The Future of Structured Finance Ratings After the Financial Crisis

Abstract

The authors believe that the rating agency reforms underway in Europe and the United States, as well as at the agencies themselves, are steps in the right direction but do not go far enough to ensure accuracy and timeliness of ratings. Most importantly, they fail to address the conflict-ridden rating agency compensation system. The authors believe that credibility of ratings cannot be restored until rating agencies are paid not by the sell side or the buy side, but by both the buy side and the sell side, via a transaction charge on new issues and secondary market trades. Their proposal is to pay for ratings via an industry fund such as has been operated for over two decades by the U.S. Municipal Securities Rulemaking Board (MSRB), albeit on a smaller scale and for a more limited purpose, for the benefit of the municipal securities markets. Carefully structured, such a compensation system would give rating agencies more appropriate incentives to produce more accurate and timely ratings that can hold up through both up and down markets.