The SEC is creating a password protected EDGAR for credit ratings data

andrew_donohue.gi.top.jpgAndrew "Buddy" Donohue, director of the SEC?s Office of Investment Management, speaks during the Investment Company Institute's 52nd annual general membership meeting May 7, 2010 in Washington, DC. By Ken Stier, contributor


FORTUNE -- The Securities and Exchange Commission is about to start requiring credit-rating agencies and the companies they rate to publicly share the information used in those ratings. The SEC hopes opening the books will encourage other ratings shops to sound off, providing an independent check on abusive 'ratings shopping', and giving smaller agencies a better chance to compete.

The initiative, which starts June 2, requires the hired rater to post its deal sheet on its website and the arranger or issuer to similarly post all the information it provided to the rater. So, when Moody's evaluates a large structured finance transaction, both Standard & Poor's and a smaller agency like Toronto-based DBRS, will have access to the data -- to challenge the rating and offer the commentaries based on their own analysis.

The early verdict: The measure does little to improve the status quo and the Big Three - Moody's (MCO), Standard & Poor's, and Fitch - have nothing to fear. And though Morningstar and other research firms have advocated to make this information publicly accessible, it will remain firmly password-protected -- for raters' eyes only.

S&P: Moody's AAA is not our AAA

Standard & Poor's has previewed how this kind of second-guessing might look. In late April, using already-public information, the agency examined this year's first private-label U.S. RMBS transaction, the $237.8 million Sequoia Mortgage Trust 2010-H1, sponsored by RWT, and rated AAA by Moody's.

S&P noted that the 255 underlying first-lien mortgages, originated in 2009 by CitiMortgage, were not as geographically diverse as its own "archetypical pool" and that it would have required a higher cushion or credit enhancement -- 7.50% rather than Moody's 6.50% -- for Sequoia to have earned a AAA S&P grade.

S&P spokesman Edward Sweeney says it isn't his company's aim to get into a "tit-for-tat" with Moody's but that the rule encourages "healthy competition" that will alert investors to a diversity of opinions.Sweeney added S&P is in favor of the SEC's action.

Credit data still isn't as open as other financial info. "It's just weird."

"It takes a huge amount of resources and experience to do these [kinds of ratings]," Mary Keogh, the managing director for regulatory affairs at DBRS, the fourth largest full-service ratings firm, says. Even with shared credit data, hired raters will keep the advantage of interacting with management, which Keogh insists is vital to quality ratings for complicated structured-finance deals. "It's a laudable effort, but we don't see a lot of unsolicited ratings in structured finance occurring among smaller agencies."

Yet Catherine Odelbo, the president of Morningstar's Equity Research Group, says even credit analysts will privately admit such management interactions rarely affect ratings. "I believe that a very strong EDGAR type effort around access to credit data would solve about 90 percent of the issues that everyone is upset about with credit ratings," she says.

But, "don't make it available to just a handful of NRSROs." (Nationally Recognized Statistical Rating Organizations, the official designation for credit-rating agencies.) "Make it available to anybody and let the market decide who is good at rating these things," says Odelbo. "Why should credit ratings be any different in terms of government regulation than any other mutual fund ratings, stock ratings, any kind of financial ratings. It's just weird."

Of course, Morningstar's business model is based on publicly available information, but since its start 26 years ago it has pushed hard for greater disclosure - like the names and holdings of portfolio managers - that the SEC has mandated and is now regarded as the norm. Morningstar is in the process of acquiring RealPoint, a CMBS-only rating shop spun from GMAC, and has started issuing corporate bond ratings, but Odelbo says it has no plans to become a credit-rating agency.

DBRS' Keogh is skeptical that all openness is good. "Ratings quality will suffer if all ratings are based solely on public information," she says, because management will never reveal strategy and forecasts it considers "trade secrets" on the corporate side and on the structured side as some deals are quite complicated and require additional discussion.

Open data would let the public call shenanigans

"I don't think the consequence would be less disclosure," says NYU finance Professor Lawrence White, an expert in credit ratings agencies. "The whole process would be less opaque, it will make it easier for third parties, the PIMCOs of the world, to be able to follow-up, form them their own judgments, [and] in instances where [they feel] the raters have made a mistake, to loudly proclaim so."

As a money manager, PIMCO could not become an NRSRO, but that hasn't stopped the National Association of Insurance Commissioners from retaining PIMCO to analyze underlying collateral in structured finance deals.

The drift away from full disclosure and public accessibility

When the SEC originally embarked on its rule change process it leaned towards full disclosure by requiring that credit data be made public at the end of the business day the issue closed. Some objected that this would be too late to prompt unsolicited ratings.

Ultimately, the idea of publicly releasing the data ran aground of industry objections: first that the data release could violate offering rules, and second, the fact that not all securities are registered with the SEC.

Even Morningstar allows that opening credit data to all NRSROs is huge step forward. It's just that they also think it's a mere half-measure to busting open the ratings sector to real competition, and opening up data so that any investor can see exactly what it is they're buying. To top of page