Top U.S. Securities and Exchange Commission officials are frustrated over lack of progress in finalizing rules for credit rating agencies and asset-backed securities (ABS), seen by regulators as major drivers of the 2007-2009 financial crisis.
Two of the SEC’s five commissioners told Reuters recently that the federal agency needed to do a better job prioritizing how it enforced the changes pushed through by the 2010 Dodd-Frank financial reform law.
“I am disappointed that we haven’t done more to move forward toward adopting Dodd-Frank rules that are now close to three years old,” Democratic Commissioner Luis Aguilar said in an interview a few weeks ago.
Regulators see credit raters and the securitization market as especially ripe for reform because of their role in the crisis, with banks packaging subprime mortgages into securities and rating agencies bestowing AAA ratings on the assets.
Unwitting investors later lost hundreds of billions of dollars when the housing market collapsed after subprime borrowers with poor credit defaulted. Credit raters, which had given the high-risk securities overly positive ratings, were also slow to downgrade them.
Dodd-Frank, passed by the then-Democratic-controlled Congress with President Barack Obama’s support, ordered the SEC to write rules limiting the government’s reliance on credit ratings, reducing conflicts of interest in the securitization market, and, in conjunction with other regulators, requiring ABS sponsors to retain a portion of the credit risks.
The law also assigned more liability to the credit raters in an effort to prompt them to issue higher-quality ratings.
In a separate interview late last month, Republican Commissioner Daniel Gallagher said the SEC should start seriously focusing on finalizing some of the critical Dodd-Frank rules proposed in 2011, while being careful not to rush to get them out.
“A real serious assessment needs to be done here,” Gallagher said. “Let’s not just march through these things rotely to get them done. Let’s reflect a little bit as an agency on the causes of the crisis … let’s prioritize things in a rational way.”
An SEC spokesman declined to elaborate on the outstanding ABS and credit rating rules, saying the agency is “working hard to write effective rules as soon as possible.”
Dodd-Frank critics, including some on Wall Street, argue that its reforms can disrupt markets. They point to an incident in which a provision imposing liability on credit rating firms automatically went live upon the law’s passage in July 2010.
The ABS market froze after the credit raters, fearing the liability, refused to allow their ratings to appear in offering documents for the securities.
The SEC was forced to temporarily waive the legal liability provision of the law until further notice, a situation that remains unchanged.
“It is perilous … to just simply put the blinders on and implement Dodd-Frank,” Gallagher said.
Although SEC Chair Mary Jo White, an independent who took over the agency’s top job in April, sets the SEC agenda, the views of Aguilar and Gallagher are especially important because the terms of two other commissioners expire soon.
Obama has nominated Democrat Kara Stein and Republican Michael Piwowar to replace the two outgoing members and a U.S. Senate panel is expected to vote on their nominations next week. The full Senate would then decide whether to confirm their appointments.
Dodd-Frank called for the SEC to complete nearly 100 rules in a variety of areas, from over-the-counter derivatives to hedge funds and municipal advisers. The agency has finalized 34 of them, according to a July report by the law firm Davis Polk, which routinely tracks Dodd-Frank rule-making progress.
Included are rules that pertain to asset-backed securities and credit ratings, including one that requires ABS issuers to conduct a review of the underlying assets and make certain disclosures.
The SEC also completed a study into potential conflicts in ABS ratings, and adopted some less controversial rules to strip rating references from the regulations, but it has not tackled the larger and more complicated rulemaking in these areas.
Some critics say it dedicated significant time to completing Dodd-Frank rules not directly tied to the crisis, including a measure requiring oil, gas and mining companies to disclose payments to foreign governments, and another that would force companies to disclose if their products included “conflict minerals” extracted from the Democratic Republic of Congo. Earlier this month, a federal judge tossed out the rule forcing disclosure of foreign government payments, saying the SEC erred in its interpretation of the Dodd-Frank law and failed to properly weigh requests for relief.
Another judge is weighing the validity of the SEC’s rule requiring manufacturers to disclose whether their products contain “conflict minerals” such as gold and tin from the Democratic Republic of Congo, where armed groups have been accused of human rights abuses.
White has said completing the rule-writing process would be among her top priorities, and there are signs momentum is building.
SEC staff recently started making the rounds to discuss one of the main ABS proposals requiring securitizers to have “skin in the game” by retaining five percent of the risk in the asset-backed securities they issued.
The heads of the major regulatory agencies working on the risk retention rule also met last month to discuss the next steps, Mary Miller, the Treasury Department’s under secretary for domestic finance, told lawmakers this week.
But reform advocates are unhappy that rules seen as most responsive to the crisis are not close to being finished.
“A lot of these rules are extremely important, and it is incredibly frustrating that they are so far behind,” said Lisa Donner, the executive director of the non-profit Americans for Financial Reform.
Dennis Kelleher, the chief executive of the non-profit Better Markets, a lobby group advocating greater transparency in financial markets, blames the delays on industry representatives who fear the new rules will make structured products less profitable.
He said industry’s push for detailed cost-benefit analysis and the subsequent lawsuits challenging Dodd-Frank rules have paralyzed the SEC, making it a “slow, defensive cautionary, agency that takes too long to get things done.”
But Tom Deutsch, the executive director of the trade group American Securitization Forum, said some rules required the approval of multiple agencies and others, such as those aimed at preventing conflicts of interest in asset-backed securities, were tough to get right.
The securitization conflict rule “has got to be the most challenging piece of Dodd-Frank in my opinion for the SEC to get through the eye of the needle,” Deutsch said.
“We believe the legislation was written in such a poor manner that it creates a very difficult time for the SEC to not prevent virtually every kind of structured finance transaction.”