[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
A NOTCH ABOVE? EXAMINING THE
BOND RATING INDUSTRY
=======================================================================
HYBRID HEARING
BEFORE THE
SUBCOMMITTEE ON INVESTOR PROTECTION,
ENTREPRENEURSHIP, AND CAPITAL MARKETS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
SECOND SESSION
__________
MAY 11, 2022
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-83
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
47-650 PDF WASHINGTON : 2022
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri ANN WAGNER, Missouri
ED PERLMUTTER, Colorado ANDY BARR, Kentucky
JIM A. HIMES, Connecticut ROGER WILLIAMS, Texas
BILL FOSTER, Illinois FRENCH HILL, Arkansas
JOYCE BEATTY, Ohio TOM EMMER, Minnesota
JUAN VARGAS, California LEE M. ZELDIN, New York
JOSH GOTTHEIMER, New Jersey BARRY LOUDERMILK, Georgia
VICENTE GONZALEZ, Texas ALEXANDER X. MOONEY, West Virginia
AL LAWSON, Florida WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TED BUDD, North Carolina
CINDY AXNE, Iowa DAVID KUSTOFF, Tennessee
SEAN CASTEN, Illinois TREY HOLLINGSWORTH, Indiana
AYANNA PRESSLEY, Massachusetts ANTHONY GONZALEZ, Ohio
RITCHIE TORRES, New York JOHN ROSE, Tennessee
STEPHEN F. LYNCH, Massachusetts BRYAN STEIL, Wisconsin
ALMA ADAMS, North Carolina LANCE GOODEN, Texas
RASHIDA TLAIB, Michigan WILLIAM TIMMONS, South Carolina
MADELEINE DEAN, Pennsylvania VAN TAYLOR, Texas
ALEXANDRIA OCASIO-CORTEZ, New York PETE SESSIONS, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
Subcommittee on Investor Protection, Entrepreneurship,
and Capital Markets
BRAD SHERMAN, California, Chairman
CAROLYN B. MALONEY, New York BILL HUIZENGA, Michigan, Ranking
DAVID SCOTT, Georgia Member
JIM A. HIMES, Connecticut ANN WAGNER, Missouri
BILL FOSTER, Illinois FRENCH HILL, Arkansas
GREGORY W. MEEKS, New York TOM EMMER, Minnesota
JUAN VARGAS, California ALEXANDER X. MOONEY, West Virginia
JOSH GOTTHEIMER. New Jersey WARREN DAVIDSON, Ohio
VICENTE GONZALEZ, Texas TREY HOLLINGSWORTH, Indiana, Vice
MICHAEL SAN NICOLAS, Guam Ranking Member
CINDY AXNE, Iowa ANTHONY GONZALEZ, Ohio
SEAN CASTEN, Illinois, Vice Chair BRYAN STEIL, Wisconsin
EMANUEL CLEAVER, Missouri VAN TAYLOR, Texas
C O N T E N T S
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Page
Hearing held on:
May 11, 2022................................................. 1
Appendix:
May 11, 2022................................................. 31
WITNESSES
Wednesday, May 11, 2022
Gomez-Vock, Mariana, Senior Vice President, Policy Development,
American Council of Life Insurers (ACLI)....................... 9
Le Pallec, Yann, Executive Managing Director and Head of Global
Ratings Services, S&P Global Ratings........................... 5
Liang, Angela, General Counsel and Executive Committee Member,
Kroll Bond Rating Agency (KBRA)................................ 6
Linnell, Ian, President, Fitch Ratings........................... 8
Schulp, Jennifer J., Director, Financial Regulation Studies,
Center for Monetary and Financial Alternatives, Cato Institute. 11
APPENDIX
Prepared statements:
Gomez-Vock, Mariana.......................................... 32
Le Pallec, Yann.............................................. 41
Liang, Angela................................................ 51
Linnell, Ian................................................. 61
Schulp, Jennifer J........................................... 67
Additional Material Submitted for the Record
Sherman, Hon. Brad:
Written statement of Creative Investment Research............ 73
NRSRO Corporate Issuer Ratings Scores........................ 83
Davidson, Hon. Warren:
Letter to Financial Services Committee Chairwoman Waters from
Financial Services Committee Ranking Member McHenry and
IPECM Subcommittee Ranking Member Huizenga requesting a
hearing with the full SEC, dated May 5, 2022............... 84
Le Pallec, Yann:
Written responses to questions for the record from
Representatives Hill and Huizenga.......................... 86
A NOTCH ABOVE? EXAMINING THE
BOND RATING INDUSTRY
----------
Wednesday, May 11, 2022
U.S. House of Representatives,
Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Brad Sherman
[chairman of the subcommittee] presiding.
Members present: Representatives Sherman, Maloney, Scott,
Foster, Vargas, Gottheimer, Axne; Huizenga, Wagner, Hill,
Emmer, Davidson, Gonzalez of Ohio, Steil, and Taylor.
Ex officio present: Representative Waters.
Chairman Sherman. The Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. Also, without
objection, members of the full Financial Services Committee who
are not members of the subcommittee are authorized to
participate in today's hearing, pursuant to committee rules.
Today's hearing is entitled, ``A Notch Above? Examining the
Bond Rating Industry.''
I will now recognize myself for 4 minutes for an opening
statement. I will then recognize the ranking member of the
subcommittee, Mr. Huizenga, for 5 minutes, followed by the
Chair of the full Financial Services Committee, Chairwoman
Waters, for 1 minute.
Each year, roughly $3 trillion worth of money flows based
upon the ratings of the bond rating agencies, in commercial
paper, asset-backed securities, and corporate bonds. If the
rating is good, the interest rate is low and the project can go
forward. If the rating is low, well, it doesn't pencil out. It
is like when you get a bad credit score and you don't buy a
home, or, in this case, a business doesn't build a factory.
Earlier this year, S&P Global Ratings, the largest of the
rating agencies, came up with a proposal which triggered these
hearings, and that proposal was described as, ``notching,''
because the bond rating agencies play two roles: they rate the
insurance companies that buy the bonds; and then, they rate the
bonds the insurance companies buy. And the notching proposal,
in effect, told insurance companies that if you buy bonds that
weren't rated by S&P, that when S&P went to grade your
insurance company, you could be notched downward. That is what
triggered this hearing.
And I am pleased to say that this is the most successful
hearing I have had as Chair of this subcommittee, because S&P,
just 2 days before the hearing, announced that they were
withdrawing the proposal. Thank you for being here, thank you
for doing that, but I still believe that we should pass
legislation to prohibit notching. Current statutes prohibit
notching with regard to asset-based securities, and we now need
to extend that to corporate bonds and other issues.
There are other issues that this hearing will also deal
with, one of which is relatively new to our subcommittee, and
that is whether our bond rating agencies should be allowed to
rate the bonds of Russia or Belarus, and whether we should
allow our issuers to pay for bond ratings from foreign bond
rating agencies that choose to continue to provide services,
that is to say, whether we should impose secondary sanctions
designed to prevent the rating of Russian and Belarusian bonds.
Another issue is whether the bond rating agencies will be
forced to do something that they haven't chosen to do, which is
to speak English to the 320 million Americans who don't
understand that the 12th highest rating, Ba2, unless the 12th
highest rating is BB, which, I might add, is better than B+/2
ratings. There are those who think that maybe we should tell
people what is the highest rating, what is the second-highest
rating, what is the third-highest rating, et cetera. There are
others who believe that bond rating agencies ultimately paid
for by the American people should speak in a language
understandable to those not initiated to Wall Street.
A final issue comes up, and that is the incentives for the
bond rating agency to give the rating that the people who
select the bond rating agencies, the issuers of the bond,
prefer. This is the only game where the umpire is selected by
one of the teams. Trust me, if the Dodgers got to pick the
umpire, Kershaw would never throw another ball. So, whether or
not bond rating agencies should continue to be the only
professionals in our society not subject to professional
liability for malpractice, and at the same time, should be
selected by the issuer, which means all of the incentives are
to please the issuer and there is no risk of liability for
giving too strong a rating, those are the issues that this
hearing will address, in addition to whatever other issues
Members wish to bring up.
I now recognize the ranking member of the subcommittee, Mr.
Huizenga, for 5 minutes.
Mr. Huizenga. Thank you, Chairman Sherman. While the title
for this morning's hearing, ``A Notch Above? Examining the Bond
Rating Industry,'' gets an A for creativity, I sadly have to
give the subcommittee's work and agenda a failing grade.
Unfortunately, hearings for the subcommittee have become very
rare in leaving precious time and resources to focus on issues
that are actually timely. In fact, Democrats have failed to
hold a meaningful hearing on our capital markets in over a
year. I know that it is called the Subcommittee on Investor
Protection, Entrepreneurship, and Capital Markets. I have seen
a lot of discussion about investor protection, a little bit of
conversation about entrepreneurship, not a whole lot, and it
has been a big fat zero on the capital markets side. So, let me
be very clear. I have my own concerns about S&P's recently-
rescinded proposal, but to hold yet another hearing on our
nation's credit rating agencies is, at the very least,
misguided.
Earlier this week, as you noted, Mr. Chairman, S&P pulled
back on proposed changes to the risk-based adequacy methodology
for insurers, which begs the question, why is this hearing
moving forward in this fashion? At the very least, pushing
Congress to engage on this issue seems premature, given that
stakeholder input had seemed to move that ball. So, let us be
clear: Our capital markets are under attack. Since the
gentleman from California has become Chair, the SEC released a
rulemaking agenda that contains nearly 60 far-reaching
proposals. And what is even more alarming from that list is
that the Agency has proposed 16 rules in the first quarter, the
first 3 months of this year alone, often leaving a scant 30-day
window to comment.
So, since the start of the calendar year, the only time
Democrats have cared to comment on the SEC's agenda was to
congratulate them on their proposed climate disclosure rule. A
500-page rule, I might add, which, SEC's own analysis, will
cost billions of dollars to comply, with most of that cost
being passed down to hardworking Americans. In contrast,
Republicans have continued to sound the alarm on a number of
these harmful proposals. So, let me ask the question: What will
prompt Democrats on this committee to get serious about
oversight? In the 116th Congress, with a Republican in the
White House, Chairwoman Waters held a hearing with the entire
SEC Commission, but has repeatedly ignored requests from myself
and Ranking Member McHenry to hold one this year. Why is that?
Are they hiding something?
Given the breadth of issues before the Commission, and
given the size and importance of our markets, I am sure Members
on both sides of the aisle would appreciate a hearing to
understand the Commission's ongoing deliberations, given their
aggressive agenda. I would hope my Democrat colleagues would
also appreciate a hearing to explore why the Commission is
ignoring its mission to facilitate capital formation. If you
don't want to bring the full Commission in to testify, how
about an oversight hearing with the the SEC's Division of
Enforcement? Last month, the SEC acknowledged a very
significant breach in protocols between the SEC's adjudicatory
and enforcement functions, with potential ramifications
regarding the fairness over prior SEC enforcement actions. How
about a hearing on digital assets?
Last week, the SEC announced an expansion of its crypto
enforcement team, which nearly doubled the size of the unit.
Why is this significant and timely? Well, given the Chair's
inability to provide clarity and transparency to the $3
trillion digital asset ecosystem, I would be interested in
knowing what prompted his decision to move forward on that. To
quote Commissioner Hester Peirce, ``The SEC is a regulatory
agency with an enforcement division, not an enforcement
agency.'' So, why are we leading with enforcement in crypto?
What about a hearing on the impact of the bipartisan Jobs Act,
which just had its 10th anniversary last month, or maybe we
could focus on legislative proposals to help fuel capital and
growth on Main Street? Just because the SEC has zero capital
formation items on its agenda, doesn't mean we can't focus on
it; it does not mean we should be ignoring our job.
These are the timely topics for the hearings, and, by the
way, ones that Republicans held while we were last in the
Majority, yet, again, today's hearing topic is not. So this
subcommittee, and we as lawmakers, should focus and prioritize
issues that will expand opportunity for retail investors and
promote capital formation for small businesses, all while we
are protecting those investors. I look forward to hearing from
our witnesses today in how we can best accomplish that.
Mr. Chairman, I yield back.
Chairman Sherman. Without objection, I will put in the
record a letter dated April 14th, signed by 13 Democratic
Members of this committee and 9 Republican Members of the Full
Committee, asking the SEC to intervene to stop the
anticompetitive S&P notching proposal, which was withdrawn just
2 days ago.
Without objection, it is so ordered.
And with that, I will now recognize the Chair of the Full
Committee, Chairwoman Maxine Waters, for 1 minute.
Chairwoman Waters. Thank you so very much, Chairman
Sherman, for holding this very timely hearing. I am so pleased
with the leadership that you are providing for this
subcommittee, and I am so pleased today that we have oversight
on bond rating agencies, and that what you have done has caused
them to pull back something that would have been grossly
unfair, and so you have done a great job. And as for the
gentleman from Michigan, I think he does not understand that we
are in charge, and I am the Chair of this committee. You are
one of the subcommittee Chairs. He does not dictate to us what
our agenda is. We develop that agenda, and if he is trying to
draw attention away from the oversight on bond rating agencies,
that is not going to happen.
Mr. Huizenga. It will be remembered.
Chairwoman Waters. I have long called for robust oversight
of the bond rating agencies, particularly after Wall Street's
and the financial market's overreliance on the often-erroneous
credit ratings of just three agencies directly contributed to
the 2008 financial crisis. It has been my goal to empower
investors and other market participants with an abundance of
accurate information, and anti-competitive practices, like the
S&P's latest proposal, run counter to those--
Mr. Huizenga. Mr. Chairman--
Chairwoman Waters. While S&P may have withdrawn this
proposal, I am concerned it and other credit rating agencies--
Mr. Huizenga. Mr. Chairman, we are 30 seconds over time.
Chairwoman Waters. --have other anti-competitive practices
that, if allowed to fester--
Mr. Huizenga. Mr. Chairman, we are 30 seconds over time.
Chairwoman Waters. --will harm our market and the American
public investing their hard-earned dollars.
Mr. Huizenga. [Inaudible].
Chairwoman Waters. Thank you for holding this hearing, and
I yield back the balance of my time.
Chairman Sherman. Today, we welcome the testimony of our
distinguished witnesses.
I now recognize our first witness, Yann Le Pallec, who is
the executive managing director and head of global ratings
services for S&P Global Ratings. You are recognized for 5
minutes.
STATEMENT OF YANN LE PALLEC, EXECUTIVE MANAGING DIRECTOR AND
HEAD OF GLOBAL RATINGS SERVICES, S&P GLOBAL RATINGS
Mr. Le Pallec. Mr. Chairman, Mr. Ranking Member, Madam
Chairwoman, and members of the subcommittee, good morning. My
name is Yann Le Pallec. I am an executive managing director and
head of global ratings services at S&P Global Ratings, and a
member of the S&P Global Ratings Operating Committee. I oversee
a group of approximately 1,400 credit analysts present in 28
countries and covering more than 1 million outstanding ratings
on entities and securities across a wide range of sectors,
including governments, corporations, financial institutions,
and structured finance. I appreciate the opportunity to testify
as part of today's hearing.
S&P Global Ratings is committed to providing the financial
markets with timely, transparent, and high-quality credit
ratings. Credit ratings are forward-looking opinions about the
ability and willingness of debt issuers, like corporations or
governments, to meet their financial obligations on time and in
full. As opinions, credit ratings are not fungible, meaning
that there are true analytical differences among the credit
ratings and credit ratings' methodologies on different credit
rating agencies. And just like how opinions evolve, our credit
ratings and our credit rating methodologies can and do evolve
over time.
By regulation and S&P policy, we publish all new proposed
rating methodologies and proposed material updates to our in-
use methodologies in advance so that market participants can
review and comment on our proposals. We consider comments
received from the market, and we make those comments publicly
available upon the publication of our final criteria. By SEC
regulation and S&P policy, employees participating in
developing or approving our procedures and methodologies used
for determining credit ratings cannot be influenced by sales or
marketing considerations. And we maintain a strict separation
between analytical and commercial activities within S&P Global
Ratings.
On December 6, 2021, we published a request for comment, or
RFC, on certain proposed changes to our methodology and
assumptions for analyzing the risk-based capital adequacy of
insurance companies. An insurer's risk-based capital adequacy
considers the amount of capital that an insurance company may
need to cover any losses across its different exposures and is
one of the key factors in our framework for rating all
insurers. Our RFC process gives the market the opportunity to
provide feedback and voice any concerns about our proposals
prior to the finalization and implementation of our final
criteria. We thank market participants for the extensive
engagement and high volume of comments they have provided in
response to our December 2021 RFC. We take the market's
comments and feedback seriously.
As set out in our RFC publications, our proposed
methodology change was intended to improve our ability to
differentiate risk, enhance the global consistency of our
methodology, improve the transparency and usability of our
methodology, and account for more recent data and experience
since our last update of our insurance capital model criteria
in 2010. However, given the nature of some of the concerns
raised in the comments that we received through our RFC
process, on May 9, 2022, we announced to the market that we
have withdrawn parts of the proposed approach and we are
considering alternatives. While we believe certain of the
criticisms made to date in the press misconstrued our proposal
and are unfounded, we have heard the markets' concerns.
My submitted testimony goes into more depth on the proposed
application and the intent of the withdrawn sections of our
RFC, but I am happy to address any questions you may have on
these issues. As I mentioned, we are considering alternatives
for the withdrawn elements of the proposed criteria. After we
have had sufficient time to consider the high number of
comments received, we intend to issue a subsequent RFC and then
will finalize the criteria article in its entirety, consistent
with our criteria development process.
Throughout our RFC process, we have engaged in high levels
of transparency and interaction with the market, and we are
committed to maintaining that transparency and interaction as
we move forward to the next phase of our process. Thank you,
and I look forward to your questions.
[The prepared statement of Mr. Le Pallec can be found on
page 41 of the appendix.]
Chairman Sherman. Thank you. Next, we have Angela Liang,
who is the general counsel at the Kroll Bond Rating Agency.
STATEMENT OF ANGELA LIANG, GENERAL COUNSEL AND EXECUTIVE
COMMITTEE MEMBER, KROLL BOND RATING AGENCY (KBRA)
Ms. Liang. Thank you. Chairman Sherman, Ranking Member
Huizenga, Chairwoman Waters, and distinguished members of the
subcommittee, thank you for the opportunity to testify today. I
am Angela Liang, KBRA's general counsel and Executive Committee
member. I am grateful for the subcommittee's strong bipartisan
interest in issues being discussed today. This hearing is
particularly critical and timely given the impact of S&P's
proposed risk-based capital methodology. While S&P temporarily
withdrew certain sections of its methodology a mere 2 days
before this hearing, the proposal caused immense concern and
confusion among market participants in all sectors as they
grappled with the likely negative effects of the proposal and
decreased competition among nationally recognized statistical
rating organizations (NRSROs).
KBRA was founded in 2010, and it is a full-service credit
rating agency. It is one of the five largest rating agencies
globally, and the largest rating agency established after the
2008 financial crisis. Mr. Chairman, we believe that KBRA's
entry into the market has been extremely positive for
investors. We offer a diverse perspective and have restored
transparency and analytical rigor to credit analysis. However,
we and other small and medium-sized NRSROs continue to face
barriers to competition. Despite KBRA's success over the past
12 years, the Big Three still command approximately 95 percent
market share and are woven into the fabric of our financial
system. For example, many investor guidelines still refer to
only the incumbent NRSROs. Certain key bond indices require
that its security be rated by at least one of the Big Three.
Government regulations and recent government facilities still
reference the largest NRSROs by name, rather than all NRSROs.
I would also like to highlight the importance of bond
indices. Many investors benchmark to the S&P Bond Index or
Bloomberg's Fixed Income Indices and, therefore, are not able
to purchase bonds not rated by the Big Three because they are
not index-eligible. We believe that the continued lack of open
competition is by far the biggest problem facing the credit
rating industry today. KBRA has been successful because of its
relentless focus on transparent, thorough research and investor
feedback, but it has not been easy.
In our view, entrenchment of the Big Three disadvantages
the financial markets, investors, and the public writ large.
The impact that a mere proposal had on the market demonstrates
S&P's significant market power and its ability to impede
competition using that power. While S&P withdrew for the time
being the anti-competitive sections of its proposal, we are
concerned that S&P will continue to consider approaches with
similar anti-competitive effects.
In addition to already-significant systemic barriers to
competition, S&P's proposed methodology would have allowed S&P
to notch down KBRA's ratings from AAA to as low as CCC. If
S&P's methodology had been implemented, it would have further
reinforced S&P's position as the most-dominant credit rating
agency by establishing disparate and arbitrary treatment of
non-S&P ratings on bonds across all asset classes held in S&P-
rated insurance company portfolios.
The negative market reaction to S&P's proposal was swift,
clear, and widespread. We are aware that many diverse market
participants submitted comments and provided feedback to S&P
beginning in early January. In addition to the concerns raised
by this committee, the Department of Justice submitted a
comment identifying potential violations of antitrust laws
stemming from S&P's proposal, and yet it took S&P 5 months to
withdraw the problematic sections of the proposal.
What can we do to prevent the aversion of fair competition
among NRSROs? Mr. Chairman, in our view, many components of the
NRSRO provisions of the Dodd-Frank Act have been highly
successful and have meaningfully improved the credit rating
industry. The requirement that NRSROs publicly post their
methodologies and substantive changes to them allows investors
to analyze methodologies in advance of implementation. This
requirement was key in S&P's withdrawal of proposed changes
that would have had further negative effects on the market and
NRSRO competition. Still, we believe there is room to
strengthen Federal law to bolster competition and increase
disclosure. We support current legislative efforts to prohibit
notching and to prohibit credit rating agencies from taking
actions that have an anti-competitive effect while maintaining
credit rating agencies' ability to determine their rating
methodologies.
We encourage Congress, the Department of Justice, and the
SEC to continue to scrutinize S&P's proposed methodology, and
to take swift and decisive action to prevent anti-competitive
behavior such as notching, or any feature that includes
disparate treatment of other NRSROs.
Mr. Chairman, I thank the subcommittee for the opportunity
to testify today, and I look forward to your questions.
[The prepared statement of Ms. Liang can be found on page
51 of the appendix.]
Chairman Sherman. Now, I recognize Ian Linnell, the
president of Fitch Ratings.
STATEMENT OF IAN LINNELL, PRESIDENT, FITCH RATINGS
Mr. Linnell. Chairman Sherman, Ranking Member Huizenga, and
distinguished members of the subcommittee, I appreciate the
invitation to appear before you to discuss the anti-competitive
practice called notching, and how S&P is, in our view, using
this practice in its proposed insurer capital adequacy
methodology to further its market dominance.
While we are pleased that on Monday, S&P effectively
admitted that they had no basis for the proposed methodology,
we hope that both S&P and Moody's will now consider
alternatives to notching in local government investment pools,
money market funds, bond funds, and collateralized loan
obligations (CLOs), which fund U.S. small companies where
either one or both of them are currently engaged in this
behavior.
In 2006, Congress passed the Credit Rating Agency Reform
Act to foster accountability, transparency, and competition in
the credit rating agency industry. Although the Reform Act
addressed the notching conducted by both S&P and Moody's in the
period before its passage, both agencies have continued to
engage in this activity, and the SEC has failed to stop it.
Fitch Ratings is a global rating agency located in over 25
countries. During the last 3 decades, Fitch has become the only
credible challenger to the duopoly of Moody's and S&P in the
credit rating industry. Credit ratings play an important role
in the efficient allocation of capital by providing the
financial markets with an independent view of credit risk. Any
measure that reduces competition in the credit rating agency
industry hurts the marketplace.
S&P's methodology is fundamentally anticompetitive because
it incorporates the practice of so-called notching into S&P's
assessment of insurer capital adequacy. Notching occurs when an
agency either insists on rating most, if not all, of the assets
owned by an entity and/or significantly reducing the ratings
that other agencies have assigned to assets that they have not
rated.
The proposed methodology applies significant haircuts to
all non-S&P-rated investments held by insurance companies. As a
result, securities held by an insurer rated AAA by Fitch or
Moody's could have their credit rating lowered to AA- by S&P,
while securities rated AAA by other agencies or by the National
Association of Insurance Commissioners (NAIC) could be rated
CCC. We believe that S&P withdrew the methodology and continues
to fail to explain its methodology because no explanation
exists. The methodology was a pretext by S&P to use its
dominant market position in insurance to increase its market
share in the securities commonly purchased by insurers,
including areas where S&P has a low market share.
S&P's ratings are hardwired into many insurers' broker
systems and brokers typically have criteria for recommending
insurers to clients that only refer to S&P or AM Best ratings.
This market power gives S&P a monopoly on insurer financial
strength ratings and makes insurers hostages to S&P. As
insurers are focusing on maintaining their S&P ratings, they
would be discouraged from purchasing securities in those
sectors where S&P rates relatively few securities. Insurers and
the issuers of securities that insurance companies purchase
would select S&P to avoid the punitive notching of the
methodology and the negative impact on insurance financial
strength ratings.
Fitch was not alone in criticizing the methodology. Many
market participants have condemned S&P's proposals. In
addition, the Department of Justice recently commented that
S&P's methodology has the potential to suppress competition
from rival rating agencies.
S&P and Moody's have been engaging in notching for over 20
years. It is time for Congress to ban notching in all market
sectors and for the SEC to start enforcing this ban.
Thank you for your time and your attention on this critical
matter. I welcome any questions that you may have.
[The prepared statement of Mr. Linnell can be found on page
61 of the appendix.]
Chairman Sherman. Next, we have Mariana Gomez-Vock, who is
the senior vice president for policy development at the
American Council of Life Insurers.
STATEMENT OF MARIANA GOMEZ-VOCK, SENIOR VICE PRESIDENT, POLICY
DEVELOPMENT, AMERICAN COUNCIL OF LIFE INSURERS (ACLI)
Ms. Gomez-Vock. Good morning. Thank you, Chairwoman Waters,
Chairman Sherman, and Ranking Member Huizenga, for having me
here today. My name is Mariana Gomez-Vock, and I am proud to be
here today representing the American Council of Life Insurers.
Before I dive too much into the details, I would like to
briefly touch on the big picture, because I think it
demonstrates why we care about this issue so much.
The big picture is that 90 million American families,
people you represent, depend on the life insurance industry to
protect their financial future. Life insurance annuities,
disability insurance, paid medical leave, and other products
make certain that they can care for themselves and their loved
ones in good times and bad. Our policies often stay with
families for decades, and our promise to them is that we will
be there no matter what, and we are. When the pandemic hit,
life insurers were there. The pandemic hit many industries
hard--retail, restaurants, airlines--but we were the industry
that was writing checks and paying out to families. We were
there when the worst came for too many. Benefits paid in 2020
were the highest in history. The industry paid over $90 billion
in life insurance benefits, and it is our long-term investments
that are the bedrock of our commitments to be there when we are
called.
We invest $7.4 trillion in the U.S. economy. That is $572
million every day. That makes life insurers one of the largest
sources of investment capital in the nation, and our
investments do more than protect policyholders. They drive
economic growth in every corner of the country. Steady slow-
growth investments make it possible to keep our promises while
providing business owners, farmers, school systems, and
communities with the working capital that they need to open
their doors, fund infrastructure, and grow their workplace.
That is the big picture. Now, let us dig deeper.
Insurer capital models like the one proposed by S&P are so
critical to insurers that they will often shape their long-term
investment and capital management strategies to align with
them. When a rating agency notches an investment, it is
signaling that it believes the asset has a higher risk of loss
or default, and the insurer should hold more capital against
it. S&P has proposed a notch, and, in some cases, disregarded
credit ratings from competitors and designations from the NAIC
Securities Valuation Office. In some cases, the notching would
assign a 100-percent capital charge to an investment-grade
asset without any clear reason for the notching, other than it
is rated by an S&P competitor. We appreciate S&P's decision to
revisit that part of their proposal because notching assets
just because they are rated by a competitor will compromise the
integrity of financial strength ratings and could disrupt
capital markets. That is a bad outcome for consumers and the
economy.
Before I conclude, I would like to make three brief points.
The first is that ACLI supports robust competition. Competition
and diversity among the NRSROs benefits the insurance industry,
the economy, and ultimately, consumers.
The second point is that automatic notching is not
harmless. It creates a fundamental disconnect between the
asset's value and the asset's charge. Large swathes of
insurance bond portfolios would have been notched, and
structured products not rated by S&P would have been treated as
junk under the S&P's original proposal.
We look forward to exchanging views with S&P on the
appropriate treatment of NAIC-designated securities. The
proposal's disregard of these designations is counterintuitive,
given that the NAIC designations are designed for and overseen
by State regulators whose mission is to preserve the solvency
of insurers and protect consumers. There is no conflict of
interest there. Automatic notching essentially inflates asset
charges. It would force insurers to choose between holding
artificially-inflated levels of capital or to avoid high-
quality, high-yield assets just because they are rated by a
competitor. Both outcomes are bad.
The third point addresses the proposal's impact on the
competitive global insurance market. Some of the changes were
designed to promote global consistency, an understandable goal,
but some elements of the proposal appear to disadvantage
American regulatory and accounting regimes. This could
disadvantage U.S. insurers' ability to offer key products to
consumers, like variable annuities and whole life. We look
forward to continuing the dialogue on this issue.
One final observation. Much of this is highly technical,
but the details matter. They matter because individuals and
families all across this country are seeking certainty, and we
are in the business of providing certainty. We are there for
our policyholders when they need us. We are there for
communities who rely on our economic investments in our towns,
suburbs, and cities so they can feel America's commerce and
ingenuity. A change by the world's largest rating agency will
have an impact. Those changes should be transparent and
supported by data. We urge you to think of those details and
the impact that they will have.
Thank you for the opportunity to share our view. I look
forward to answering any questions you may have.
[The prepared statement of Ms. Gomez-Vock can be found on
page 32 of the appendix.]
Chairman Sherman. And finally, we will hear from our last
witness, Jennifer Schulp, the director of financial regulation
studies at the Cato Institute.
STATEMENT OF JENNIFER J. SCHULP, DIRECTOR, FINANCIAL REGULATION
STUDIES, CENTER FOR MONETARY AND FINANCIAL ALTERNATIVES, CATO
INSTITUTE
Ms. Schulp. Chairman Sherman, Ranking Member Huizenga, and
distinguished members of the Subcommittee on Investor
Protection, Entrepreneurship, and Capital Markets, my name is
Jennifer Schulp, and I am the director of financial regulation
studies at the Cato Institute's Center for Monetary and
Financial Alternatives. Thank you for the opportunity to take
part in today's hearing.
The state of competition within the bond rating industry is
a perennial question. The Security and Exchange Commission's
most recent report to Congress describes the concentrated
NRSROs industry, with the three largest NRSROs accounting for
approximately 95 percent of all outstanding ratings as of the
end of 2020, but such broad statistics can be deceptive. As the
Commission points out, smaller NRSROs have increased their
total number of ratings outstanding, and have increased their
share in some ratings categories. Moreover, drawing conclusions
about competition from these numbers alone is difficult. A
number of factors may explain the long-term tendency for the
ratings industry to be comparatively concentrated. And,
importantly, regulatory barriers can decrease competition.
Legislative solutions should focus on lowering regulatory
barriers and decreasing the artificial demand for NRSRO
ratings.
The subject of today's hearing relates to a recent proposal
now withdrawn by S&P Global Ratings to notch down ratings of
non-S&P-rated securities when applying its methodology to rate
life insurers' investment portfolios. While such notching may
raise concerns about its effect on competition, legislative
action is premature.
First, the proposal has been withdrawn in response to
critical comments. S&P has indicated that it will issue a new
request for comment which may ameliorate any potential anti-
competitive concerns or raise different ones. It would be
prudent to delay consideration of potential legislative action
until the issue becomes more clear.
Second, other laws already prohibit anti-competitive
behavior. In addition to the antitrust laws that apply without
regard to industry, Section 15E of the Exchange Act, and the
Commission's rules, prohibit unfair, coercive, or abusive NRSO
behavior. Additional legislation may not be required.
Finally, rushing to judgment on the methodology change
proposed may itself harm ratings quality by limiting NRSROs
from considering the creditworthiness of instruments rated by
another agency, or by substantively regulating credit ratings
and rating methodologies.
Given this committee's hearing on NRSROs less than a year
ago, I respectfully suggest that there are other issues more
suited to the investment of this committee's limited resources.
For example, the Commission's agenda may be the most ambitious
in its history. It is being undertaken at breakneck speed and
with an unprecedented disregard for the importance of public
comment to the rulemaking process. While short comment periods
have the potential to limit public comment on proposed rules,
particularly where those rules are complex, public input is
limited even further when commenters are unable to analyze the
interrelationship of a large number of proposed rules,
including their unintended consequences.
The Commission's recent announcement that it would extend
the time period for its climate risk disclosure proposal, and
reopen comment on two other proposed rules, is welcome, but
does little to alleviate broader concerns where short comment
periods have predominated and continue to do so. The ability of
the public to comment on proposed rules and the effect of
limited public comment on the quality of rulemaking should be
of concern to this committee.
The Commission's agenda also raises a number of issues
relevant to this committee's interests in investor protection,
entrepreneurship, and capital markets, including the
Commission's proposed rules on climate risk disclosure and
private fund disclosure. What is missing from the Commission's
agenda is also notable. There is little that arguably
constitutes a plan for supporting capital formation, and many
of the Commission's proposed rules and agenda items may operate
to deter entrepreneurship. The Commission's agenda also lacks
items relevant to the regulation of digital assets, except
where rule proposals may have effects the Commission has
declined to discuss. The Commission has instead chosen to lead
with enforcement actions over rulemaking in this space.
These are just a few of the issues in connection with the
Commission's current agenda that are more deserving of this
committee's time and attention than additional focus at this
time on NRSRO regulation. Thank you, and I welcome any
questions that you may have.
[The prepared statement of Ms. Schulp can be found on page
67 of the appendix.]
Chairman Sherman. Thank you. We have heard from our
witnesses. I will now recognize myself for 5 minutes for
questions.
This is known as the Capital Markets Subcommittee. Our last
hearing was on the stock markets. This hearing is about the
most critical part of the bond markets. It is hard to say that
we are not focusing on our capital markets. Though as a
philatelist, I believe that perhaps we are leaving out the
market for collectible stamps. So, we are covering the bond
market. We are covering the stock market.
The critical role that the bond rating agencies play is
exemplified by the fact that if you are putting together a
portfolio, and you generate a 5.7 percent return on bonds rated
either AA or AAA, you look good compared to somebody else who
puts together a portfolio meeting the same requirements, who is
only getting 5.6 percent. The fact is, whether you are putting
together a portfolio for an insurance company and trying to
please your boss there, or whether you are putting together a
portfolio for a mutual fund, the ratings determine what you
need to put into that portfolio.
As to the problem that is focused on in this hearing, we
are being told by some that it is not an important problem.
Nine Republican Members signed the letter urging that this
problem be dealt with, and I think our witnesses have
illustrated how important this problem is. And as I say, I
think this subcommittee hearing was remarkably effective and
that the proposal has been withdrawn, but that raises the
question for our witness from S&P, Mr. Le Pallec, is this
proposal dead or just sleeping for a while?
Mr. Le Pallec. Thank you, Mr. Chairman, and I appreciate
you giving me the opportunity to give more information on the
ongoing request for comment process. On Monday, the 9th of May,
we published a FAQ that announced the withdrawal of one
particular section that was describing the way we were
proposing to deal with a fairly complex technical issue, which
is how to assess the thousands of securities held by insurers.
Chairman Sherman. I am going to interrupt you there. We
have an anti-notching statute that deals with asset-based
securities. Is there any reason we shouldn't extend that to all
bond issuances?
Mr. Le Pallec. I have no particular view about that. What I
am trying to say is that--
Chairman Sherman. Well, that is the major proposal being
considered by this subcommittee, and on our list of proposals,
and the fact that you aren't here to oppose that proposal
commends it to all of our colleagues.
Mr. Le Pallec. We have an open request for comment that
continues. We will continue to take in comments. There were
serious concerns raised. We took them into account. It is out
there for everyone to see.
Chairman Sherman. I thank you for doing that, and knowing
that this issue could come up in the months and years ahead, I
think that we need legislation. Why don't I ask the gentleman
from Fitch? One proposal before us is that we prevent the bond
rating agencies of the United States from rating any new
instruments coming out of Russia and Belarus more particularly,
or we might limit it to certain state-affiliated firms. We
could go further with secondary sanctions and turn to the
foreign-based bond rating agencies and say, if they rated such
bonds, they could not rate bonds here in the United States, or
at least American issuers couldn't pay them to do so. What
effect would denying bond ratings to all future issuances by
Belarus and Russia have on their ability to raise capital? Mr.
Linnell?
Mr. Linnell. For us, in Russia, the ship has already
sailed. We announced the suspension of commercial operations in
Russia on March 7th. We announced on March 23rd our intention
to withdraw the ratings in Russia. Towards the end of March,
several banks--
Chairman Sherman. Thank you. I will ask the gentleman from
S&P, Mr. Le Pallec, are you still rating Russia?
Mr. Le Pallec. No, we don't. We withdrew all our ratings on
Russian entities--
Chairman Sherman. Are foreign-based bond rating agencies
rating them, the Japanese, the Europeans? You don't know?
Mr. Linnell. I'm sorry to just interrupt. The EU passed a
law that for any rating agency based in Europe that endorses
international ratings, they have to withdraw their ratings by
April 15th.
Chairman Sherman. Okay. Next, I will ask our representative
from Kroll, Ms. Liang, we have a system of different ratings.
Instead of saying first-best, second-best, third-best, fourth-
best, all the way up to 18th-best, we have weird combinations
of plus and minus signs, and capital and small letters, which
are absolutely unintelligible. What would be the harm to the
bond rating agency if you just said, first-best, second-best,
third-best? Would it be a great harm to our society if my
constituents could understand what you are saying?
Ms. Liang. Thank you for your question, Chairman Sherman. I
don't think it would be any harm to your--
Chairman Sherman. I see that my time has expired. I am
going to ask you to respond for the record.
Ms. Liang. Okay.
Chairman Sherman. I now recognize the ranking member of the
subcommittee, the gentleman from Michigan, Mr. Huizenga, for 5
minutes.
Mr. Huizenga. Thank you. Ms. Schulp, the pace and substance
of the SEC rulemaking is unlike anything I have seen as well in
the 6 terms that I have been here doing this. And as you had
pointed out, coupled with those short comment periods, they are
releasing rules really without articulating how they are going
to interact or potentially contradict some of their other
proposals. For instance, SEC securities lending, short
disclosure, and swaps rules impact similar markets without
specifying how the rules will interact with one another. Do you
believe that the SEC has clearly articulated how these rules
are supposed to work together?
Ms. Schulp. No, I don't believe they have. A similar
problem exists with respect to the 10b5-1 plans and the share
repurchase disclosure as well.
Mr. Huizenga. Okay. And you have sort of articulated this
in your opening statement. You would agree that the common
effect of all of their rules really isn't understood by the
Commission, much less those that they are actually regulating,
correct?
Ms. Schulp. Correct.
Mr. Huizenga. Okay. It should be noted that these rules are
being released during a period of extreme market volatility as
well. And I am curious, in your view, do you think these rules
could be potentially adding to some of that volatility that we
are currently seeing?
Ms. Schulp. It is difficult to say what exactly is adding
to the market's volatility, but the uncertainty caused by these
rules can be disruptive, both to the economy, as well as the
financial industry generally.
Mr. Huizenga. We have lots of reasons to talk to the SEC
and other regulators. I guess we will have to get to those
hearings in about 7 months, but trust me, it is going to be
busy, so buckle up and hang on everybody.
Ms. Gomez-Vock, one of the overreaching criticisms of the
S&P proposal is that it diverges significantly from the U.S.
regulatory framework. As I noted in my opening remarks, some of
my original concerns remain, and I certainly would like to see
S&P address those in any forthcoming proposals. My concern is
that the divergence from the U.S. system will have material
impact on insurers and their products that they offer in the
financial marketplace. For instance, it appears that long-term
guarantee products, such as variable annuities, which our U.S.
companies offer, will be especially impacted by this proposal,
unnecessarily raising costs, limiting availability, et cetera,
and I am just wondering if you could comment on that?
Ms. Gomez-Vock. Yes, products like variable annuities and
their availability, accessibility, and affordability, which
help people live and retire with predictable income, could be
particularly impacted. And we are concerned with the S&P's
proposal, the fact that it does diverge significantly.
Mr. Huizenga. What is the management issue there? What is
going to make it more difficult to manage that and put you at a
competitive disadvantage?
Ms. Gomez-Vock. I think there are a number of different
reasons, given the complexity of the actual formula itself. But
the big-picture issue is that for insurers, it is very
difficult, if not impossible, to manage two different capital
standards, and the U.S. system is the NAIC risk-based capital
system. It is a book value-type approach that uses reserves and
is more cash flow-based. The S&P global capital model is more
similar to Solvency II and the ICS. It is more of a market-
consistent framework which tends to be unfriendly to long-term
products.
Mr. Huizenga. Okay. Thank you. Mr. Le Pallec, I would like
to take a moment and discuss S&P's recent decision to publish
ESG indicators for U.S. States. Do you agree that these
ratings, whether they are done by S&P or, frankly, any other
credit rating agency, should be based solely on financial
indicators within the State and items that are material to the
creditworthiness of the rated entity, or are you looking at
something else?
Mr. Le Pallec. We have taken into account ESG risks in
credit ratings all along, whenever those risks have had an
impact on creditworthiness, and we have published that in our
rating rationale--
Mr. Huizenga. Let me stop you right there. So, materiality.
Mr. Le-Pallac. The indicators that you are talking about
are an additional element of transparency and disclosure that
we have been publishing on corporations, financial
institutions, and more--
Mr. Huizenga. Is that for everybody, whether it is material
or not?
Mr. Le Pallec. That is for all entities we rate, because
investors for the past 2 years around the world have been
asking us constantly the same question, tell us whether ESG
risks have had an impact on creditworthiness or if they have,
and why? And those indicators--
Mr. Huizenga. How about D&I? How about D&I issues or some
of those other, maybe not the ``E'' side of the ESG? Is
diversity and inclusion now also part of how you rate a company
or--
Mr. Le Pallec. To the extent that it has an impact on
creditworthiness, we have to take any ratings--
Mr. Huizenga. Again, only if it is material.
Mr. Le Pallec. The ``S'' would typically be aging
population in any municipality or State that has an impact on
cash flows--
Mr. Huizenga. My time has expired. I appreciate it. Thank
you.
Chairman Sherman. The Chair of the Full Committee,
Chairwoman Waters, is recognized for 5 minutes.
Chairwoman Waters. Thank you very much. Mr. Le Pallec,
shortly after this hearing was announced, S&P withdrew a
controversial proposal that many market observers have
suggested was anticompetitive. In fact, S&P was warned by the
Justice Department that the proposal would violate antitrust
laws. S&P deserves no praise, however, for withdrawing a
proposal it never should have put forward. Notably, this wasn't
the first time S&P proposed notching down its competitors'
ratings. In 2007, just before the financial crisis, S&P was
trying to increase the market's reliance on its own ratings by
similarly proposing to undermine its competition. One positive
outcome of S&P's latest proposal has been to draw attention to
other anti- competitive practices by the largest bond rating
agencies.
Before the 2008 economic crisis, for example, it was a
common practice among the largest two rating agencies, S&P and
Moody's, to stipulate that they would only provide a credit
rating for collateralized loan obligations (CLOs), and bond
insurers if they also rated all of the underlying securities
issued by that CLO or the bond insurer, aiming to prevent
smaller rating agencies from rating any of the underlying
securities. A decade later, does S&P's rating criteria still
stipulate that S&P will only provide ratings for bond insurers
if S&P also rates every underlying issuance of that bond
insurer? Yes or no?
Mr. Le Pallec. No, we don't.
Chairwoman Waters. I beg your pardon?
Mr. Le Pallec. We don't.
Chairwoman Waters. Ms. Liang, as a smaller rating agency,
what is the effect of this policy on KBRA and your ability to
rate securities?
Ms. Liang. Thank you, Madam Chairwoman. The effect on KBRA
as a smaller and medium-sized NRSRO would be the same as what
S&P proposed recently. I will note that the CLO market and the
bond insurer market is smaller, and so the effect may not be as
great as it would be in the insurance industry, but the effect
would be anticompetitive in practice.
Chairwoman Waters. Thank you. In 2015, Moody's, whom we
invited to today's hearing but declined to come, drew criticism
when a Wall Street Journal article reported that after a
Pennsylvania bank contracted with KBRA for a rating, Moody's
threatened to release an unsolicited rating that was lower than
the KBRA rating. Ms. Liang, from your perspective at KBRA, what
was the effect of this action by Moody's?
Ms. Liang. Thank you, Madam Chairwoman. At the time, we had
just started rating community banks, and Moody's and the larger
rating agencies were not rating that space because their
methodology had a size bias and did not permit the rating of
the smaller banks. And so, when we published our rating and
heard that Moody's was going to publish an unsolicited rating
with a lower rating, we took that to mean that they were trying
to discourage our entry into the market and also to undercut
the viability of KBRA as a rating agency.
Chairwoman Waters. More recently, S&P purchased IHS Markit,
which at the time was one of the largest data and analytical
firms in the world, for $44 billion. Rating agencies need data
to conduct their analysis. Some have raised concerns that now
that S&P is in control over IHS Markit, it may limit the
provision of this data to its competitors.
Mr. Linnell, do you share these concerns about S&P owning
such a trove of data and analytical capabilities?
Mr. Linnell. I think there is a broad benefit from groups
having and offering a broader range of credit and risk
products. It does indirectly help their core ratings business,
but I don't think you can draw a line one-for-one saying that
this reinforces their duopoly. I think the issue on the table
today around notching and anti-competitive practices is more
important, and it is a shame you didn't ask the colleague from
S&P about their CLO bond fund money market funds. The
reinsurance sector is not really a big sector anymore.
Chairwoman Waters. I have only asked you about a few of
these practices, but the list is longer. For example, S&P's
exclusion of non-S&P-rated securities from its mixed-income
indexes, S&P's notching practices in money market funds, S&P's
and Moody's heavy engagement with institutional investors to
maintain investment guidelines that favor S&P and Moody's,
among others. Investors need a diversity of ratings opinions,
and I am glad that this committee is shining a light on how
incumbent large rating agencies employ various anti-competitive
practices--
Chairman Sherman. Thank you.
Chairwoman Waters. I yield back the balance of my time.
Chairman Sherman. Yes. The gentlelady from Missouri, Mrs.
Wagner, is recognized for 5\1/2\ minutes.
Mrs. Wagner. Thank you, Mr. Chairman. I hope you can watch
the clock a little more closely here in respect to everyone,
our witnesses and our Members.
Ms. Schulp, does the Commission's rulemaking agenda include
any proposals to help facilitate capital formation? And further
to that, why should the SEC be focused on reducing burdens for
companies to access capital?
Ms. Schulp. First, the Commission's agenda does not have a
specific rulemaking or capital formation agenda items on it.
And, in fact, I am concerned, because many of the agenda items
that are on the Commission's agenda go towards putting
additional burdens on capital formation themselves, such as the
ESG disclosure rules.
Mrs. Wagner. And what else? Please elaborate.
Ms. Schulp. The ESG disclosure rules are private fund
disclosure rules where the SEC is beginning to insert itself
further into private markets, where the SEC has previously not
done so before, which puts additional costs on capital
formation in those spaces as well. There are a number of places
where the SEC's proposed rules can harm entrepreneurship and
harm the efficient allocation of capital.
Mrs. Wagner. And certainly, one would think that we should
be focused, at the SEC in particular, on reducing those burdens
to capital formation, correct?
Ms. Schulp. I agree. Part of the SEC's tripartite mission,
as they are happy to say, is to facilitate capital formation.
Mrs. Wagner. We will get to that. Our priorities in this
committee should be, I think, as I stated, reducing the cost of
capital for companies, and helping investors, our retail
investors, real people out in Missouri's 2nd Congressional
District who are trying to make both ends meet, helping those
investors grow their savings, especially during these very
difficult inflationary times. Instead, I have to say that
committee Democrats and the Commission are focused on climate
disclosure requirements for public companies and other
initiatives, as you have outlined some, Ms. Schulp, that will
ultimately discourage companies from going or staying public,
which means fewer investment options for Main Street Americans.
Ms. Schulp, there has been much discussion surrounding the
impact of the SEC's short comment periods, especially when it
comes to the multitude of potentially interconnected proposals.
Will you discuss the impact that short comment periods have on
market participants and how these historically short comment
periods impact the Commission's rulemaking process as its
ability to uphold the three-part mission as you meant--
Ms. Schulp. First, I think it is important to clarify that
market participants really mean all of us, when we are talking
about market participants here, all the way down from your
retail investor who might have opinions about how the SEC
should be regulating here, all the way up through your largest
Wall Street banks. Your largest Wall Street banks may very well
have an army of lawyers who can spend their time reading
through these proposals. But even at that, being able to
determine how these proposals interrelate, to really sit down
and think about the unintended consequences of these proposals,
short comment periods, harm that. And they harm the SEC's
ability to really understand and weigh the potential effects of
the rules that they have proposed. Short comment periods also
result in fewer comments. They likely result in fewer
complicated comments that bring some of these deeper issues to
light. That is less for the SEC to deal with when they are
finalizing rules under the Administrative Procedure Act, and I
think that is a negative. The SEC should be able to gather as
much information as possible in order to create quality
rulemakings that benefit the American people, benefit the
markets, and will also be able to stand the test of time--
Mrs. Wagner. And obviously, the smaller investors and the
smaller capital formation companies are greatly hindered by
this. Ms. Schulp, there has been no discussion on removing
barriers for everyday investors from my Democrat colleagues.
Are there any regulatory barriers you see that we in Congress
could work to remove today?
Ms. Schulp. One of the easiest is to open up the accredited
investor definition to more investors. In fact, that is on the
SEC's agenda, but not with the intention of opening it up
further, but rather taking a look at it again to close it down
and to make private market investments less available to
average individuals.
Mrs. Wagner. Barriers, barriers, barriers, when we have to
be concentrating on growing capital, capital formation, and
helping our investors grow their savings. I thank you for your
input, and I yield back the balance of my time.
Chairman Sherman. The gentleman from Georgia, Mr. Scott,
who is also the Chair of the House Agriculture Committee, is
recognized for 5 minutes.
Mr. Scott. Mr. Linnell, let me start with you. I am very
concerned about competition in the credit rating agency
industry and the impact that market domination could have on
banks, insurers, financial companies, and other industry
participants. And about the ratings market, there are some who
feel that they should remain as they are, which really looks
like an oligopoly where only a small number of participants
compete in order to safeguard their reputations of the ratings.
However, studies that have been brought to my attention have
shown that competitive dynamics, even amongst a small number of
rating agencies, can result in higher-quality ratings and
potentially mitigate the inherent conflict of interest in the
issue-payers model.
Mr. Linnell, tell me, how would you assess competition
amongst the credit rating agencies, and how is this competition
distinct from other markets?
Mr. Linnell. I think since the passing of the Dodd-Frank
Act after the financial crisis, competition in the rating
agency industry in general has intensified. We are seeing more
and more new entrants. I think a good example of that is what
we are talking about today, really one aspect of it, which is
the U.S. structured finance market. There, back around 2010,
you really had the Big Three firms competing with each other:
Fitch; Moody's; and S&P. But since then, you have had the new
entrants. We have Kroll, and then you have had DBRS expanding
with the merger with Morningstar, and their market share has
increased significantly. They are up to about 20, 25 percent of
the market each, while the Big Three have come down quite
steadily to around about 45 percent, and we are about 30
percent.
What you have there is a market that has gone from three
large players to one, where there are five agencies competing
with each other, and there are new agencies coming up all the
time. So I think competition is good, but there are still
problems in the industry, and S&P and Moody's benefit from
institutional barriers, but some due to their own policies
which they have put in place, such as notching, which is what
we are here to discuss today.
Mr. Scott. Okay. Do you believe that robust competition for
the credit rating industry is the absolute best way to promote
the continued integrity, reliability, and quality of their
ratings?
Mr. Linnell. Yes, as long as it is combined with
transparency. As long as you have transparency around the
performance of those ratings, how those ratings have been
developed, what analysis and what issues support those ratings,
then, yes, absolutely, competition tends to produce--
Mr. Scott. How would you rate transparency in the industry
right now?
Mr. Linnell. I think it is pretty good. The agencies
generally had a high level of transparency going into the
financial crisis, but regulatory reforms around Dodd-Frank and
similar regulations in Europe promoted a much greater level of
consistency in the way that agencies provide information to the
market. I think the level of transparency is--
Mr. Scott. Yes. I want to get to Ms. Liang with this
question. Ms. Liang, you cited in your testimony how difficult
it is to even enter the credit rating agency market, and
highlighted the Securities and Exchange Commission's
registration process as a barrier to new entrants. What
specific changes would you suggest that the SEC consider making
to increase the number of new credit rating agency registrants?
Ms. Liang. Thank you for your question. Currently, the SEC
regulation requires new entrants to the market to basically
provide attestations from investors who have used that
applicant rating agency's ratings for 3 years. This is a very
difficult bar to achieve because most investors have little use
for ratings from non-NRSROs. So, I think it might be helpful
for the SEC to look at different ways that new entrants could
enter the market. I leave it to them in their research on how
best to do that, but I would be happy to continue the
conversation.
Mr. Scott. Thank you, Ms. Liang. I am done with my
questions, Mr. Chairman, relatively on time.
Chairman Sherman. Thank you. Relatively. I now recognize
the gentleman from Arkansas, who is also the Republican lead on
the Russia and Belarus Financial Sanctions Act, Mr. Hill, for 5
minutes.
Mr. Hill. First, let me thank the Chair for our
collaboration together on economic cost, raising the economic
cost on Putin and the Kremlin for their illegal invasion of
Ukraine. And yesterday, we had excellent work on that on a
bipartisan basis to send the signal to our transatlantic
partners that the U.S. speaks with one voice on raising the
economic, diplomatic, and military costs of Putin's illegal
invasion. So today, thanks for having this hearing to talk
about our rating agencies, and I couldn't help but notice a
number of the bills that were noticed and attached to this
hearing. One was of particular concern to me, which is the
Commercial Credit Rating Reform Act, that proposes to change
the rating assignment model process.
After the financial crisis, as we have talked about this
morning, Dodd-Frank tasked the Democrat-led SEC at the time
with implementing a ratings assignment model, which meant the
creation of a quasi-governmental board to assign qualified
rating agencies to provide ratings. The SEC thoroughly
considered a range of business models, and many other market
participants raised concerns that the writing assignment
model's quasi-governmental board would hold significant
influence over the capital markets by being the sole party to
select and assign ratings for the entire market rather than
relying on market checks and balances, competition, and
investors.
And after a thorough review and public feedback, the
Commission decided not to mandate any structural changes to
what is known as the issuer pay model. We have talked about
this now for over a decade, and we certainly recognize that
credit rating agencies have potential conflicts of interest,
regardless of whether issuers, investors, or governments pay
for those ratings or assign those ratings. Our goal as
policymakers should be to ensure that these potential conflicts
are managed and mitigated. That is the whole secret to the
capital market system, is, of course, it has built-in conflicts
of interest in it. And the whole question about public policy
is, can those be transparent? Can they be managed in the right
way? Can they be subject to the checks and balances of those
market forces? So, despite those potential conflicts of
interest, issuer pay produces a stronger and, I think, less
biased signal for market participants. My thoughts are, we had
these conflicts, and they are not going to be solved, in my
view, by turning more power over to the government.
Let me start with you, Mr. Le Pallec, and I will, in turn,
ask the other rating agencies present to comment. Would you
agree that a rating assignment model would discourage
independent competition and risk that would end up
deteriorating the quality and future innovation in the credit
rating industry?
Mr. Le Pallec. Thank you for your question. Certainly, we
have reservations about this proposal. We think it treats
ratings as a commodity, and prevents investors from making
their own choices. Investors may have very different use cases,
and they rely on the diversity of view in the market, and we
want the market to be competing on the quality of our ratings.
Mr. Hill. Thank you
Mr. Le Pallec. Also, in terms of the feasibility,
particularly for the corporate market, it would be very
important to consult with the corporate issuers. Apart from
Treasuries, that is the biggest section of the market in the
United States.
Mr. Hill. Right. Mr. Linnell, what do you think?
Mr. Linnell. Just a moment ago, we talked about the
benefits of competition, and what is the best way to provide
high-quality credit ratings to the market. A board or some sort
of selection process is essentially a government subsidy and
just removes that incentive. We continue to think it is a bad
idea. It just introduces new potential conflicts, new costs,
and new bureaucracy, and isn't needed.
Mr. Hill. Good. Thank you. I would like to invite the other
agencies here to send me a written answer to that question.
Let me switch gears to Ms. Schulp from Cato. Given the
significant influence that this quasi-governmental board would
have for a ratings assignment model, doesn't this approach in
and of itself carry its own conflict of interest?
Ms. Schulp. It absolutely does.
Mr. Hill. Tell me more. Tell me why you think that is just
a bad idea in search of a challenge?
Ms. Schulp. I think we have recognized, and as Congress has
recognized before, by promoting and seeking to promote
competition in the rating space, that competition is the way to
keep these conflicts within check. And in order to encourage
the additional development of new methodologies, refinement of
methodologies, and continuing to innovate in the credit rating
space, the government, a quasi-governmental board, or a
governmental board assigning ratings in that way removes the
incentives for all of that development and the focus on quality
in the same way.
Mr. Hill. Thank you. And, Mr. Chairman, thank you for the
hearing, and I yield back.
Chairman Sherman. Thank you. The gentleman from Texas, Mr.
Taylor, is recognized for 5 minutes.
Mr. Taylor. Thank you, Mr. Chairman. I appreciate that. Mr.
Linnell, I wanted to hear from you about what changes have been
made in your business model over the last decade since the
financial crisis?
Mr. Linnell. The business model itself is unchanged, the
issuer pay model. But since the financial crisis, particularly
after the passing of Dodd-Frank, we put in a number of
different changes to reflect the legislative requirements but
also just to continue to invest and grow and improve our own
risk management infrastructure.
The Dodd-Frank Act, in particular, introduced a formalizing
control framework around the determination of ratings, formal
legal attestation around those controls being adequate to
manage those risks. It requires the board now to independently
approve all criteria. It created a formal compliance officer
role and also strengthened the regulatory oversight of the
rating agencies for the creation of the credit ratings unit
within the SEC. And it also encouraged greater transparency and
disclosure around things like key rating drivers and
standardization, of how agencies talk about key risks in their
ratings. And these regulations, which, as we all know, run many
hundreds of pages, are echoed as well in the EU regulation
around the credit rating issue, Directives Number 2 and 3.
So, there has been a significant strengthening of the
control infrastructure, all designed to more effectively manage
this conflict of interest that we all talk about. And then, in
addition, disclosures have been significantly stepped up across
the industry. And I think there is a general acceptance, or at
least that is what I hear, that disclosure standards are pretty
robust.
Mr. Taylor. And in terms of your underwriting, how has that
changed over the last decade?
Mr. Linnell. Essentially, we are trying to predict the
future with credit ratings, right? Is the company going to
honor their obligations in 10, 15, 20 years' time? We continue
to think about new ways of how we can analyze risks, how we can
look at new and emerging risks. There is a discussion on ESG
risks but cybersecurity risks, conduct risk, all new risks are
starting to come and play a greater prominence.
We continue to strengthen things like different access to
information, the way that we look at data and using new
technologies around machine learning, artificial intelligence,
and also strengthening internal control functions, such as our
credit policy group, which is not aligned to any particular
group. It is an independent internal task force, if you like,
that looks at the quality of our ratings. And we continue to
think about how we can improve our methodologies and criteria
to reflect the ever-changing risk environment in which we
operate. And I think overall, you can see that in the
performance of the ratings that continue to be very strong
since the financial crisis.
Mr. Taylor. Ms. Schulp, just to switch to you, are there
any regulatory barriers that you think could be removed, that
would help improve the markets?
Ms. Schulp. Sure, and it has been discussed before, but I
think the--
Mr. Taylor. Why don't you just add on new information--
Mr. Schulp. Yes. The registration, the letters from
investors for 3 years in order to become an NRSRO has been
cited time and again as a barrier to entry into the NRSROs
space. And regulations and legislation across the government
that recognize particular NRSROs for recognition for investment
and other purposes itself creates an anti-competitive
environment where the smaller ratings agencies are
disadvantaged. I think those are places to focus on.
Mr. Taylor. Okay. Thank you. Mr. Chairman, I yield back the
balance of my time.
Chairman Sherman. Thank you. I now recognize the gentleman
from Wisconsin, Mr. Steil, for 5 minutes.
Mr. Steil. Thank you very much, Mr. Chairman. Ms. Schulp,
as we have discussed today, the SEC has been rushing out new
significant rulemakings and setting unusually short comment
periods. I am concerned with the substance of many of these
rules, but I am also worried about the SEC's pace, that is
designed to limit substantive public comment. I know you have
authored multiple public comments for rules. Is this correct?
Ms. Schulp. Correct.
Mr. Steil. How long does it typically take to draft
substantive comments on a significant rule proposal?
Mr. Schulp. Quite a bit of time. It depends on the rule
proposal, but it is a solid--
Mr. Steil. Give me a range.
Ms. Schulp. A couple of weeks' work for me, while I am not
focused on other things--
Mr. Steil. So from the moment you start, it is a couple of
weeks of full-time work, from the moment you start to getting
those rules out. In that context, if you have other things
going on, which most people do, when we have unusually short
periods of time, it makes it incredibly difficult for
individuals, companies, and stakeholders to provide substantive
comments to SEC rules. Is that correct?
Ms. Schulp. It does, and I will say that the pace has
caused me to pick and choose what I would comment on in ways
that I would otherwise not do.
Mr. Steil. So you pick and choose, but it also limits
others who are able to provide comments, meaning it limits
those who might want to provide comments from providing those
comments?
Ms. Schulp. Absolutely.
Mr. Steil. And what does it do to the quality of our
regulations? Is the SEC at risk of having blind spots because
they are not going to have the opportunity to receive comments
from stakeholders?
Ms. Schulp. I think that is true.
Mr. Steil. Let me shift gears slightly. You wrote an
article last year criticizing the SEC's paternalistic attitude.
And in many ways, I share some of the concerns you put forward
in that article, in particular as it relates to excessive
restrictions and burdens on retail investors, reducing
opportunities for millions of American families to be able to
participate in our capital markets. And my colleagues are
concerned about wealth inequality. I think one of the areas
that we have an opportunity to push back on is some of the SEC
rules and regulations we see being put forward in a
paternalistic manner.
I would like you to just, tightly here because I want to
jump to another question as well, identify some of the
proposals or general beliefs that you think the SEC exemplifies
with this paternalistic approach?
Ms. Schulp. The ESG rules that are coming out, the climate
risk disclosure rules, those in particular are problematic
because they are going to encourage companies either to not be
public or to go private as the situation depends. And that will
remove the ability of average investors to invest in those
companies that are having important roles in our economy.
Mr. Steil. I think that is really important. So, your
average mom-and-pop retail investor, when companies leave the
public markets, go into the private markets, it gives an
advantage to private equity firms. It gives an advantage to
some of the biggest players on Wall Street, and removes the
opportunity for Main Street mom-and-pop kind of investors to be
able to invest and take advantage of U.S. capitalist
structures.
Ms. Schulp. Absolutely.
Mr. Steil. Let me shift gears with you for a moment. I want
to talk about one of the core principles of securities law that
seems to continually come up in this hearing, or in this
committee, and that is materiality. As you know, this principle
underpins our disclosure-based system. And it served investors
quite well for decades, and under current law, if information
is material to investors, it needs to be disclosed. Is that
correct?
Ms. Schulp. Within the broad categories that the law
already requires disclosure on, correct.
Mr. Steil. Correct. And the SEC, in my opinion, appears to
be moving away from this traditional interpretation of
materiality, in particular as it relates to the climate
disclosure rule that they are working on. SEC Chairman Gensler
and Commissioner Lee have argued that there is an investor
demand for climate disclosures, so the SEC should be required
to act on that. Can you talk about how the SEC's interpretation
of materiality in their argument supporting the climate
disclosure rules differs from the traditional understanding of
the term?
Ms. Schulp. When looking at the climate risk disclosure
rules, the connection between so many of the things that are
disclosed and financial materiality is tenuous at best, and, in
some cases, completely absent. What is also important to know
is that investor demand can be a component of whether something
is material to an investor. The SEC relies, in its climate risk
disclosure rules, solely on demand from large institutional
investors who have worked climate risk into their modeling.
While that is not unimportant, they are focused solely on the
largest investors rather than on what the whole market and
perhaps what individual investors might want in an investment.
Mr. Steil. Thank you very much. Mr. Chairman, I remain
concerned about where the SEC is headed as it relates to
shifting away from materiality, and, in particular, the rush of
some of these rulemakings. Cognizant of time, Mr. Chairman, I
yield back.
Chairman Sherman. I now recognize the gentleman from
Illinois, Mr. Foster, who is also the Chair of our Task Force
on Artificial Intelligence, and has recently arrived from his
important work at the Science Committee, and he is recognized
for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman. The Dodd-Frank Act
required SEC staff to study and publish a report, and one that
the credit rating system would benefit from requiring NRSROs to
adopt uniform rating scales and rating symbols. In the final
report published in September of 2012, the Commission found
that, ``Standardizing credit rating terminology may facilitate
comparing credit ratings across rating agencies and may result
in fewer opportunities for manipulating credit rating scales to
give the impression of accuracy.'' However, the SEC staff
ultimately recommended the Commission not to take further
action, to require increased standardization, primarily because
of concerns over feasibility. A discussion draft attached to
this hearing would direct the SEC to issue rules to require all
NRSROs to use a uniform set of credit ratings for each of the 6
categories of credit ratings recognized under the Securities
and Exchange Act.
So, Mr. Le Pallec, Mr. Linnell, Ms. Liang, all three of
your firms use an identical set of rating symbols for corporate
issuers. Do you feel that uniformity in your rating scales
allows investors to more quickly and easily understand your
ratings?
Mr. Le Pallec. What we know from investors is that they
benefit from a diversity of views, and we don't think that
treating ratings with common definitions across the piece could
lead to handling them like commodities, and would lead to
convergence of methodologies, and would, therefore, limit
competition on quality in the market.
Mr. Linnell. Yes. I would just add that you have to
differentiate between the two issues of the standardized
criteria and the definitions of those ratings versus the actual
nomenclature of the scale. You could, if you wanted to, propose
and argue for a standard scale. In fact, there are some pieces
the same at Fitch, and Moody's is pretty similar. It uses 21
gradations. And I figured that as an industry, we should be
open to positive feedback or criticism that a common scale
itself may be facilitate little transparency and comparability.
But you don't want to undermine the independent integrity and
the diversity these agencies have by putting and enforcing the
same criteria across the agencies.
Mr. Foster. Yes. Ms. Liang? About those--
Mr. Liang. Thank you. I would agree with my colleagues
regarding preserving the diversity of perspectives, and better
serving the market. Another way we could come at it is perhaps
requiring more disclosure, because I have heard you and your
colleagues talk about the difficulty in understanding rating
scales, and perhaps increasing disclosure on those rating
scales might help with clarity and understanding.
Mr. Foster. Yes. Another mechanism that I have heard
suggested is that a small fraction, say 1 percent, of all
issuance would have to be rated by everyone, all major players
in the market. So that, combined with standard ratings, and you
could actually have an interesting discussion when you saw a
wide divergence of ratings for a single issue. Is that
something you would have any comments on as a possible way to
get it part of the whole conflict-of-interest problem in this?
Mr. Linnell. Maybe I will take a stab at that. It could be
an interesting way of doing it. But I think in reality, if you
look in most markets and you did the Venn diagram of coverage
of the agencies and even at the new agencies, you probably have
plenty of examples where they are already covering 1, 2, 5
percent of similar rating. You may already have that in play.
And indeed, part of our approach has been to do unsolicited
ratings where we believe our ratings are different from the
existing ones of S&P and Moody's on some of the major issuers
that are of interest to investors. Again, the competition
between the agencies creates that comparability in many of the
industries and sectors we are talking about.
Mr. Foster. So, when you issue an unsolicited rating, and
in some sense you turn out to be right, does the market reward
you for making a correct objection to one of your competitors'
ratings?
Mr. Linnell. I would hope, but I figure it is more in the
long term. It is about building your reputation and your
franchise for the quality of the work that you do, and that is
what everybody should be striving for, to compete on the
quality of their analytics and the quality of their ratings.
Over the long term, you hope that kind of action would result
in that benefit.
Mr. Foster. That is right. Of course, one of the big
challenges is that you only see in times of distress, whose
ratings are not as solid as they might have been.
Well, my time is up now, and when you figure all this stuff
out, let me know. We have been struggling with it for a decade.
Thank you, and I yield back.
Chairman Sherman. And longer. The gentleman from Ohio is
recognized for 5 minutes.
Mr. Gonzalez of Ohio. Which one?
Chairman Sherman. Mr. Gonzalez.
Mr. Gonzalez of Ohio. Thank you, Chairman Sherman, and
thank you to our witnesses for being here today. I want to
start by echoing some of the comments of Mr. Huizenga and other
colleagues expressing concern with the direction of the
subcommittee. Just recently, the financial stability report
came out from the Federal Reserve. This is the Capital Markets
Subcommittee, and one of the things being highlighted is low
liquidity and cash, Treasury securities, and equity-indexed
futures. That is a major issue. If we have liquidity
challenges, if the depths of our markets all of a sudden are
impaired, the ability of the financial system to respond to
large shocks is severely diminished. And I hope at some point,
we will start taking up some of these, what I would consider
more pressing issues, and certainly ones that could really harm
the financial system.
That aside, Ms. Liang, I want to start with you. As part of
this hearing, the Majority attached a discussion draft called
the Commercial Credit Rating Reform Act. A provision within
this legislation would establish a newly-created credit rating
agency assignment board that would assign NRSROs to provide
ratings for corporate issuers. Can you discuss some of the
concerns that you have with this sort of approach?
Ms. Liang. Absolutely. Thank you very much for the
question. I think some of these topics have already been
touched on, but I feel that an automatic assignment would be to
guarantee business for rating agencies and would create a
disincentive to provide quality research. I think, ultimately,
the market investors, and the investing public at large would
suffer from that lack of quality research.
Mr. Gonzalez of Ohio. Thank you. I couldn't agree more. I
know that there are obviously some challenges in this
particular market, but to just assign them at the Federal
level, I think is a little bit absurd.
Mr. Le Pallec, earlier this week, S&P announced that it was
going to withdraw the notching proposal, but said that, ``We
are considering alternatives for the withdrawal elements.'' Do
you expect this alternative proposal to come out in 2022, and
do you have any more information that you could share on what
is being considered?
Mr. Le Pallec. Thank you for your question. Yes, the
request for comment process continues. As we said last Monday,
we are going to go back to the market with proposals on how to
handle the technical issue at hand, and we plan to come out
with a final criterion by the end of this year. We will update
the market as we know more and as we treat more comments. We
want to maintain the same high level of transparency we have
applied up until now, and we will continue to do so.
Mr. Gonzalez of Ohio. Thank you. I think that is very, very
important.
Ms. Liang, back to you. In your testimony you, sort of
related to the first question, discuss the importance of
increasing competition in the NRSRO market. What are the key
barriers this committee should further explore to promote that
competition in the credit rating market?
Ms. Liang. Thank you for your question. I highlighted a few
instances where there continue to be systemic barriers to
competition. Many investor guidelines still require the
incumbent rating agencies by name, and certain Federal
regulations and facilities require and refer to the larger
NRSROs by name, rather than all NRSROs. I think taking a look
at those references and requirements would be helpful in
promoting competition, and certainly, I think that continued
attention to S&P's proposed methodology would benefit
competition in the credit rating industry.
Mr. Gonzalez of Ohio. Thank you. I couldn't agree more.
Again, sort of basic stuff: more competition, more choice,
deeper markets, less government dictating and interventions, I
think, is usually the direction we want to go. This is
certainly no exception. Again, I want to reiterate, I hope we
spend more time on some more pressing issues than this, but
with that, I yield back.
Chairman Sherman. For the record, I believe the gentleman
from New Jersey has asked that we waive him and go on to the
next Member, unless that is incorrect. And so, we will go to
the second gentleman from Ohio, Mr. Davidson, for 5 minutes.
Mr. Davidson. Thank you, Mr. Chairman, and thanks for
convening this hearing. I think it is useful. It is a good
hearing, and of the fact, as you highlighted in your opening
remarks, Mr. Chairman, part of the purpose was already
achieved. I look forward to the discussion with our witnesses,
and thank you for being here, but I really want to kind of join
the urgency of getting the Securities and Exchange Commission
here. We really need to weigh the weighty matters. And frankly,
my colleagues, Mr. McHenry and Mr. Huizenga, sent a letter to
Chairwoman Waters on May 5th. Since we weren't here in town,
perhaps it has escaped notice. And, Mr. Chairman, I wouldn't
want it to escape your notice, so I ask unanimous consent to
submit that letter for the record.
Chairman Sherman. Without objection, it is so ordered.
Mr. Davidson. What that calls for is a hearing of the full
Securities and Exchange Commission, because it is very clear
that Chairman Gensler is exceeding the authority that Congress
has granted to the Securities and Exchange Commission. He is
acting outside of the scope of the authority. And certainly,
even within the authority, there has been some ongoing concern
for regulation by enforcement and the harm that is causing to
capital formation here in the United States. And, frankly, when
they say they are protecting investors, obviously their view of
protection sometimes means preventing investors from even
participating in markets and owning certain assets, and there
are huge consequences for that, no more so than in fintech and
digital assets. I hope that, frankly, the letter will not just
be submitted for the record, but that it will be read and fully
supported, because this kind of accountability ought to be
overwhelmingly bipartisan. It will certainly happen with a
Republican Majority, but we might as well get it underway now.
Mr. Le Pallec, can you explain the process of mapping
ratings given by other firms and factoring them into S&P
ratings? How does it work?
Mr. Le Pallec. Mapping is one of the options that we have
to get to a view on the creditworthiness of assets held by
insurers as per the withdrawal methodology, so we don't
consider everything is junk. Actually, we do mapping by
exception. And we do mapping for credit rating agencies for
whom we have common ratings, a lot of ratings in common so that
we can translate, if you will, their ratings into our own. This
is what mapping tries to do.
Mr. Davidson. Is it similar to crowdfunding,
crowdsourcing--the wisdom of crowds, and to some, is it
vulnerable to groupthink?
Mr. Le Pallec. No. It is a statistical study that just
looks at default and performance statistics published by all of
the credit rating agencies. And wherever we have ratings in
common, we translate their ratings into our own because, as we
said, rating definitions differ from one credit rating agency
to the other. This is what mapping tries to do.
Mr. Davidson. It basically translates how you score versus
somebody else?
Mr. Le Pallec. It is a translation exercise.
Mr. Davidson. Okay. I would like to ask an open-ended
question to the three witnesses representing credit rating
agencies today. The COVID-19 pandemic provided a real-world
stress test within every aspect of the financial industry. This
includes credit ratings, since access to Federal emergency
lending facilities is tied directly to an applicant's credit
rating--not in every case, but often. My question for the
rating agencies is, of all the defaults that you saw among
companies that you provided ratings for, what percentage of
them were of speculative grade?
Mr. Le Pallec. Most of those that defaulted were of
speculative grade because the definition of a, ``speculative
rating,'' is that it is more likely to default than an
investment-grade rating. But COVID was the biggest stress test
for the industry that we had since the great financial crisis,
and now, if you look at rating's performance through COVID, you
will see that they are completely in line with rating
definitions and expectations built in the rating. So we can say
that, in our case, COVID pressure tested our ratings and they
performed as expected, which, for us, makes us very proud.
Mr. Linnell. Can I just add to that? Actually, I think the
default way of companies is actually quite low and lower than
what you would expect in a typical stress test. And the reason
why was because of the unprecedented policy response by
governments around the world, which offensively created a
bridge from a stressed COVID world to a post-COVID world. And
the performance of companies and, therefore, the performance of
credit ratings benefited from that.
Mr. Davidson. Thank you. Any other comments on that?
Ms. Liang. I apologize. I don't have those statistics at my
fingertips, but I would be happy to follow up with you and the
committee on that.
Mr. Davidson. Thank you, and we certainly hope that stress
test is behind us, and hopefully, the lessons learned can help
us in the future, so that we can keep pandemic risk and
minimize the political risk. Governments around the world laid
a pretty heavy hand on industry, certainly helpful in some
cases, and so, thank you for highlighting that positive aspect.
My time has expired, and I yield back.
Chairman Sherman. I want to thank the Members and,
particularly, the witnesses, for participating in this
important hearing today.
The Chair notes that some Members may have additional
questions for these witnesses, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned.
[Whereupon, at 11:41 a.m., the hearing was adjourned.]
A P P E N D I X
May 11, 2022
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