Hybrid Hearing - A Notch Above? Examining the Bond Rating Industry (EventID=114740)

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Connect with the House Financial Services Committee Get the latest news: https://democrats-financialservices.house.gov/ Follow us on Facebook: https://www.facebook.com/HouseFinanci... Follow us on Twitter: https://twitter.com/FSCDems ___________________________________ On Wednesday, May 11, 2022, at 10:00 a.m. (ET) Subcommittee on Investor Protection, Entrepreneurship and Capital Markets Chair Sherman and Ranking Member Huizenga will host a hybrid hearing entitled, “Hybrid Hearing - A Notch Above? Examining the Bond Rating Industry." ___________________________________ Witnesses for this one-panel hearing will be: • Yann Le Pallec, Executive Managing Director, Head of Global Ratings Services, S&P Global Ratings • Angela Liang, General Counsel and Executive Committee Member, Kroll Bond Rating Agency • Ian Linnell, President, Fitch Ratings • Mariana Gomez-Vock, Senior Vice President of Policy and Legal, American Council of Life Insurers • Jennifer J. Schulp, Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives, Cato Institute ___________________________________ Overview Bond or credit rating agencies are Securities and Exchange Commission (SEC) registered and regulated entities that assign creditworthiness ratings to public and private institutions and the individual debt instruments these institutions issue. Market participants, including retail and institutional investors, commonly use credit ratings to determine whether to invest in bonds and other debt instruments. The three largest Nationally Recognized Statistical Ratings Organizations (NRSROs)— S&P, Moody’s, and Fitch—collectively provided 95% of all available ratings outstanding as of December 31, 20201 and employ an “issuer pays” model wherein the rating agencies are compensated by the issuers of the securities that they rate. This model has been criticized as a source of significant conflicts of interest that may contribute to biased ratings because rating agencies have an incentive to provide issuers with favorable ratings to ensure they remain customers. Such perceived and actual conflicts contributed to the 2008 financial crisis. Congress has also enacted legislation to address some of these conflicts and increase the number of rating agencies by expanding NRSRO eligibility. Overseen by the SEC’s Office of Credit Ratings, NRSROs are statutorily subject to, among other things: (1) various reporting and examination requirements; (2) required disclosure of their ratings methodology; (3) requirements that their analysts pass qualifying examinations; (4) potential deregistration by the SEC; and, (5) prohibitions on engaging in certain unfair, coercive, or abusive practices to the extent they are practiced with an anticompetitive effect. NRSROs are also subject to rules on managing certain conflicts of interest and rules that provide outright prohibitions on other conflict of interest scenarios. The S&P Proposal In December 2021, S&P published a request for comment regarding its proposed methodology for analyzing the risk-based capital (RBC) adequacy of insurers and reinsurers (“S&P Proposal”), including a controversial proposal for how it would use the ratings from other NRSROs of securities owned by insurers and reinsurers. In general, when providing ratings for insurance companies, S&P analyzes the credit risk (i.e., risk of default) by reviewing the individual risks of the assets owned by the insurer, including bonds, loans, credit derivatives, mortgages, and counterparty credit exposure relating to reinsurance contracts, deposits, and over-the-counter derivative contracts. When an NRSRO is contracted to perform an analysis of a pool of securities or, for example an insurance or reinsurance company, it may incorporate the ratings other NRSROs assigned to the underlying assets into its own analysis of the pool’s risk profile. Notching is a practice in which an NRSRO marks up or down those individual credit ratings by other bond rating agencies. SEC Rule 17g-6(a)(4) generally prohibits notching when it is engaged in for an anticompetitive purpose. The rule reads: “A [NRSRO] is prohibited from engaging in any of the following unfair, coercive, or abusive practices... Issuing or threatening to issue a lower credit rating, lowering or threatening to lower an existing credit rating, refusing to issue a credit rating, or withdrawing or threatening to withdraw a credit rating, with respect to securities or money market instruments issued by an asset pool or as part of any asset-backed securities transaction, unless all or a portion of the assets within such pool or part of such transaction also are rated by the nationally recognized statistical rating organization, where such practice is engaged in by the nationally recognized statistical rating organization for an anticompetitive purpose.” Hearing page: https://democrats-financialservices.house.gov/events/eventsingle.aspx?EventID=409376