Moody's, S&P Face Closer Scrutiny on Structured Bonds
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Moody's, S&P Face Closer Scrutiny on Structured Bonds (Update2)
By John Glover and Neil Unmack
May 28 (Bloomberg) -- Moody's Investors Service and Standard & Poor's, reeling from criticism over the way they rated asset- backed debt, face tougher global regulation to prevent a repeat of the U.S. subprime mortgage crisis.
The International Organization of Securities Commissions, the forum for more than 100 regulators, said ratings firms will be banned from recommending how products are structured to help prevent conflicts of interest, and called for independent reviews of the way rankings are assigned. The companies should create new ratings to differentiate structured bonds from corporate securities, Madrid-based IOSCO said today.
U.S. Securities and Exchange Commission Chairman Christopher Cox and European regulators have rebuked Moody's, S&P and Fitch Ratings, all based in New York, for giving top rankings to mortgage securities that contributed to $383 billion of writedowns and losses triggered by the subprime slump. The 27- nation European Union also may consider requiring rating companies to register with authorities, French Finance Minister Christine Lagarde said today. New SEC rules are scheduled to be published June 11, Cox said.
``They will be sturdy rules based on the lessons learned in the subprime experience,'' Cox said in an interview at IOSCO's annual meeting in Paris.
Moody's Corp., parent of the ratings company, rose $1.43, or 4.1 percent, to $36.30 at 3:02 p.m. in New York Stock Exchange composite trading. S&P parent McGraw-Hill Cos. fell 21 cents to $39.64.
No Direct Role
As a forum, IOSCO has no direct regulatory role, working instead through its members, which include the SEC and the U.K.'s Financial Services Authority.
IOSCO first drafted a credit ratings code in 2004 in response to the ratings companies' failure to act before the bankruptcies of formerly investment-grade issuers such as Enron Corp.
The SEC's rules will require greater disclosure so that regulators can ``test the quality of the analysis,'' Cox said.
``We're going to prohibit the kinds of practices that were found to be particularly troublesome in the subprime crisis, so conflicts of interest will either be flat-out prohibited or subjected to procedures to minimize those conflicts,'' Cox said.
The SEC has been probing whether ratings companies were pressured to give top rankings to securities by issuers who paid for the ratings.
France's Lagarde plans to raise the idea of registering the ratings firms at a meeting of her counterparts in July, she said in a speech to the IOSCO conference today.
``It will facilitate a monitoring mechanism,'' Lagarde said of registration, which she said would also match the situation in the U.S. and some other countries.
Under the new code, ratings companies will be required to ``differentiate ratings of structured finance products from other ratings, preferably through different rating symbols,'' IOSCO said in the statement on the new code.
Moody's and S&P are reviewing the IOSCO's code and examining ways to implement it, spokespeople for the companies said.
Fitch will shortly issue a consultation paper seeking comment on ``potential additional and complementary rating scales for structured finance securities,'' Fitch Ratings President Stephen W. Joynt said in an e-mailed statement.
Regulators have trailed behind some investor opinions on structured finance for the past year. Bill Gross, manager of the world's biggest bond fund, said 11 months ago that ratings companies were duped into giving top credit ratings on some structured transactions and warned bondholders could lose all their money.
``AAA? You were wooed Mr. Moody's and Mr. Poor's by the makeup, those six-inch hooker heels and a `tramp stamp,''' said Gross, chief investment officer at Pacific Investment Management Co. Gross manages the $128 billion flagship PIMCO Total Return Fund in Newport Beach, California.
Moody's and Fitch said earlier this year they received little interest from investors in a new ratings scale.
Moody's in February asked investors for comments on five options it was considering to improve ratings, including substituting the letter grades created by founder John Moody about a century ago with a designation of ``.sf'' to set apart a structured finance ranking from a corporate credit rating.
Market participants who responded, including investors together holding more than $9 trillion in fixed income securities, ``overwhelmingly'' rejected the idea of a separate rating scale for asset-backed securities, Moody's said May 14.
`Still a Pig'
Calling the rating something new won't really help because ``it's like painting a different face on the pig,'' said Lawrence White, professor of economics at New York University's Stern School of Business. ``It's still a pig.''
Regulators worldwide traditionally define risk by credit scores on investments owned by insurance companies and banks. Pension funds as well are often restricted to holding investment- grade securities, or those rated BBB- or higher at S&P and Fitch and Baa3 at Moody's.