House Subcommittee Talks Rating Agency Pay Models

As the House Financial Services Committee moves forward with its aggressive financial reform agenda, credit rating agency executives appeared before a subcommittee yesterday to discuss their companies' roles in the new financial environment.

Lawmakers pressed the companies about a variety of issues, ranging from pay models (subscriber-paid versus issuer-paid), to investors' due diligence shortcomings, to agency transparency.

Rep. Paul Kanjorski, D-Pa., and chair of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, has disseminated a draft discussion of legislation that seeks to overhaul the way these agencies do business. Kanjorski's draft borrows from Obama administration proposals and adds a contentious "accountability through liability" component that would effectively hold all Nationally Recognized Statistical Rating Organizations (NRSROs) accountable for the actions of any one NRSRO.

Standard & Poor's President Deven Sharma said agencies are already held accountable by investors and the Securities and Exchange Commission. James Gellert, testifying on behalf of the panel's only non-NRSRO, Rapid Ratings International, said the pooled liability provision in Kanjorski's draft would hinder the rate of new entrants in the market. For a prospective NRSRO to enter the market with full acknowledgment that it could be held liable for lawsuits against its competitors would be "like swimming toward the Titanic," Gellert said.

Kanjorski's draft, also borrowing a concept from the insurance industry, proposes that rating firms provide checks and balances on their competitors, allowing, for example, Standard & Poor's (S&P) to assess ratings from Moody's. Several lawmakers questioned the practicality and constitutionality of such a proposal, and Robert Dobilias, president and CEO of RealPoint LLC, said the approach may disincentivize companies from using proprietary rating methodologies.

Reducing the concentration of business and preventing agency shopping should be reform legislation's top goals, he said. Moody's, S&P and Fitch hold a combined market share of approximately 95%.

Several witnesses, including Fitch President and Chief Operating Officer Stephen Joynt, said they were in favor of increasing transparency on the data that agencies use to rate financial products. Moody's Chairman and CEO Raymond McDaniel and S&P President Deven Sharma, in response to a question from Rep. Sepencer Bachus, R-Ala., agreed that agency shopping is a problem that exists in the current marketplace.

The subcommittee dedicated much of the hearing to discussing the industry's two primary pay models. The issuer-pay model in use at the big three agencies presents inherent conflicts of interest, lawmakers said. Rep. Brad Sherman, D-Calif., used a baseball analogy, likening the practice to a home team picking the umpire.

Several witnesses suggested the subscriber-pay model used by some firms, on the other hand, restricts compensation.


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