Credit Ratings Regulation

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Dodd-Frank Timeline, Removal of Certain References to Credit Ratings Under the Securities Exchange Act
Comment Deadline Final Rule Issue Effective Date
March 28, 2011 August 3, 2011 September 2, 2011
Dodd-Frank Timeline, Removal of Credit Ratings References Under Securities Exchange Act of 1934, SEC
Proposal Date Comment Deadline Final Rule Issue
May 6, 2011 July 5, 2011 December 27, 2013
Timeline, References to Credit Ratings in Money Market Fund Rules, SEC
Proposal Date Re-proposed Rule Comment Deadline
March 9, 2011 July 24, 2014 60 Days After Federal Register
Dodd-Frank Timeline, NRSROs, SEC
Proposal Date Final Rule Issue Effective Date
June 8, 2011 September 15, 2014 November 14, 2014
Dodd-Frank Timeline-Removing References to Credit from Commission Regulations
Proposal Date Final Rule Issue Effective/Compliance Date
November 2, 2010 July 25, 2011 September 23, 2011

Subsequent to the financial crisis of 2008, credit ratings agencies such as Standard & Poor's, Moody's and Fitch came under fire for having assigned top ratings to securities backed by subprime debt obligations. The debate centered on the ratings agencies' compensation models as creating an inherent conflict of interest.[1]

Among the mandates of the Dodd-Frank Wall Street Reform and Consumer Protection Act is the removal of references to or reliance upon credit ratings in U.S. regulations. The Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC) and other prudential regulators have proposed and finalized various rulemakings pertaining to credit ratings.

The rules are designed to remove the nationally recognized statistical rating organization (NRSRO) condition for investment grade securities, and create new tests for offerings of non-convertible securities, such as debt securities. The various rulemakings are designed to set credit standards that rely on criteria other than ratings issued by NRSROs.

The CFTC published its final credit ratings rules in July 2011.

The SEC has finalized several Dodd-Frank related rulemaking regarding credit ratings. In July 2011, the commission finalized rules replacing NRSRO ratings on securities with four short-form eligibility tests. In November 2012 it published final rules on business and industrial development companies (‘‘BIDCOs’’). The commission's other credit ratings rules were finalized in one package on August 27, 2014.

Also, in September 2015, the SEC finalized a rule that removed credit rating references in its rules governing money market funds and the form that money market funds use to report information to the Commission each month about their portfolio holdings. Previously, the rule required a money market fund to invest at least 97 percent of its assets in securities that have received the highest short-term credit rating. The new rules require money market funds to assess certain prescribed factors in determining the credit risks associated with a security. The compliance date for the rule is October 14, 2016.[2]


CFTC Final Rule

At its July 19, 2011 open meeting, the CFTC approved its final rules regarding the removal of any reference to or reliance on credit ratings in Commission regulations. The two rules are:

  • Final Rule 1.49, General Regulations Under the Commodity Exchange Act – Denomination of Customer Funds and Location of Depositories, Qualifications for Depositories, and
  • Final Rule 4.24, Commodity Pool Operators and Commodity Trading Advisors – General Disclosures Required; Investment Program and Use of Proceeds

The final rules also remove references to credit ratings in Rule 1.25 (Investment of Customer Funds), Rule 30.7 (Treatment of Foreign Futures or Foreign Options Secured Amount), and Appendix A to Part 40 (Application for Designation of Physical Delivery Futures Contracts and Application for Cash Settled Futures Contracts).[3]

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SEC Final Rules: Nationally Recognized Statistical Rating Organizations

On July 26, 2011, the Securities and Exchange Commission (SEC) finalized rules regarding the removal of references to credit ratings from the Securities Exchange Act of 1933. According to the rule, credit ratings criteria will be replaced by four short-form eligibility tests. The SEC also passed a three-year grandfather provision to assist companies with this transition.[4]

Summary points:

  • "The new rules remove the condition for an NRSRO investment grade rating that is included in current short forms, Form S-3 and Form F-3, which are used by eligible issuers to register offerings of non-convertible securities under the Securities Act."
  • Companies can be tested for issuer eligibility through four new short-form tests.
  • "The final rules also rescind Form F-9, which is the form certain Canadian registrants use to register non-convertible investment grade debt."
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SEC Final Rule: Security Ratings

On July 26, 2011, the Securities and Exchange Commission (SEC) finalized rules regarding the removal of references to credit ratings from the Securities Exchange Act of 1933. According to the rule, credit ratings criteria will be replaced by four short-form eligibility tests. The SEC also passed a three-year grandfather provision to assist companies with this transition.[5]

Summary points:

  • "The new rules remove the condition for an NRSRO investment grade rating that is included in current short forms, Form S-3 and Form F-3, which are used by eligible issuers to register offerings of non-convertible securities under the Securities Act."
  • Companies can be tested for issuer eligibility through four new short-form tests.
  • "The final rules also rescind Form F-9, which is the form certain Canadian registrants use to register non-convertible investment grade debt."
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Background: On February 9, 2011, the Securities and Exchange Commission introduced its first proposed rulemaking concerning the removal of credit ratings as an eligibility standard for companies using short-form registration when registering securities for public sale.[6] The final rule mirrors the proposal.

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SEC Final Rule: Purchase of Certain Debt Securities by Business and Industrial Development Companies Relying on an Investment Company Act Exemption

Business and industrial development companies (‘‘BIDCOs’’) are companies that operate under state statutes that provide direct investment and loan financing, as well as managerial assistance, to state and local enterprises. Because they invest in securities, BIDCOs frequently meet the definition of ‘‘investment company’’ under the Investment Company Act. Certain BIDCOs had been prohibited from investing in securities issued by investment companies and private funds other than debt securities that are rated investment grade by at least one NRSRO and securities issued by registered open-end investment companies that invest at least 65 percent of their assets in investment grade securities or securities that the fund determines are comparable in quality.

Since Section 939 of the Dodd-Frank Act removes a reference to credit ratings from the Investment Company Act and replaces it with a reference to ‘‘such standards of credit-worthiness as the Commission shall adopt,’’ new language was required in the statute covering BIDCOs.

On November 26, 2012, the SEC published a final rule on the purchase of securities by BIDCOs, which requires such securities to be, at the time of purchase, of moderate credit risk, and to be sufficiently liquid.

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SEC Proposed Rules

Removal of Certain References to Credit Ratings Under the Securities Exchange Act of 1934 Regulation Z; Truth in Lending; Proposed Rule
On April 27, 2011, the Securities and Exchange Commission introduced another proposal in a series of proposals to remove references to credit ratings from certain Exchange Act rules.[7]

Under the proposed rules, references to credit ratings would be deleted and replaced by standards of creditworthiness. Proprietary positions held within broker-dealers would be subject to haircuts. Alternate computations shall be conducted to determine net capital reserve requirements. A link to a copy of the proposed rule and detailed summary can be found below.

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References to Credit Ratings in Certain Investment Company Act Rules and Forms
On March 2, 2011, the Securities and Exchange Commission proposed rule amendments to remove references to credit ratings from certain Investment Company Act rules and forms.[8]

The current rule sets out a two-tier rating system to determine a security's eligibility to be included in a money market fund, depending on the credit quality of the securities in a money market fund. A copy of the rule and detailed summary, including the definitions of the two security tiers, can be found by clicking the link below.

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Prudential Regulators Proposed Rules

Risk-Based Capital Guidelines: Market Risk; Alternatives to Credit Ratings for Debt and Securitization Positions
On December 21, 2011, the Office of the Comptroller of the Currency (OCC), Department of the Treasury; Board of Governors of the Federal Reserve System ("Fed"); and Federal Deposit Insurance Corporation (FDIC) jointly issued a proposed rule incorporate into the proposed market risk capital rules certain alternative methodologies for calculating specific risk capital requirements for debt and securitization positions that do not rely on credit ratings. This is an amended proposal to a proposal issued in January 2011. The amended proposal includes "alternative standards of creditworthiness to be used in place of credit ratings to determine the capital requirements for certain debt and securitization positions covered by the market risk capital rules."[9]

The proposed standards for creditworthiness are based partially on risk classifications published by the Organization for Economic Cooperation and Development (OECD) and the Basel Committee on Banking Supervision. The regulators believe the implementation of these standards will be consistent with those of the Basel Committee.

Public comments will be accepted until February 3, 2012. Comments may be submitted HERE.

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Note: On August 30, 2012, the Prudential Regulators implemented the final rule on the market risk section of this proposed rule. The credit ratings portion will be addressed in a subsequent rulemaking.

References

  1. Credit rating execs to face congressional heat. Reuters. Retrieved on November 22, 2011.
  2. SEC Removes References to Credit Ratings in Money Market Fund Rule and Form. SEC. Retrieved on October 7, 2015.
  3. Open Meeting on Three Final Rule Proposals and Two Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on July 19, 2011.
  4. SEC Adopts New Short Form Criteria to Replace Credit Ratings. SEC. Retrieved on July 26, 2011.
  5. SEC Adopts New Short Form Criteria to Replace Credit Ratings. SEC. Retrieved on July 26, 2011.
  6. SEC Proposes First in Series of Rule Amendments to Remove References to Credit Ratings. SEC. Retrieved on February 9, 2011.
  7. SEC Proposes Rule Amendments to Remove Credit Rating References in Exchange Act Rules. SEC. Retrieved on April 27, 2011.
  8. SEC Proposes Rule Amendments to Remove Credit Rating References in Investment Company Act Rules and Forms. SEC. Retrieved on March 2, 2011.
  9. Agencies Seek Comment on Additional Revisions to the Market Risk Capital Rules. Board of Governors of the Federal Reserve System. Retrieved on December 22, 2011.

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