Discussion Document: Alternate Model and Other Potential Initiatives Page 1

The Credit Ratings subcommittee of the FIMSAC has spent the last year exploring a variety of credit 

ratings related topics. One of the main areas of exploration has been conflicts of interest in the industry 

payment model (i.e. issuer pays for the credit ratings assignment and maintenance), and the impact, if 

any, on market structure and efficiency. The subcommittee has heard from many industry participants 

on this topic, and has hosted panels at FIMSAC meetings to expose the broader Committee to its 

deliberations. This discussion document presents some of the ideas debated by the subcommittee to 

potentially address industry conflicts of interest, and is meant to encourage FIMSAC and broader 

industry discussion and feedback. 

Background

Credit ratings, and their utility, have been controversial for a number of years. Credit ratings, and credit 

ratings agencies (aka Nationally Recognized Statistical Rating Organizations or NRSROs) have been 

criticized for their role in the Global Financial Crisis. Some of the criticism stems from perceived conflicts 

of interest in the issuer payment model, as well as a significant market concentration among the top 

agencies suggesting a lack of sufficient market competition. As part of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, a number of aspects of the credit ratings industry were 

addressed. In addition to establishing self-executing requirements applicable to NRSROs and SEC 

rulemaking associated with NRSROs, the Dodd-Frank Act required the SEC to submit a report specifically 

related to a study on credit ratings for structured products as well as any recommendation for 

regulatory or statutory changes it determined should be made. The report was to discuss conflicts of 

interest associated with issuer-pay and subscriber-pay models, the feasibility of establishing a selfregulatory organization to assign NRSROs to rate structured products, metrics which could be used to 

determine the accuracy of credit ratings for structured products, and alternative compensation to incent 

accurate credit ratings for structured products. In addition, the Dodd-Frank Act directed the Commission 

to establish an assignment system to determine initial credit ratings of structured products, if it deems it 

necessary or appropriate in the public interest or for the protection of investors. The report was 

released in December 2012 and can be found here: https://www.sec.gov/news/studies/2012/assignedcredit-ratings-study.pdf

Subsequent to the Assigned Credit Ratings Study, the SEC hosted a Credit Ratings Roundtable in May, 

2013. The roundtable explored multiple topics, including the potential creation of a credit rating 

assignment system for asset-backed securities (ABS), the effectiveness of the current system to 

encourage unsolicited ratings for ABS, and alternatives to the issuer-pay model.

Current Environment

The SEC’s Office of Credit Ratings (OCR) is responsible for examining each NRSRO at least annually, in 

eight specific areas. OCR also monitors trends affecting the credit rating industry and liaises with 

international regulators on relevant topics. OCR reports on its findings annually. In their report, they 

provide market information, which sheds light on the concentration of the market. Following is 

excerpted from their December 2018 report:
Discussion Document: Alternate Model and Other Potential Initiatives Page 2

The NRSRO market remains concentrated, despite efforts such as Rule 17g-5, which was broadly 

designed to allow/encourage competition and reduce conflicts of interest. Many believe that 17g-5 has 

not been effective in promoting competition because rating agencies require revenue to cover the 

research costs that underlie substantive ratings. Thus, the economic incentives to compete in an 

unsolicited way are weak. With the objective of creating a broader, level playing field among a great 

number of NRSROs, the subcommittee has debated different initiatives to better achieve better 

outcomes on competition.

In addition to market concentration, there remains skepticism surrounding the issuer-pay model, and 

the potential conflicts of interest that accompany that model, specifically in the structured product 

space. The Credit Ratings subcommittee has heard from several market participants including investors, 

issuers, scholars and current and former NRSRO executives over the months leading up to the 

publication of this discussion document, including anecdotal evidence of conflicts ranging from analyst 

compensation (i.e. analysts motivated to provide ratings which result in obtaining business) to ratings 

shopping (i.e., an issuer chooses the rating agency that will assign the highest rating or that has the most 

relaxed criteria for achieving a desired rating).

A good deal of work has been done post-GFC surrounding oversight of NRSROs. This discussion

document is designed to leverage feedback the subcommittee received through its assessment of these 

issues, in exploring an alternate model for credit ratings and other potential initiatives to address 

conflicts of interest. The subcommittee anticipates and welcomes receiving additional industry 

feedback, and will examine that feedback and determine the feasibility of advancing a preliminary 

recommendation to the FIMSAC in the future.
Discussion Document: Alternate Model and Other Potential Initiatives Page 3

Discussion

The subcommittee considered asking the SEC to explore creating an entity to oversee a random 

assignment process for both structured products and corporate bond ratings, with at least two NRSROs 

being assigned to each issue, to provide diversity of views.

Issuers could continue to pay for ratings through fees assessed by the “oversight entity” and an 

additional amount could be set aside for the administration costs associated with the “oversight entity”. 

This entity could be responsible for setting the compensation for initial and maintenance ratings.

The subcommittee also discussed the potential for the SEC to consider creating a workable (and simple) 

performance scorecard for the NRSROs, and exploring increased NRSRO public disclosure of deviations 

from ratings methodologies. Ultimately, as any random selection model matures, the selection could be 

based on performance, in that the higher the performance (more relevant and accurate ratings), the 

greater the chance of being selected to rate issues. The performance scorecard, outlined below, could 

be a starting point for such evaluation. 

While many of the potential issues discussed could apply to municipal bonds, additional clarity is needed 

to determine if the SEC could implement an alternate model in the municipal bond market especially 

since it would mandate additional rating agency costs to the issuer. Other potential initiatives 

surrounding NRSRO performance scorecards and increased disclosure of deviations from ratings 

methodologies could also be considered for the municipal bond market. 

There would need to be cooperation by various market participants regarding this approach for it to be 

successful. For example, index providers and investors may need to update their criteria and/or 

investment guidelines to broaden acceptance to all registered NRSROs, rather than citing specific 

NRSROs. This may take time to evolve, and it is outside of the purview of the SEC.

Details of an alternate model and other potential initiatives follow.
Discussion Document: Alternate Model and Other Potential Initiatives Page 4

Random Assignment

The objective of using a random assignment system would be to remove the ability of the issuer to 

influence the NRSRO and/or the ultimate rating for a deal, thus eliminating ratings shopping. The two 

NRSROs, selected by the Oversight Entity using a random assignment process, could offer investors 

unbiased views of the probability of default for a given issue. To ease the transition process, issuers may

have the option for one of the randomly assigned NRSROs to be selected from the pool of NRSROs which 

has rated securities for the issuer historically. 

The issuer may still choose to hire additional rating firms outside the purview of the Oversight Entity to 

provide a rating. Issuers which choose to hire an additional firm to provide a rating could be required to 

delineate which ones were randomly selected by the Oversight Entity and which one(s) were selected by 

the issuer. In addition, issuers could be required to disclose at least the same information to the 

randomly selected agencies as the solicited agency to avoid information (dis)advantages.

Capacity issues may arise, in that due to market concentration, there may be too many deals chasing too 

few NRSROs. Expertise and resource constraints may differ by product and sectors as well. As a result, 

NRSROs could be required to disclose products and sectors that they are qualified to rate in order to be 

considered as part of the random assignment (perhaps as an addendum to the registration process). 

Additionally, selected NRSROs could be allowed to opt out of selected ratings assignments due to 

capacity, resource and/or expertise constraints. As the Oversight Entity would set prices, particularly 

complex ratings assignments could be priced distinctly to help keep opportunities relatively equal 

related to potential NRSRO margins. If a randomly selected NRSRO opts out, another NRSRO would be 

randomly selected. The pool of NRSROs could contain both legacy and “new” NRSROs (i.e. NRSROs 

which may have no experience with a particular issuer).

This discussion did not contemplate altering the existing process for NRSRO registration, except 

potentially an addendum to “opt-in” into a particular sub-class, as noted above. 

Payment for Ratings

The current compensation model of issuer-pays could remain if NRSROs are randomly assigned, as the 

inherent conflict of interest would be mitigated. NRSROs could be encouraged to disclose fees as well as 

resources committed to the ratings process, to not only allow investors insight on the information value 

of the rating but also to enable the Oversight Entity to better set pricing.

Performance Evaluation

Another idea discussed by the subcommittee is to request that the SEC create a workable (and simple) 

performance scorecard for the NRSROs. An example of this could include:

• Annual disclosure of companies/issuers downgraded (and upgraded) which exceeded two 

ratings categories (i.e., Single-A plus to Triple-B plus) within the past 12 months, 24 months and 

36 months

• Annual disclosure of companies/issuers downgraded (and upgraded) which exceeded 5 ratings

categories within the past 12 months, 24 months and 36 months

• Annual disclosure of companies/issuers downgraded (and upgraded) which exceeded 7 or more

ratings categories within the past 12 months, 24 months and 36 months
Discussion Document: Alternate Model and Other Potential Initiatives Page 5

This scorecard could apply to all rating categories (i.e., structured products, corporate credit, munis, 

governments, etc.).

Additionally, in an effort to increase disclosure, the subcommittee considered asking the SEC to 

investigate the feasibility of requiring NRSROs to publish a ratings assignment based solely on a 

quantitative application of their ratings methodologies (e.g. similar to Moody’s internal metric 

scorecard1

). This could allow investors to determine where NRSROs are adjusting their ratings higher or 

lower based on qualitative factors and create a transparency into potential conflicts of interests (e.g. if 

there was a consistent deviation from quantitative ratings in a certain sector). A common performance 

metric standard and scorecard could evolve that would be common to all NRSROs. Investigation into the 

feasibility of this could extend to all rating categories (i.e., including munis, governments, etc.).

Company Disclosure on Utilization of Specific NRSROs

The subcommittee also considered asking the SEC to consider requiring companies to include in their 

annual 10-k filings a summary report detailing which NRSROs were chosen (randomly or otherwise) to 

assign ratings for the previous year, and accompanying rationale to support those choices.

Oversight Entity

The subcommittee also discussed the possibility that the composition of the Oversight Entity could be 

structured similar to that proposed in the Franken-Wicker Amendment. While the make-up of the Credit 

Ratings Board discussed in the Franken-Wicker Amendment was not prescribed, some details were 

given. Particulars include having an odd number of members, ensuring that investors represent the 

majority of the Board, and having at least one representative from the NRSROs and issuers. Having an 

“independent” member is also a consideration. The Oversight Entity members could have finite terms.

Conclusion

While this is a very complex topic with global ramifications, these challenges should not inhibit 

additional study and potential action to improve the structure surrounding the credit ratings industry. 

The time to explore improvements is now, and market participants and other observers are urged to 

provide feedback over the coming months. 

 1 “Scorecard’ is a terminology used by Moody’s to refer to their sector / product based guidelines that determines the factors can be used in 

most cases to approximate credit profiles in a given sector / product. While not an official rating, it is a systematic determination of the most 

likely drivers of the ratings of an issuer.