Nationally recognized statistical rating organization


A nationally recognized statistical rating organization is a credit rating agency approved by the U.S. Securities and Exchange Commission to provide information that financial firms must rely on for regulatory purposes.

History

The use of the term NRSRO began in 1975 when the SEC promulgated rules regarding bank and broker-dealer net capital requirements.
Originally, the SEC did not adopt specific standards for determining which credit rating agencies were "nationally recognized", and instead addressed the question on a case-by-case basis. NRSRO recognition was granted by the SEC through a "No Action Letter" sent by the SEC staff. Under this approach, if a CRA were interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would research the market to determine whether ratings from that particular CRA are widely used and considered "reliable and credible." If the SEC staff determined that this was the case, it would send a letter to the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff would not recommend enforcement action against that entity. These "No Action Letters" were made public and could be relied upon by other regulated entities, not just the entity making the original request. The SEC later sought to further define the criteria it uses when making this assessment, and in March 2005 published a proposed regulation to this effect. According to the SEC:
In 2006, following criticism that the SEC's "No Action letter" approach was simultaneously too opaque and provided the SEC with too little regulatory oversight of NRSROs, the U.S. Congress passed the Credit Rating Agency Reform Act of 2006,. This law required the SEC to establish clear guidelines for determining which credit rating agencies qualify as NRSROs. It also gives the SEC the power to regulate NRSRO internal processes regarding record-keeping and how they guard against conflicts of interest, and makes the NRSRO determination subject to a Commission vote. Notably, however, the law specifically prohibits the SEC from regulating an NRSRO's rating methodologies. In June 2007, the SEC promulgated new regulations that implemented the provisions of the Credit Rating Agency Reform Act. In February 2009, the SEC promulgated amended regulations designed to address concerns about the integrity of the process by which NRSROs rate structured finance products, particularly mortgage-related securities.
Since 2010, there have also been changes in laws and regulations due to the Dodd–Frank Wall Street Reform and Consumer Protection Act.

Controversies

Many private users of ratings data now demand that ratings be from an NRSRO. Consequently, there is some debate that, by "recognizing" certain CRAs, the SEC has bestowed a competitive advantage on them. This view is supported by the vigor by which many non-NRSRO CRAs seek NRSRO recognition. On the other hand, historically, many private users of ratings data have "defaulted" to Standard & Poor's and Moody's when specifying which ratings must be used for their own purposes. Accordingly, it is conceivable that the NRSRO designation has actually increased competition in the industry by providing an unintended government "seal of approval" on certain smaller CRAs. If true, this, of course, raises the question of whether this is something the government should do, and whether the NRSRO recognition process is the best mechanism to achieve this goal.
The larger NRSROs have also been criticized for their reliance on an "issuer-pays" business model, whereby the bulk of their revenue comes from the issuers of the bonds being rated, so that the company receiving the credit rating pays the CRA directly. While this is recognized by regulators as a potential conflict of interest, the larger NRSROs claim that the issuer-pays model is the only feasible model for them, because, in an age of email and faxes, the ratings of the larger CRAs are so widely and so quickly shared that a subscription-based model would not be profitable. Conversely, the predominance of the issuer-pays model has led to concerns that a CRA will be tempted to artificially inflate its rating to retain a valued customer.
Furthermore, the larger CRAs often receive non-public information from issuers and, under the SEC's Regulation FD, a CRA may only use such information if its ratings are made available to the public for free.
This threat has been taken seriously by U.S. regulators who have adopted amendments to existing regulations designed to separate the payment negotiation and the credit assessment branches within a firm.
Some smaller CRAs, including Egan-Jones, use a subscription-based business model whereby ratings are not made public but are available only to subscribers, who pay a monthly fee for access to credit rating information. These smaller CRAs argue that such a business model makes them less reliant on the good will of the issuers they rate, thereby eliminating one major potential conflict of interest.

Subprime mortgages, CDOs, and the financial crisis

The ratings agencies were heavily involved in the markets that enabled the subprime credit bubble of 2000-2008 and the subsequent financial crisis. In 1984 the federal government of the United States passed the Secondary Mortgage Market Enhancement Act to improve the marketability of private-label mortgage-backed securities, which declared NRSRO AA-rated mortgage-backed securities to be legal investments equivalent to Treasury securities and other federal government bonds for federally-charted banks, state-chartered financial institutions unless overridden by state law by October 1991, and Department of Labor-regulated pension funds.
The agencies made substantial profits from rating Collateralized debt obligations, residential mortgage-backed securities, and other creatures of structured finance intimately connected to the subprime industry. The ratings on these products were essential to the way the banks marketed the products. Buyers, like pension funds, university endowments, and cities, relied on these ratings in their decisions to purchase CDOs and other structured finance products. The activities of the ratings agencies have been detailed in many books, including The Big Short, by Michael Lewis, Confidence Game by Christine S. Richard, All The Devils are Here by Bethany McClean and Joe Nocera, and in many other accounts of the financial crisis. Janet Tavakoli, author of Structured Finance and Collateralized Debt Obligations, has suggested that these agencies lose their NRSRO status in relation to certain financial products. In 2011, the US Senate released the Levin-Coburn report on "Wall Street and the Financial Crisis"; it did a case study of the behavior of some of the CRAs during the crisis.

List of NRSROs

As of December 2016, nine organizations were designated as NRSROs, including the Big Three.