Will Ratings Agency Reform Produce More Insider Trading?

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The SEC’s push to improve how credit ratings agencies work may have an unintended consequence: more insider trading.

Last week, the Commission announced a series of proposals to strengthen the tarnished system.

Among the SEC’s targets: The pay-to-play model, which is (incorrectly) assumed to be the root problem.

But, as Floyd Norris of The New York Times explains, regulators are unwilling to do away with the old system, in part because that would leave investors without access to ratings unless they paid for them. So the SEC’s solution is to encourage other rating agencies to grade the products.

Hence this proposal that all rators have access to the same information:

SEC: The amendment would require an [Nationally recognised Statistical Rating organisation] – that is paid by an arranger to rate a structured finance product – to disclose to other NRSROs that it is in the process of determining such a credit rating. The amendment would also require that the NRSRO obtain a representation from the arranger that the arranger will provide the same information to other NRSROs seeking to rate the product.

An NRSRO that wants to access information provided by an arranger would only be allowed to access that information for the purpose of determining a credit rating and only if it rates a certain percentage of products. The competing NRSRO would have to file a certification to this effect annually with the SEC.

Additionally, the Commission voted to adopt an amendment that would revise Regulation FD (Fair Disclosure) to enable issuers to allow NRSROs to access the information so the NRSROs can determine the credit rating – even if the NRSROs do not make their credit ratings publicly available for free.

That could mean more insider trading.

NYT: The result will be that analysts for the other rating agencies, like Egan-Jones Ratings, will have access to information not available to the general public, and their analysis will go only to clients. Those clients will have the benefit of nonpublic information, or at least of their agent’s analysis of what it means.

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