Securities Regulation Daily Wrap Up, CREDIT RATING AGENCIES—SEC issues annual staff report on registered credit rating agencies, (Jan 31, 2022)

By Lene Powell, J.D.

An annual report of SEC-registered credit rating agencies found that competition is strong among NRSROs and conflicts of interest have slightly increased over the last five years.

The SEC's Office of Credit Ratings (OCR) published its annual staff report providing a summary of the SEC staff’s examinations of NRSROs and discussing the state of competition, transparency, and conflicts of interest among NRSROs. The report covers calendar year 2021.

"OCR's examinations protect investors by scrutinizing NRSRO compliance with applicable laws and rules and identifying instances of non-compliance," said OCR Director Ahmed Abonamah. "The report provides a comprehensive and integrated overview of OCR's activities, demonstrating the exceptional work of my colleagues in their efforts to protect investors."

About NRSROs. A nationally recognized statistical rating organization (NRSRO) is a credit rating agency registered under Exchange Act Section 15E and issues credit ratings certified by qualified institutional buyers. A credit rating agency that does not apply for registration as an NRSRO may issue credit ratings as a credit rating agency, but not as an NRSRO.

As of December 31, 2021, there were nine credit rating agencies registered as NRSROs:

• A.M. Best Rating Services, Inc. (AMB).

• DBRS, Inc. (DBRS).

• Egan-Jones Ratings Company (EJR).

• Fitch Ratings, Inc. (Fitch).

• HR Ratings de México, S.A. de C.V. (HR).

• Japan Credit Rating Agency, Ltd. (JCR).

• Kroll Bond Rating Agency, Inc. (KBRA).

• Moody’s Investors Service, Inc. (MIS).

• S&P Global Ratings (S&P).

Competition. The report found healthy competition among the NRSROs. Although the large NRSROs continue to account for the highest percentages of outstanding ratings, the small and medium NRSROs continue to compete with the large NRSROs, with each increasing its total number of ratings outstanding as compared to declines among two of the large NRSROs.

This trend also held with respect to revenue. With the exception of fiscal year 2020, the percentage of aggregate NRSRO revenue reported by the large NRSROs has gradually declined since 2017, while the percentage of total revenue reported by the medium and small NRSROs has correspondingly gradually increased.

However, barriers to entry do continue to exist in the credit ratings industry, which presents competitive challenges for small and medium NRSROs. One potential barrier is that the investment management contracts of some institutional fund managers as well as the investment guidelines of some fixed income mutual fund managers, pension plan sponsors, and endowment fund managers require the use of ratings of specified rating agencies. Also, some regulatory requirements can be burdensome for small NRSROs to implement.

Transparency. Under Exchange Act rules, NRSROs are required to disclose certain information, including about material changes and significant errors in the procedures and methodologies used to determine credit ratings. NRSROs must also disclose certain information in connection with each rating action.

NRSROs may also provide transparency about commentaries or research. For example, after COVID-19 emerged in early 2020, NRSROs began publishing commentaries and research that gave their perspectives on the potential credit and rating impacts of COVID-19 on issuers and debt obligations in different market sectors. They also began publishing COVID-19-related commentaries on economic and market trends. In addition, NRSROs have produced research in recent years regarding their views on ESG matters and how they incorporate ESG considerations in their credit rating actions.

Conflicts of interest. Most NRSROs mainly operate under the “issuer-pay” model, which is subject to a potential conflict in that the credit rating agency may be influenced to give higher ratings than warranted to retain the obligors or issuers as clients. Another business model is the “subscriber-pay” model, under which investors pay a subscription fee to access an NRSRO’s ratings. This model also poses potential conflicts of interest, as for example if an influential subscriber holds a securities position that could be advantaged if a credit rating upgrade or downgrade causes the market value of the security to change.

Conflicts of interest accounted for 11.5 percent of all essential findings from Section 15E examinations conducted from 2016 to 2021.

Commission orders and releases. The SEC issued the following orders and releases relating to NRSROs or credit ratings in general during the report period:

• SEC v. Morningstar Credit Ratings, LLC, No. 1:21-cv-1359 (S.D.N.Y. filed Feb. 16, 2021). The SEC filed a civil action alleging that former credit rating agency Morningstar Credit Ratings, LLC, violated disclosure and internal controls provisions of Section 15E and the rules promulgated thereunder in rating CMBS.

• In re DBRS, Inc., Exch. Act Rel. No. 92952 (Sept. 13, 2021) (settled action): DBRS’s policies and procedures were not reasonably designed to ensure that it rated CLO Combo Notes in accordance with the terms of those securities.

• Continuance of Exemption Pursuant to Order Granting Temporary Conditional Exemption for Japan Credit Rating Agency, Ltd. from Certain Requirements of Section 15E(t) of the Securities Exchange Act of 1934, Release No. 34-83884 (Aug. 17, 2018). A temporary, conditional exemption for from certain corporate governance requirements under Section 15E(t), granted August 17, 2018, automatically renewed until August 20, 2023.

RegulatoryActivity: CreditRatingAgencies ExchangesMarketRegulation