The Future of Structured Finance Ratings

Abstract

The authors believe that restoration of confidence in ratings will require a change in the conflict-laden issuer-pay rating agency compensation models, careful studies of which are mandated under Sections 939D and F of the recently passed Dodd-Frank Act. While the investor-pay model is attractive, it has several limitations as the potential solution. The authors propose instead that both investors and issuers should pay for ratings, and describe how the Congressionally mandated method of payment used since 1975 to finance operations of the Municipal Securities Rulemaking Board could be cloned for this purpose. The establishment of the proposed new rating agency compensation system would require a buy-in by domestic and international market participants. If carefully crafted and implemented, the new system would be privately run, have virtually no additional costs, and eliminate the long-standing conflicts of interest that have plagued rating agency compensation models, providing the right rating agency incentives to ensure that ratings are both timely and accurate.