Rethinking Regulation of Credit Rating Agencies: An Institutional Investor Perspective

Abstract

This white paper was commissioned by the Council of Institutional Investors for the purpose of educating its members, policymakers, and the general public about important credit rating agency regulation proposals and their potential impact on investors. It offers an institutional investor perspective of the pros and cons of several proposals for redesigning credit rating agency regulation. It focuses on two areas of primary importance - oversight and accountability - and offers specific recommendations in both areas.

First, Congress should create a new Credit Rating Agency Oversight Board (CRAOB) with the power to regulate rating agency practices, including disclosure, conflicts of interest, and rating methodologies, as well as the ability to coordinate the reduction of reliance on ratings. Alternatively, Congress could enhance the authority of the Securities and Exchange Commission (SEC) to grant it similar power to oversee the rating business. Second, Congress should eliminate the effective exemption of rating agencies from liability and make rating agencies more accountable by treating them the same as banks, accountants, and lawyers.

As financial gatekeepers with little incentive to “get it right,” credit rating agencies pose a systemic risk. Creating a rating agency oversight board and strengthening the accountability of rating agencies is thus consistent with the broader push by U.S. policymakers for greater systemic risk oversight. Over the long term, other measures for assessing credit risk may become more acceptable and accessible to regulators and investors. Meanwhile, a more powerful overseer and broader accountability would help reposition credit rating agencies as true information intermediaries.

Keywords: credit ratings, credit rating agencies, derivatives, structured finance, regulation, accounting, credit derivative

JEL Classification: G18, G28, G38, K20, K22, K23, L10, L40