The International Organization of Securities Commissions has published for consultation a report recommending a host of changes to the code governing the role of credit rating agencies in the structured finance markets.

The report, prepared by IOSCO’s Technical Committee, discusses the role of CRAs in the recent credit crisis and proposes ways to strengthen processes and procedures at CRAs. In particular, the report proposes expanding upon IOSCO’s code of conduct provisions relating to the quality and integrity of the rating process; CRA independence and avoidance of conflicts of interest; CRA responsibilities to the investing public and issuers; and disclosure of the CRA’s code of conduct and communication with market participants.

Proposed changes in the quality and integrity of ratings area require that CRAs: ensure that the decision-making process for reviewing the rating of a structured finance product is objective; establish an independent function for periodic reviews of the firm’s rating methodologies and models; take reasonable steps to ensure that the information they use is of sufficient quality to support a credible rating; spelling out when ratings involve products with limited historical data; refrain from rating a product if the complexity or structure of a new type of rating creates doubts about the feasibility of a rating action; and, prohibit analysts from making proposals or recommendations regarding the design of structured finance products that the CRA rates.

In terms of CRA independence and avoidance of conflicts of interest, it calls for CRAs to: establish policies and procedures for reviewing the work of analysts who leave to join an issuer the CRA rates, or a financial firm with which the CRA has significant dealings; conduct formal and periodic reviews of remuneration policies and practices for its employees to ensure that these policies do not compromise the CRA’s rating process; disclose whether any one client and its affiliates make up more than 10% of the CRA’s annual revenue; and, define what it considers and does not consider to be an ancillary business and why.

Finally, in terms of CRA responsibilities to investors and issuers, IOSCO proposes that CRAs should: assist investors in understanding what a credit rating is, the attributes and limitations of each credit opinion, and the limits to which it verifies information provided to it by the issuer of a rated security; indicate if it receives break-up fees for a preliminary assessment, even if it does not subsequently rate on the product; when rating a structured finance product, provide investors with the information to understand the basis for the rating; disclose whether it uses a separate set of rating symbols for rating structured finance products, and why; and, disclose the methodology used in determining a rating.

Michel Prada, chairman of IOSCO’s technical committee noted that IOSCO is proposing significant changes to the current code. “These changes are required in order to ensure that investors and the financial markets can have confidence that CRAs are producing clear, well-researched ratings, free from bias which can be easily understood by their users.”

“The role played by credit rating agencies in the development of the market for structured finance products has raised serious issues for regulators globally, and I believe that these changes to IOSCO’s Code of Conduct will contribute to addressing some of the issues that the current crisis has exposed in relation to the ratings system,” he added.