Rating Agencies Face New Standards; Cannot Recommend Deal Structure

Standard & Poor’s Ratings Services, Moody’s Investors Service, and Fitch Ratings will need to make some strong adjustments covering how their structured finance ratings businesses operate, according to new standards published by regulators today.

The new rules include provisions that will prohibit analysts from “making proposals or recommendations regarding the design of structured finance products” that the agency rates, according to a new code of conduct for credit rating agencies published Wednesday by the International Organization of Securities Commissions, an international conglomerate representing more than 100 securities regulators.

Among other rules in the code of conduct, rating agencies must also differentiate their ratings of structured financial products — such as residential mortgage-backed securities and CDOs — from other rated debt, a proposal that has been hotly-debated in the States and largely supported by internal proposals from both Moody’s and Fitch.

“IOSCO’s Code of Conduct aims to improve investor protection, improve the fairness,
efficiency and transparency of securities markets and to reduce systemic risk,” said Michel Prada, Chairman of IOSCO’s technical committee. “We have engaged in a frank and constructive dialogue with the CRA industry, issuers and investors and have taken a broad range of views into account in finalizing the changes to our code.”

IOSCO first proposed a code of conduct for rating agencies in December 2004, and although not binding on U.S. operations of each major rating agency, the organization has seen support for coordinating global financial regulations grow amidst the current financial crisis.

The guidance from international authorities comes ahead of expected support for the IOSCO code of conduct by U.S. Securities and Exchange Commission chairman Christopher Cox, who has said the SEC will likely roll out its own changes to rating agency regulations on June 11. HW’s key sources suggested Wednesday morning that much of the new regulation will be tied to IOSCO’s proposal, and that Cox will push for stronger international oversight of the debt ratings business as a result.

He’ll certainly have company, with IOSCO’s Prada — a key financial regulator in France — vocalizing his support for the idea to the Financial Times’ Gillian Tett on Wednesday.

Other key changes in the IOSCO proposal include provisions that would force rating agencies to better disclose their financial ties to issuers; one such provision would have agencies “disclose in their ratings announcements whether the issuer of a structured finance product has informed it that it is publicly disclosing all relevant information about the product being rates,” while another would force agencies to disclose if the issuer (or any other connected client) make up more than 10 percent of revenue.