Vol. III - Penn State Abington

transactions have become increasingly complicated and diversified. So it may be unrealistic to
disclose all the details of CRAs’ rating procedures, but there is one thing that can be done: the
underlying data supplied to CRAs from the issuers or arrangers should be regulated and exposed
to the public, so any CRA can examine the accuracy of its competitors’ reports. And, obviously,
the SEC has been aware of this option (U.S. Securities and Exchange Commission, 2008:13).
2) The Pay Model
Some have argued that the issuer pay model has to be altered to an investor pay model in
order to solve the conflicts of interest problem (Strier, 2008:533-553). However, the investor pay
model will bring in another problem—a “free ride”. In fact this is one of the reasons the big three
moved gradually to depending on issuers rather than investors in the 1970s. This creates the
danger that information bought by some investors may be spread to others who don’t subscribe
to the CRAs’ service (Richardson, 2009). That would make it difficult for CRAs to make enough
profits to sustain their high-quality staff, which would harm the initiative and capacity of CRAs.
If a shift from an issuers pay model to an investor pay model will induce another problem
in the course of trying to solve a problem, it would not be an optimal solution.
3) Reducing regulators’ reliance on CRAs
According to the SEC report, privilege extended to the securities which are rated highly
by NRSROs should be reduced (Gullo, 2009). In this way, investors will depend more on their
own assessments rather than NRSROs’ ratings.
Although this is the right direction to reform the NRSRO mechanism, it has to be noticed
that it is almost impossible to eliminate all these requirements from all the systems, because they
involve too many regulations and rules. And, in fact, in some regulations, their guidelines are
necessary to regulate the financial market. It would be costly for regulators to keep watching the
market respectively to make these guidelines.
So, the key point here is not to remove all these regulations and rules from all systems,
but that the regulation of the NRSRO needs to match the power they gain from these rules.
4) Facilitating New Entrants
Another way to offset the negative effect of conflicts of interest is to increase competition
in the credit rating market, especially among NRSRO. In the reform act of 2006, the SEC defines
the conditions of registration for NRSRO, including participating in the credit rating business for
at least three years, and the wide recognition of its ratings by financial institutions, issuers,
insurance companies (Credit Rating Agency Reform Act, 2006). After this act was put in
practice, ten CRAs were accepted as NRSROs by the end of 2008 (Hunt, 2008). In this way, the
monopoly status of the big three can be gradually weakened.
In addition to clarifying NRSRO conditions, the SEC can examine the qualification for
all NRSRO based on a set of criteria after a period of time. Most importantly, the SEC can
establish a record center for historical ratings of all NRSRO. In this way, NRSRO will be forced
to act more cautiously because being classed as an “NRSRO” provides privilege in the credit
rating market and can bring great benefit to a business.
THE DIALECTICS ▲ 2009
www.abington.psu.edu/dialectics
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