S&P Lawsuit: US action seeks to increase competition in ratings industry while SEC rules favour top companies

NEW YORK: The US lawsuit against S&P’s raises pressure to accelerate competition in the ratings industry while the government itself has adopted rules that left the business dominated by the same companies whose flawed grades sparked the worst financial crisis since the Great Depression. The Justice Department accuses McGraw-Hill and its S&P unit of deliberately understating the risk of bonds backed by mortgages made to the riskiest borrowers to win business from Wall Street banks. S&P, Moody’s Investors Service and Fitch Ratings provided 96% of all ratings for governments and companies in the $42 trillion debt market in 2011, versus 97% in 2008.

The lawsuit is unlikely to change the relationship because a 2006 law intended to open the field to new entrants has instead insulated the top three. Startups have struggled to obtain the designation that lets them sell rankings because of everything from a missing recommendation letter to prohibitive compliance costs to being able to provide years of ratings performance. Even as the biggest investors say they disregard the grades, their use is still embedded in bond deals and bank reserve rules. The law “discourages entry and discourages new ideas and new ways of doing things,” Lawrence White an economics professor at NY University’s Leonard N Stern School of Business, said on January 24.

“Ironically, it reinforces the position of the big three.” Judith Burns, a spokeswoman in Washington for the Securities and Exchange Commission, which oversees applications for ratings firms, declined to comment on the process.

NRSROS FORMED

In 1936, at the depth of the Great Depression, the Office of the Comptroller of the Currency banned banks from holding bonds that were below investment grade, or securities rated under BBB- by S&P and Baa3 at Moody’s. In 1975, SEC regulations designated S&P, Moody’s and Fitch as Nationally Recognized Statistical Rating Organizations, or NRSROs, and required some investors to buy only securities stamped with the companies’ creditworthiness opinions. There are now 10 NRSROs.