The Role of Credit Rating Agencies in Structured Finance Markets - Final Report

THE ROLE OF CREDIT RATING AGENCIES IN STRUCTURED FINANCE MARKETS FINAL REPORT TECHNICAL COMMITTEE OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS MAY 2008 BACKGROUND TO THE TASK FORCE WORK In 2003, the Technical Committee of the International Organization of Securities Commissions formed a task force of its members’ principal representatives to study issues related to the activities of credit rating agencies (CRAs). This Chairmen’s Task Force on Credit Rating Agencies (frequently referred to as the CRA Task Force) issued a report in September 2003 describing the role CRAs play in the global capital market and issues that CRAs currently face that may have an impact on the quality of the credit ratings they publish.1 At the same time that the Technical Committee published this report, it also published a set of principles that regulators, CRAs and other market participants might follow as a way to better guard the integrity of the rating process and help ensure that investors are provided with ratings that are timely and of high quality.2 The IOSCO CRA Principles are high-level and meant to be used by CRAs of all types and sizes, using all types of methodologies, and operating under a wide variety of legal and market environments. Shortly after the release of the IOSCO CRA Principles, several CRAs advised IOSCO’s Technical Committee that it would be helpful to them and other market participants, if the Technical Committee were to describe in more detail how the IOSCO CRA Principles might be applied in practice. Subsequently, the CRA Task Force drafted the Code of Conduct Fundamentals for Credit Rating Agencies (IOSCO CRA Code of Conduct)3 designed to serve as a model upon which CRAs could base their own codes of conduct as a way of implementing the IOSCO CRA Principles. Like the IOSCO CRA Principles, the IOSCO CRA Code of Conduct was designed for CRAs of all sizes and business models operating around the world. The IOSCO CRA Code of Conduct contains more than 50 different provisions that IOSCO’s Technical Committee believes should govern the activities of CRAs to help them guard against conflicts of interest, ensure that their rating methodologies are used consistently by their employees, provide investors with sufficient information that they can judge the quality of a CRA’s ratings, and generally help ensure the integrity of the rating process. In February 2007, the Technical Committee published as a consultation document a “Review of Implementation of the IOSCO Fundamentals of a Code of Conduct for Credit Rating Agencies,” which noted, among other things, that most major CRAs had adopted codes of conduct based on the IOSCO CRA Code of Conduct, but that implementation varied among smaller CRAs.4 The Implementation Report concluded that for the most part, the IOSCO CRA Code of Conduct was accomplishing its stated objectives, but IOSCO should do more to publicize the IOSCO CRA Code of Conduct and that some aspects of the IOSCO CRA Code of Conduct could be improved through clarification. Comments IOSCO received from 1 Report on the Activities of Credit Rating Agencies (IOSCO Technical Committee, September 2003, accessible via the Internet at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD153.pdf) (CRA Report). 2 IOSCO Statement of Principles Regarding the Activities of Credit Rating Agencies (IOSCO Technical Committee, September 2003, accessible via the Internet at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD151.pdf) (IOSCO CRA Principles). 3 Code of Conduct Fundamentals for Credit Rating Agencies (IOSCO Technical Committee, December 2004, accessible via the Internet at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD180.pdf). 4 Review of Implementation of the IOSCO Fundamentals of a Code of Conduct for Credit Rating Agencies (IOSCO Technical Committee, accessible via the Internet at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD233.pdf) (Implementation Report). CRAs, issuers, investor groups and other market participants generally supported the Technical Committee’s conclusions. In the first quarter of 2007, however, observations relating to the market for certain structured finance instruments, residential mortgage-backed securities (RMBSs) and collateralized debt obligations (CDOs) collateralized by or referencing RMBSs raised questions about the quality of CRA ratings and the independence of the CRAs rating RMBSs and CDOs. In particular, as the number of delinquencies on subprime mortgages in the United States suddenly increased