The Obama administration is pressing ahead with proposed tough reforms for credit rating agencies, starting with potential conflicts of interest.

Treasury Department officials delivered proposed legislation to Capitol Hill that would bar credit rating firms from consulting with any company they rate. Agency accountants would not be permitted to provide financial services to the rated companies, for instance.

In an effort to put a halt to the practice of shopping for favorable ratings, issuers would be required to disclose preliminary ratings received from other agencies. This would give investors a more transparent picture of how the eventual rating compared with earlier scores.

Business relationships that pose a potential conflict would have to be disclosed, and the agencies would be required to appoint a compliance officer who reports to the board or head of the company.  The government wants the compliance officers to file annual reports with the Securities and Exchange Commission (SEC).

Some commercial real estate investors and analysts have blamed rating agencies for not providing a more accurate assessment of risks associated with commercial mortgage-backed securities (CMBS) and other investments. The CMBS market has virtually dried up since late 2007, eliminating an important source of credit for commercial real estate transactions.

A key provision of the government’s current reform package is that rating agencies would need to present a more complete picture of the risks associated with a rated security. According to the Treasury Department, investors did not fully realize that risks presented by structured products such as asset-backed securities are fundamentally different from those posed by corporate bonds, including those with similar ratings.

Under the reforms, the rating agencies would use different symbols for structured finance products to show different risks.

Fitch supports ‘thoughtful review’

The rating agencies are examining the proposals sent to Congress on Tuesday, but at least one, New York-based Fitch Ratings, cautiously welcomed the reforms.

"The Administration's proposals are generally consistent with Fitch’s views on the importance of providing the markets with greater transparency into the ratings process and managing more effectively any conflicts of interest,” said Fitch CEO and president Steve Joynt in a statement.

Fitch has frequently noted the benefits to the market of a globally
consistent approach to regulating the agencies, Joynt added.  “Fitch
supports a thoughtful review of ways to encourage the market to use ratings in a balanced and constructive manner."

Standard & Poor’s, also based in New York, is taking a look at the proposals. “We’re studying the document from the Treasury and the administration,” says spokesman Ed Sweeney. “We’re committed to restoring confidence in the ratings process and the credit markets.”

The reforms would give the SEC greater authority in supervising the rating agencies.  An office would be set up within the SEC to carry out the new regulations, Treasury officials said.

The Commercial Mortgage Securities Association (CMSA), based in New York, supports aspects of the plan, while opposing other provisions. “We certainly advocate some checks and balances for the rating agencies so they can avoid conflicts of interest, and we’ve always supported the need for additional transparency in the ratings,” says spokesman Ken Reed.

However, CMSA objects to using a different system for rating mortgage-backed securities versus other financial products.

 “We do strongly oppose the ratings differentiation described in some of the recent Treasury provisions,” Reed says. The organization feels it causes confusion in implementing the different measures for ratings.  

“We feel it reopens a previously settled debate, a debate we feel will delay and exacerbate the market’s current recovery effort,” says Reed.

CMSA supports transparency, but feels that insights on credit risks can be better served through more disclosures rather than a separate ratings scheme, he explains.

The reforms would include mandatory registration of credit rating agencies, rather than the voluntary system now in place.