Regulatory Use of Credit Ratings: How It Impacts the Behavior of Market Constituents

Abstract

In July 2008 the United States Securities and Exchange Commission (SEC) published three releases relating to the use in its rules and forms of credit ratings issued by Nationally Recognized Statistical Rating Organizations (NRSRO). The proposed amendments were designed to address concerns that the references to such ratings in SEC documents may have contributed to an undue reliance on NRSRO ratings by market participants. Publishing the proposals, the SEC sought market feedback regarding the effect the removal of such references may produce on investors, issuers and regulated entities.

This article examines the use of ratings by various market constituents, including the regulators themselves and analyzes the details of the SEC proposals. This is done against a backdrop of the origin and history of the credit rating business. Further, the article reviews the feedback provided in response to the SEC proposals and identifies the areas of conflicting views. With credit ratings serving the purpose of regulatory compliance, the use of rating by various market participants deviated from what ratings were originally designed for. One of the major findings of this research is that the market participants are not ready to accept responsibilities for an independent credit risk assessment and, for the most part, opposed the SEC proposals. We infer that investors, fiduciaries and regulated entities are looking to regulators to offer a common measure of risk, accurate and free of conflict of interests.

Keywords: credit rating agencies, NRSRO, regulation, financial market

JEL Classification: G14, G20, G28, G29