Filed Under:  U.S. & World

Bond Rating Agencies Implement Mandatory Reforms

Contributed by on December 30, 2014 at 4:08 pm

The Securities and Exchange Commission (SEC) reported in late December that Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings have improved their functioning in key areas of the municipal bond ratings industry but continue together to dominate the field.

 

In August, the SEC ruled that municipal bond rating agencies were required to amend their operations in order to assure, primarily, that securities were not given higher ratings than were justified. These changes were instigated after the SEC determined that many securities went into default even though they had been deemed investment-worthy.

 

Among the required changes: municipal bond rating agencies are now expected to publish the methodologies used to determine individual ratings and to provide explanations of the limitations of their methodologies in accurately predicting credit-worthiness.

 

The SEC determined that the ratings organizations have improved their record keeping and self-monitoring processes, but still need to make strides in clarifying their methodologies and managing conflicts of interest.

 

Conflicts of interest can arise in municipal bond ratings when organizations pay to be rated. In some cases, the SEC has determined that this model has resulted in the issuing of inflated ratings. Inflated ratings may lead investors to believe a bond is less risky than it actually is.

 

The municipal bond market is an important tool for the funding of public infrastructure improvements. Without municipal bonds, many cities and non-profit / public organizations would find it difficult, if not impossible, to fund necessary improvement projects. Nonetheless, when municipal bonds default, it can seriously impact the stability of the underlying market.

 

Representatives from Moody’s, Standard & Poor’s, and Fitch Ratings have all indicated continued willingness to improve, according to the SEC regulations.