Sunday, November 15, 2009

We're not talking FICO here

More like Fido, as in, who let the dogs out?

But we are talking about credit ratings.


Indeed, ever since the credit bubble burst, one of commonly identified central characters in the boom and subsequent bust was the credit ratings agencies. You see, the whole sham held together on the nudge, nudge, wink, wink of credit ratings. From subprime syndications to CPDOs, it all worked only because of the credit rating grease from the complicit ratings agencies.

And so now, ever so quietly -- and why is that? -- a global movement is afoot to kick someone's ass, but whose and how hard?

In Australia, it is reported,
Ratings agencies like Moody's and Standard & Poor's will not appreciate the move by the Australian Securities and Investments Commission, to clip their wings. But in a perverse way the move may be their ultimate salvation.

The reason this should work for agencies is because they cannot continue to provide advice if they have no credibility. Issuers might seek it but investors will ignore it.

Without credibility, the ratings provided by the agencies are useless, and the issuers of securities would be wasting their money to pay to have them rated. Thus this raising of the bar for the ratings agencies may be their ultimate salvation.

Starting from a position of minimal regulation, the new regime may seem onerous, but the detail is so reasonable that one is tempted to ask why it was not implemented years ago and how has it been avoided.

In terms of the wholesale market, the ratings agencies are being asked to do no more than what one would expect. First they will have to comply with the recently adopted international code of conduct introduced by the International Organisation of Securities Commissions, or explain ''if not, why not''.

They will then need to disclose procedures, methodologies and assumptions for ratings. Yet again this would be a pretty reasonable expectation on the part of investors. Issuing credit ratings without previously explaining how they arrived at those ratings is absurd.

review ratings affected by material changes to ratings methodologies have to be announced within six months of the change.

Another requirement will be trained credit analysts who have been externally assessed as adequate. Again, it is hard to see how this was not already occurring.

The second leg to the new regulatory regime tackles what has been anti-competitive behaviour by the two credit rating agencies using what the industry calls notching.

If another ratings agency moved in, the big two threatened to issue a lower credit rating, thereby squeezing the new entrant out of the market.

As for better protection for retail investors, the ASIC move is simple. The ratings agencies have to abide by the same rules as everyone else who provides investment advice and will need to hold an Australian Financial Services Licence. They will be required to do no more than a normal stockbroker needs to do when issuing investment advice.

The new rules are not difficult or suffocating.

Guambat hadn't heard before about this International Organisation of Securities Commissions. A UN of SECs? Amazing.

To learn more about this subject, Guambat turned to the international center of world finance, Malaysia. The Star had this report:
Lessons from global crisis

The International Organisation of Securities Commissions (Iosco) has issued many statements and reports since the subprime troubles erupted in late 2007, but if you twist his arm, secretary-general Greg Tanzer will single out a thing or two that the Madrid-based body has learnt from the crisis.

“I guess it would be that systemic risks can emerge from unlikely sources, and from Iosco’s perspective, that we, as a grouping of market regulators, need to consider how we can contribute in mitigating such risks, particularly because the markets are sort of the transmission mechanism for these risks,” he told StarBizWeek.

“So there’s a key need for us to consider more deeply what tangible steps we can take to try and identify risks that are emerging in the markets and consider what we should do as a group to mitigate them.”

Wow, Guambat was impressed. Here's this genius from the International SEC telling us that "markets are sort of the transmission mechanism for these risk." Truly earth shattering insight. So he read on:
Indeed, the vulnerability of financial systems are uppermost in the minds of those overseeing the capital markets. In a recent forum hosted by the Securities Commission (SC), chairman Tan Sri Zarinah Anwar mentioned systemic risk, systemic stability and systemic regulation 11 times in her keynote address.

Fancy that!! Eleven times!!! More please:
Tanzer, who was in town to attend the forum, agrees. “You shouldn’t have a meeting for the sake of having a meeting. Who wants to do that?

He adds, "So we shouldn’t underestimate the mechanisms in trying to be both predictive and pre-emptive, and also in developing the linkages that you need for reacting to a crisis when it arises.”
Guambat was about to get board:
On an international level, a central player in improving coordination among the market regulators is the Financial Stability Board (FSB). The board was formed in April this year after the Leaders of the G20 had called for a larger membership of the Financial Stability Forum, which had brought together central banks, international groupings of regulators and supervisors, and international financial institutions.

The FSB was established to “address vulnerabilities and to develop and implement strong regulatory, supervisory and other policies in the interest of financial stability”.
Guambat was so pleased the international financial institutions where there to lead a guiding hand.
Tanzer says it has sharpened their focus on pinpointing the main risks that are likely to figure the securities markets.

A number of these, he adds, are in unregulated or under-regulated segments of the markets. This is why the regulators are paying more attention to topics such as securitised and structured finance products, the OTC (over-the-counter) markets and unregulated entities, particularly hedge funds.

“On top of that, we’ve been looking at particular types of market conduct that fall within our remit and where the crisis has thrown up potential problems. A good example is short-selling,” he says.

YES!! Short-selling the devil's playground. The bane of international financial institutions, but of course, no empirical evidence has been adduced to prove it actually had anything at all to do with the fundamental credit crap that brought down the system. But maybe they're on to something with this wild hypothesis:
The regulators are also studying areas where the markets may be subject to either overt or unknowing manipulation or events that may lead to potential problems. For instance, there is concern that the oil futures market may be used to manipulate the commodity’s spot prices.

Surely too fantastic for imagination. Guambat is feeling like paydirt is near at hand. And so it is:
Another important regulatory aspect influenced by the crisis is the implementation of existing standards.

“Having set the international frameworks for the regulation of credit rating agencies, hedge funds, short-selling and so on, now we are doing work to assess the extent to which national regulatory regimes, which are picking up those recommendations, are dealing with potential gaps or weaknesses,” Tanzer explains.

“For example, with the implementation of the regulation of credit rating agencies in the European Union, Japan, Australia, Canada and the United States, how does that line up with the agreed framework in the Iosco code? Where’s the difference and does the difference matter?”

He offers his Golden Rule for investors: “If you don’t understand how a product works for you, that’s not your fault.

“If it’s too complex or vague, there’s a chance that it’s either a scam or that it doesn’t work, because the complexity may be to cover it up.”

With that sort of specialized knowledge and insight, Guambat is going to slumber comfortably in his burrow this eve, resting assured that the global attention to credit ratings agencies will actually give us some hard prophylactic regulation.

Until the nightmares start all over again, like a Steven King novel.

UPDATE 1-Credit raters face more liability in US Senate bill

As US's Frank Finishes Off Reg Reform, Sen. Dodd Set To Begin

The Senate's Disappointing Rating Agency Reform Proposal

How Credit Raters Fended Off Oversight From Congress And The SEC

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