than in US stocks, where stocks trade in the blink of an eye and provide a faster and more transparent measure of sentiment of investors, including Monday when the S&P 500 index
SPX,
Dow Jones Industrial Average
DJIA,
and Nasdaq Composite
COMP,
bounced back to a percentage point near their historic highs.
But due to their complexity, bonds and credit ratings have also been linked for over a hundred years, according to this brief history of the industry by Lawrence White, professor of economics at New York University.
He notes that Moody’s has initially started charging investors for their valuations of railway bonds.
Credit ratings are now mainly paid by issuers, from Argentina selling sovereign debt to US companies involved in a corporate debt boom.
Despite this, Martin Fridson, chief investment officer of Lehmann, Livian, Fridson Advisors, who spoke to the SEC at its meeting on Monday, said he saw little concern in how the bonds of companies are currently rated.
“It is not obvious that there is a solution,” he said of the rating conflicts perceived in the issuer-pays model. “It is not obvious that there is a problem,” he said in an interview with MarketWatch.
Fridson writes a regular column on corporate bonds for S&P Global Market Intelligence, which is separate from its rating platform.
The other speaker on the agenda, David Jacob, a former senior S&P official and advocate for certain credit rating reforms, could not be reached for comment.
The SEC did not respond to a request for comment.