Most of the rating agencies’ problems stem from their inclusion in various regulations relating to the financial system.
The rating was included in the regulation of the U.S. financial markets, the most developed today, which have long been the reference for all other financial systems.
Today, the Basel 2 agreement marks a step forward: the revision of the regulation setting the minimum capitalization of banks is being revised.
Ratings-related regulation has, therefore, found its expression mainly in the code of conduct for credit rating agencies, which is now widely applied throughout the world.
Among other things, some recommendations aimed at increasing the transparency of the rating industry also stand out.
For investors, it is important that agencies publish default studies- analyses that help determine how accurately they assign higher rating classes to issuers with a lower risk of default.
Moreover, in view of the fact that financial markets are constantly evolving, and the fact that the use of ratings is increasingly being used for supervisory purposes, they are driving regulatory activity towards continuous evolution.
Ratings are now also considered as regulatory tools.
They are a simple and relatively low-cost tool that was believed to be used to monitor the behavior of agents and to induce them to act according to precise rules.
In particular, it is considered that ratings can be used to maximize incentives for agents to behave in a certain way, especially when it is difficult to observe or directly monitor their behavior.
In the investor-issuer relationship, agencies should be able to provide an assessment of the likelihood that the issuer will be able to repay principal and interest at the agreed maturities.
In recent years, demand for ratings has grown significantly, because, in addition to being used in determining the price of securities, there has also been demand from banks, pension funds, and regulatory trustees.
As a result, the use of ratings and the influence of agencies in the financial markets are such that ratings become an essential tool both for investment decisions and for regulation.
In 2002, ratings were included as regulatory instruments in at least 8 federal statutes and in the federal regulations of 47 states.
Most EU member states also use ratings for various purposes including financial market supervision and transparency.
Ratings-based regulation can be grouped into three areas: transparency requirements, investment restrictions and capital requirements.
The regulatory importance of ratings has further increased with the new Basel 2 agreement launched in 2004.
It states that the regulatory capital of banks should be determined according to the level of risk in the asset portfolio.
This risk must be quantified on the basis of the rating issued by agencies that have obtained recognition from one of the central banks of the states party to the Basel agreement, or it must be quantified independently by each of the financial institutions through the implementation of an internal rating system.
Despite the importance of ratings, there is no set of rules governing the operation of the agencies and the rating process.
In this sense, over the last decade, especially because of their influence on the financial markets, both national and international institutions have made efforts to regulate this sector in some way.

Regulatory of Securities & Exchange Commission (SEC)
The first use of ratings in US regulation dates back to 1931; since then, ratings have been the basis of various regulatory requirements for the eligibility of investment in certain instruments by certain entities (investment banks, pension funds, etc.).
In general, all financial instruments that are rated have more placement opportunities, are more liquid and benefit from a lower interest rate than financial instruments with identical characteristics but which are not rated.
The advantages of rating continue also because the issuers of financial instruments, which have a rating, benefit from bureaucratic simplifications for the offer on the market.
Moreover, since 1975, the SEC has required that any financial instrument wishing to be listed on the US market must be rated by at least one of the agencies that have NRSRO (Nationally recognized statistical rating organization)recognition.
This regulatory imposition led to the consolidation of the market power of the then existing agencies, making it even more difficult for others to enter the rating market.
To date, there is no regulation laying down the requirements for obtaining NRSRO recognition, but the SEC objects that the substantive requirements for obtaining recognition, although not formally published, are derived from the regulatory proposals and are widely known.
The SEC attributes the responsibility for the current lack of inter-agency competition to market forces rather than to the NRSRO recognition mechanism.
Nevertheless, all of this forces most market participants to request a rating from these agencies, increasing both the demand for the rating itself and the market power of the agencies benefiting from this status.
It is somewhat paradoxical that, in spite of this, the term NRSRO has never been officially defined by the SEC, nor have any criteria been formally defined for the granting of NRSRO status.
According to the SEC, a number of criteria are taken into account when designating a credit rating agency as an NRSRO, the most important of which is that the credit rating agency is «nationally recognised» for the reliability of its ratings.
Other factors taken into consideration are: the organisational structure of the credit rating agency, the organisation of its financial resources, the size of its human resources and their level of training and experience, the independence of the credit rating agency with respect to the entities it issues the credit rating, the rating procedures, and the availability and adoption of internal procedures to prevent the inappropriate use of private information.
Currently, favorable treatment is still given to all entities that have a high rating from an agency recognized as NRSRO even though there is no formalized procedure to analyze the performance of the agency in the assignment of ratings, and the sanctioning instruments to be applied in the event of bad performance, i.e. incorrect behavior.
In the early years of the new millennium, following the collapse of major companies (Enron, Parmalat, WorldCom, etc.), the problem of agency regulation became even acuter.
A concrete response to this need has been the publication by the SEC of a report on the role and function of agencies in the functioning of financial markets.
Although the SEC’s work augured well for some change, it did not end in anything concrete, probably also thanks to the opinion of the esteemed Lawrence White, a professor at the Stem School of Business in New York, that the SEC should not issue certifications to rating agencies.
Despite the SEC’s clear desire for change, it seemed difficult to converge on a valid and shared set of rules.
Among the main issues contained in the 2003 SEC document view on the possible abandonment of NRSRO recognition, and if this status is retained, what would be the controls to which agencies recognized as NRSROs would be subject.
The document also seeks views on whether there should be operational restrictions on agencies obtaining such status, and whether annual or periodic comments should be sought from the public on the performance of the agencies.
In 2008, the SEC abandoned granting NRSRO status and switched to a designation mechanism.
In fact, the rating market has always been a market characterized by a small number of companies.
For many years and until 2003, only three companies had NRSRO status: S&P, Moody’s and Fitch
In most cases, each issuer requests a rating from both Moody’s and S&P; there are few cases where an issuer requests a rating from all three global agencies at the same time.
In most cases, Fitch’s rating is required when there is disagreement between the ratings issued by Moody’s and S&P.
This behavior is quite consolidated in practice, in fact, many observers believe that the regulatory regime currently applicable to agencies discourages competition.
Whatever the cause of entry barriers, standard economic theory suggests that Moody’s and S&P do not compete with each other, but try to establish themselves in new markets where the double rating rule does not seem to apply at present.
Marco Barchetti
Fintech Review

Rating Operation Problem
2.5 (50.91%) 11 votes

Published by Marco Barchetti

Co-Funder of & SEO/SEM-Competitive Intelligence at & Marco Barchetti, the SEO / SEM of ICOBooster is a marketing expert with a deep knowledge of the Blockchain industry. He is co-founder of a social media web agency, leader in support and marketing advising to companies wishing to enhance their image on the web.