S&P Attempts to Fix Broken Process
Problem has roots in conflict of interest.
Standard and Poor's proposed actions to increase transparency in its ratings process erases any lingering doubt that ratings agencies failed in their charge to impartially evaluate the merits of debt offerings.
The WSJ reports that the subsidiary of the McGraw Hill Company (MHP) released a list of 27 changes to its rating procedures to try and identify potential conflicts of interest. The changes come only days after rival Moody's (MCO) announced plans to overhaul its ratings methodology for structured finance and other products that may not behave like municipal or corporate debt.
S&P's proposed operational changes raise all sorts of red flags for a process the entire credit market is reliant upon to assess risk:
- Lead analysts will be rotated between issuers every five years to prevent personal relationships from effecting ratings.
- Analysts who leave the company to join issuers will have recent deals reviewed to ensure objectivity.
- Risk Management staff will receive more training.
- Analytic tools will be added to track structured-finance performance.
- An "obudsman" will be brought on to identify potential conflicts of interest.
- An auditing expert will be brought in publicly to review the process.
So, it looks like S&P had untrained analysts rating deals the performance of which they neglected to monitor. Lead analysts gave out favorable ratings to longtime friends, who in exchange offered them lucrative positions to jump ship. No one oversaw the process, but why bother since it wasn't audited in the first place.
S&P has accurately identified the root of its ratings problems as one of a conflict of interest. However, as stated after the release Moody's similarly weak attempt to address the credibility of credit ratings:
As long as ratings agencies are paid by the issuers of securities rather than investors, they will be financially motivated to hand out generous ratings. No amount of new labeling, fancy packaging or legal ruses can disguise the fact that in the for-profit business of rating debt, business is awarded to the firm that provides the best ratings.
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