The struggle over rating-dependent regulation — often discussed in the academic literature — has been largely eclipsed in the discussion of the financial-regulation bill. But it’s been quite a tussle. The House GOP wanted to eliminate all federal regulatory dependence on ratings in three months. The Frank bill that actually passed the House would have eliminated rating-dependent regulation at certain agencies in a year and ordered the rest of the agencies to study the issue. Then we had the Dodd bill that had only a study, and the Cantwell/LeMieux amendment, which added repeal of certain statutory (but not regulatory) references.
Now we have the conference report, which seems to follow the House model and requires elimination of rating-dependent regulation within one year of enactment – see Sec. 939A of the conference report.
Most people these days seem to favor getting credit ratings out of the regulatory system. Your humble blogger has been a bit of a dissenter here, although a diffident one. It certainly makes sense to think about reducing reliance n ratings, but regulators who’ve done so since the beginning of the crisis, such as the SEC and the NAIC, seem to be backing away from the idea.
Maybe the idea is that there has been a failure of bureaucratic will here, so that what we need is to order namby-pamby regulators to do their own regulating. But completely eliminating the use of ratings throughout the federal system seems precipitous, especially given that (a) federal reliance on ratings has never to my knowledge been surveyed and critically assessed; and (b) as far as I know, no viable alternative to credit ratings exists. The legislation instructs regulatory agencies to “substitute such standard of credit-worthiness as each agency shall deem appropriate for such regulations.” Unless a lot of thinking about this has been going on behind the scenes, the order to completely replace credit ratings within a year seem a bit rash.
An interesting wrinkle: The requirement to abandon rating-dependent regulation apparently applies only to regulations that “require[] the use of an assessment of credit-worthiness of a security or money market instrument.” Although one would think that that’s where credit ratings find their way into regulations, I’m not sure that that’s true. For example, in the SEC’s net capital rule, credit ratings seem to be used as a proxy for liquidity rather than credit quality. And the “underwriter’s exemptions” under ERISA, which are an important use of ratings in the context of structured products, the high credit rating is used to satisfy conflict-of-interest standards.
Would such uses come under the requirement to eliminate rating-dependent regulation? It would be odd if these rating-dependent regulations escaped the statute precisely because they do not use ratings for their intended purpose.
