Review of the US SEC Staff Report on Nationally Recognized Statistical Rating Organizations (January 2025)
Today’s focus is on the Staff Report released by the US Securities and Exchange Commission’s Office of Credit Ratings (OCR) which focuses on Nationally Recognized Statistical Rating Organizations (NRSROs). The SEC are mandated by Congress – via Section 6 of the Credit Rating Agency Reform Act of 2006 and Section 15E(p)(3)(C) of the Securities Exchange Act of 1934 – to collate information on the previous years’ worth of investigation into the NRSRO industry, as well as pertinent data on the shape of the industry. This piece reviews that report and presents the more important and relevant highlights. All aspects of this piece are derived from the Staff Report, unless otherwise stated.
Monitoring
The Report starts out with an overview of what the OCR suggests as key issues that they have been monitoring over the past year. Interestingly, the Report focuses on two areas of direct relevance to the NRSROs: the commercial real estate market, and private credit. On commercial real estate and CMBS ratings (Commercial mortgage-backed securities), the Report says that NRSROs had reported a deterioration in the sector and that subsequently the NRSROs had been conducting increased reviews, stress tests, and had issued downgrades. NRSROs appeared to agree that the sector outlook will remain unclear in the near future until rents and vacancies started to stabilise. On the issue of private credit, and its proliferation, the Report notes several concerns. One main issue was the variety of instruments that are backed by collateral that has originated in the private credit market, including private credit funds, business development companies, and collateralised loan obligations. The rise in the private credit market has led to responses from NRSROs, with specialised departments now existing and the rate of private credit ratings provided by NRSROs – not to be made public – increasing markedly.
Essential Findings and Responses to Material Regulatory Deficiencies
Apart from the useful statistics that the Report brings to the field every year (which will be reviewed next), one critical aspect of the Report is when the OCR reveal its findings regarding breaches of law and code by the NRSROs. For a variety of reasons, most of which are challenged, the SEC has maintained its approach of anonymising its findings so that we do not get to know which NRSRO has transgressed in particular. Instead, we are told whether a ‘large’, ‘medium’, or ‘small’ NRSRO has transgressed. Most transgressions are often concluded with a comment akin to: ‘the Staff recommended to the NRSRO that they take a particular action to prevent this from happening again’. However, what the Report does help with is revealing the culture within NRSROs and how they seek to resolve the issues (if at all).
The large NRSROs (either S&P Global, Moody’s, or Fitch) committed the following material breaches:
1. One large NRSRO did not enforce policies relating to conflicts of interest around securities ownership, resulting in ‘several instances’ where analysts continued to own securities that ought to have been divested and, in one instance, one of these analysts participated in a credit rating committee for an obligor in whom the analyst owned securities. The NRSRO responded that they had convened a new committee, suspended and then terminated the contract of the analyst, and reviewed policies and hiring rounds to see if there had been any further breaches of the same type. It went on to update analyst training as a result.
2. For the same NRSRO, a non-independent director did not preclear three securities transactions or subject their related brokerage accounts to monitoring by the NRSRO, in breach of internal policy. There is no additional information to reveal what happened in this instance.
3. Another large NRSRO’s independent directors used personal email accounts to conduct NRSRO business, including transmitting nonpublic information and potential material nonpublic information. The Staff recommended new controls, but no information is provided on what happened next.
4. The same NRSRO was found to have an analyst who sent a draft rating report to an issuer ‘that inadvertently disclosed a contemplated rating action’, contrary to NRSRO policy. Again, while Staff recommend action, we do not get to find out what happened next. The theme is clear and I will not repeat it from this point on.
5. The same NRSRO did not disclose complete and correct credit rating histories in mandatory disclosures. For ‘several years’, the NRSRO posted disclosures that ‘did not include a significant number of credit ratings of a particular rating category’.
6. The remaining ‘large’ NRSRO was cited for not making nor retaining a rationale for a material difference between the credit rating it assigned to a security issued as part of an ABS transaction ‘and the credit rating implied by a model that was a substantial component of the process of determining the credit rating’. In simple English, the NRSRO said they would do one thing, and then did another. Further investigation found this issue to be replicated in other sectors.
7. The same NRSRO’s policies and procedures did not require that it promptly publish notice of the existence of a significant error in a procedure or methodology used to determine credit ratings.
The ‘medium’ NRSROs – A.M. Best, DBRS, and Kroll – also had a litany of breaches cited. They included:
· The process of submitting complaints anonymously was not apparent nor intuitive.
· A medium NRSRO did not enforce a policy designed to ensure adequate records are made and retained to allow for after-the-fact reviews of a rating action.
· A medium NRSRO’s board of directors did not approve the entirety of a methodology, with a quantitative tool that was not approved then being used by the NRSRO.
· A medium NRSRO did not made or retain records of the rationale for a material difference between the rating assigned to an ABS transaction and the model used to create it.
· Another medium NRSRO did not apply all applicable methodologies when determining an entity’s credit rating.
· An independent director used a personal email account to conduct NRSRO business, including potentially sensitive and material nonpublic information.
· A medium MRSRO’s complaints policies and procedures did not adequately address the receipt, retention, and treatment of employee complaints.
Smaller NRSROs, like Demotech, Japan Credit Rating Agency, Egan-Jones Ratings, and HR Ratings de Mexico also were cited in the report. Their breaches collectively included:
· Not enforcing policies relating to withdrawing ratings when not receiving the required surveillance information.
· Did not ensure that annual surveillance reviews were conducted on a timely basis.
· Sales and marketing employees had discussed ratings with rating analysts (although the NRSRO disagreed with and challenged this conclusion).
· A small NRSRO did not adhere to policies relating to the receipt, retention, and treatment of complaints relating to credit ratings, models, methodologies, and more.
· A small NRSRO did not complete and correct credit rating histories in their mandatory disclosures.
The Report concludes this section by reviewing some of the instances where changes were requested by the Staff. However, it concludes with confirming that many changes have not been actioned, but this is because it is difficult to confirm with the NRSROs because some changes are actively being actioned and can only be judged upon completion of the revised process or provision.
Important Statistics
The Report is often cited throughout the field and especially for its data. Every year it provides for information relating to market share, outstanding rating ratios, areas of ratings, and more. Below are some of the key statistics from this year’s Report with some short commentary to each.
Market Share by Outstanding Rating
The amount of ‘outstanding ratings’, i.e. ratings that are live and active, is usually the marker by which the field understands the relevant positions of a NRSRO with respect to other NRSROs. This year’s Report confirms a similar trend, with S&P Global dominating the space in front of Moody’s, with Fitch rounding out the oligopoly and the rest operating in much less smaller circles. Collectively, the Big Three accounted for 94.15% of all ratings that were outstanding for 2023 (virtually unchanged). It is interesting to note that the year-on-year change indicates that only Fitch are rating more this year (of the largest NRSROs). Additionally, in the second chart, we can see in what areas the NRSROs are rating:
It is also important to understand the constitution of the rating sector by looking at the staffing levels. This year’s Report indicates that despite S&P Global rating a lot more than Moody’s, Moody’s actually has more analysts:
However, whilst outstanding ratings and staffing levels are good indicators for the development of the NRSROs, the financials usually take priority. This year’s financials reveal that the large NRSROs are capturing more of the income from the collective NRSRO pot than ever before. Additionally, Moody’s revenue for 2023 was up 6% from 2022, now reported at $2.9 billion, and S&P Global was up 9%, now at $3.3 billion (the Report does not cite Fitch’s financials here).
Barriers to Entry and Conflicts of Interest
The Report concludes with assessing key issues that affect the credit rating sector. Two, selected here, are pertinent. There was considerable regulatory, political, and legislative capital wasted after the Global Financial Crisis on increasing competition in the credit rating sector and the statistics above demonstrate the size of that failure – today, the credit rating sector is become less competitive, not more. The Report cites many barriers to entry that exist, including pressure on the issuer side, the investor side, and in terms of organisational difficulties to offer ratings at scale. The Report chooses to focus on the actions taken by the SEC in terms of creating space for appropriate regulations whereby smaller NRSROs are not as burdened in certain areas to allow for growth.
In terms of conflicts of interest, the Report provides generalised information on the different conflicts of interest (and categories them by who is involved, i.e. rating analysts, relationship with issuers, internal relationships etc.) It does then provide links to interventions where they have involved themselves and recommend development in particular areas within NRSRO to prevent conflicts from occurring or being repeated.
Summary
The Report provided by the OCR is a useful addition to the field. However, despite its usefulness, some of the signals it sends are not positive. It shows a regulator intent on protecting the sector and a sector that continuously transgresses. Many of the identified transgressions in this year’s report are found in previous additions. The protection of the sector, via anonymity, has not merit. The damage that agencies may face if they were to be identified ought not to be deciding factor when determining whether anonymity should be provided. If a registered NRSRO breaches not only their own codes of conduct and procedures, but those of the regulator (or the law) then the public should be made aware. The anonymity is a moral hazard that needs to be reconsidered.
Beyond that, the Report makes clear that attempts to affect competition amongst credit rating agencies in the US has been an abstract failure. The largest credit rating agencies grow ever larger, bring in more and more revenues, and continue to dominate the act of providing credit ratings in the world’s largest economy and afar. This realisation ought to correct the reform agendas being presented in various fields, ranging from debt treatment to sustainability. The signal this Report sends is that the credit rating agencies are getting bigger, more important, and there is simply no evidence to suggest that is going to change any time soon.