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SEC Studies Rating Agency Selector Concept

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The U.S. Securities and Exchange Commission (SEC) is asking for comments about the idea of having a public utility, a private utility or a self-regulatory organization pick the agencies that rate structured finance products.

The SEC has issued the rating agency selector request for comments to implement Section 939F of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires the SEC to look into the current methods of paying for credit ratings.

Today, the large “natiobnally recognized statistical rating organizations” (NRSROs) typically charge issuers for ratings. Some NRSROs charge the users for the ratings.

The Dodd-Frank Act drafters included a variety of provisions designed to reduce SEC reliance on the NRSROs, in response to allegations that the NRSROs had done a poor job of rating the products and companies at the heart of the credit market meltdown that started in 2007.

Section 939F of the Dodd-Frank Act directs the SEC to study the conflicts that could arise in the current “issuer pay” structured product rating environment and in a “subscriber pay” environment.

The SEC uses the term “structured product” to include a variety of instruments that are often found in life insurer investment portfolios, such as residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, and asset-backed commercial paper.

The act requires the SEC to study the feasibility of having a utility or self-regulatory organization act as the rating agency selector for structured products, to reduce the likelihood that the identity of the party paying for the rating will affect the rating.

The SEC is supposed to come up with tools for measuring the accuracy of credit ratings for structured

finance products, develop proposals for rating agency compensation arrangements that could encourage rating agencies to be as accurate as possible, and tell Congress about its findings and recommendations by July 21, 2012.

The SEC already has posted the request for comments on its website. Comments will be due 120 days after the official Federal Register publication date.

In a list of questions for commenters, the SEC asks commenters to compare the conflicts that might arise in structured product rating efforts with the conflicts that might arise in efforts to rate other types of products and entities.

“Compare the potential conflicts in rating structured finance products with the potential conflicts in rating other classes of obligors, securities, or money market instruments, such as issuers that are financial institutions, non-financial corporations, insurance companies, and governments and municipalities,” officials say. “In this regard, does the concentration of underwriters and sponsors of structured finance products potentially make any conflicts more acute in this class of credit ratings? Does having a large number of clients reduce risk that a single client could unduly influence the NRSRO?”

The SEC also asks commenters to discuss mechanisms for determining rating agency fees.

“Would it be appropriate to set different fees on each type of structured finance product?” officials ask. “In addition, how would fees be determined for new product types? Furthermore, do the fees charged by NRSROs depend on their business models? If so, how would this impact the determination of what constitutes a reasonable fee?”

The SEC asks whether the different fees that rating agencies charge insurance companies and other issuers could be the basis for setting rating agency selector service fees.

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