Credit Rating Agency Reform law attests to FEI's influence.

The work of FEI's technical committees continues to be influential. Our Committee on Corporate Finance (CCF) was an early and forceful advocate of the Credit Rating Agency Reform Act of 2006. In March of this year, I testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs at a hearing on "Assessing the Current Oversight & Operation of Credit Rating Agencies," representing CCF.

The testimony assessed the current environment, noting that credit rating agencies play a very vital role in the U.S. and world financial markets. While there are more than 100 credit rating agencies operating worldwide, only five are currently designated as "Nationally Recognized Statistical Rating Organizations" (NRSROs) by the U.S. Securities and Exchange Commission (SEC). These five have enjoyed a competitive advantage over their peers because the guidelines for many government, mutual fund and other institutional investment portfolios not only specify minimum credit ratings for their securities, but also require that the ratings come from NRSROs.

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NRSRO status was obtained by requesting a staff no-action letter from the SEC. The SEC's criteria for an NRSRO was that it be "widely accepted in the United States as an issuer of credible and reliable ratings." There was no emphasis placed on ensuring that the credit rating agency continued to satisfy the criteria.

Since NRSROs were created in 1975, the importance of the NRSRO stamp of approval grew far more than anticipated. Loan agreements now often require borrowers to maintain certain ratings from NRSROs; failure to do so can trigger higher interest rates, or even default.

Call for Eliminating 'No Action' Process

The system afforded substantial advantages to the handful of credit rating agencies that received the NRSRO designation. We testified that the most effective way to increase competition was to eliminate the "no action" process at the SEC and replace it with transparent registration requirements.

By establishing stringent, yet clear criteria for registration, Congress would not only ensure the continued validity of ratings issued by registered credit rating agencies, but would generate more competition in the credit rating market. That, in turn, would provide more choice for issuers, lower costs for rating services and higher-quality service.

We asked that Congress direct the SEC to begin by developing clear criteria for registration, which might include requiring the agencies to demonstrate their procedures and methodologies used in developing ratings, demonstrate that they have developed procedures for protecting non-public information and disclose the qualifications of those tasked with developing ratings.

We also asked that Congress increase the accountability of the rating agencies through regular performance audits to ensure that the registered entities continue to satisfy operational criteria. Additionally, we asked that Congress consider conflicts of interest that may arise when the rating agencies provide fee-based advisory services to their rated clients.

New Definition and Oversight Created

On September 22, the Senate approved by unanimous consent the Credit Rating Agency Reform Act of 2006. (The House of Representatives passed its version of the bill in July). The legislation overhauls the framework for registering and overseeing credit rating agencies. The bill requires that the SEC register credit rating agencies that meet a new definition and oversee them through inspections, examinations and enforcement.

Among the items that would be listed on an SEC registration are conflicts of interest, procedures and methodologies used in determining credit ratings, credit ratings performance measurement statistics and procedures for protecting non-public information. Sound familiar?

On September 29, President Bush signed the Credit Rating Agency Reform Act into law. Through its technical committees like CCF, FEI continues to be an influential advocate for financial executives.