A Notch Above? Examining the Bond Rating Industry (U.S. House Committee on Financial Services, Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets)

Hearing	A Notch Above? Examining the Bond Rating Industry
Committee	U.S. House Committee on Financial Services, Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets
Date	May 11, 2022

 

Hearing Takeaways:

• Notching: The hearing largely focused on the practice of notching amongst bond rating agencies. Notching refers to the practice where a rating agency insists on rating most (if not all) of the assets owned by an entity and/or significantly reducing the ratings that other rating agencies have assigned to assets that they have not rated. Supporters of this practice argue that it can improve the integrity of bond ratings. Critics allege that this practice can be anticompetitive through discouraging the use of competitor rating agencies.   
  • Recently Withdrawn S&P Global Ratings Proposed Methodological Change: The hearing particularly focused on a recently withdrawn proposed methodology change form S&P Global Ratings for assessing an insurer’s risk-based capital adequacy. Under the notching proposal, S&P Global Ratings could penalize the ratings of insurance companies for not purchasing bonds rated by S&P Global Ratings. There was broad opposition to the withdrawn proposal amongst Subcommittee Members and most of the hearing’s witnesses due its potential adverse impact on competition and the availability of many products (particularly variable annuities and whole life insurance). Of note, Mr. Le Pallec testified that S&P Global Ratings was currently considering alternatives for the withdrawn methodology change and intended to soon issue a subsequent request for comment (RFC).
  • Additional Legislation to Expand Prohibitions on the Practice of Notching: Subcommittee Democrats, Mr. Linnell, and Ms. Liang noted how current law only prohibited the practice of notching with respect to asset-backed securities and called for extending this prohibition to corporate bonds and other issues. Mr. Linnell further called on the U.S. Securities and Exchange Commission (SEC) to bolster its enforcement of existing notching prohibitions. Subcommittee Ranking Member Bill Huizenga (R-MI) and Ms. Schulp contended however that Congressional action on the issue would be premature given how stakeholders (notably S&P Global Ratings) had acted on their own to address the practice.
• Other Bond Rating Agency Policy Issues: Aside from notching, Subcommittee Members and the hearing’s witnesses expressed interest in other policy areas impacting the bond rating agency industry.
  • Market Concentration Concerns: Rep. David Scott (D-GA), Ms. Liang, and Ms. Schulp highlighted how the three largest bond rating agencies still commanded approximately 95 percent of the U.S. bond rating market, which gave the impression of a highly concentrated market. Ms. Schulp and Mr. Linnell noted however that there had recently occurred an uptick in bond rating agencies entering the market, which could help to address these market concentration concerns.
  • Use of Issuer-Pay Model for Bond Ratings Subcommittee Chairman Brad Sherman (D-CA) expressed concerns with the current issuer-pay model for bond ratings. He commented that this model could lead bond rating agencies to provide bond issuers with their desired ratings in order to obtain their business, which could undermine the integrity of said ratings. Subcommittee Republicans, Mr. Le Pallec, Ms. Liang, Mr. Linnell, and Ms. Schulp argued however that the issuer-pay model created an incentive for bond rating agencies to compete based on the quality of their research, which ultimately benefited the users of these ratings.
  • Proposed Bond Rating Assignment Approaches: Subcommittee Republicans, Mr. Le Pallec, Ms. Liang, Mr. Linnell, and Ms. Schulp expressed opposition to the proposed Commercial Credit Rating Reform Act, which would establish a credit rating agency assignment board. This board would assign bond rating agencies to provide ratings for corporate issuers. They raised concerns that this legislative proposal would treat credit ratings as a commodity and would prevent investors from deciding which ratings they would consider. 
  • Standardization of Bond Rating Scales and Symbols Across Bond Rating Agencies: Subcommittee Democrats discussed how the bond rating scales and symbols were not always straightforward and not standardized across bond rating agencies, which could make it difficult for consumers to make sense of the scales and symbols. They suggested that these scales and symbols could be made clearer to consumers so that they could more easily determine which ratings were the best. They noted how Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) had required the SEC staff to study and publish a report on whether the credit rating system would benefit from requiring nationally recognized statistical ratings organizations (NRSROs) to adopt uniform ratings scales and rating symbols. They indicated that the SEC staff had ultimately recommended that the SEC not take further action to increase the standardization of the rating scales and symbols due to feasibility concerns. Mr. Le Pallec, Ms. Liang, and Mr. Linnell expressed concerns however that the standardization of these rating scales and symbols could lead investors to treat the ratings as commodities, which could lead to a convergence of methodologies. They stated that this dynamic could limit competition on quality within the market.
  • Proposal to Require Bond Rating Agencies to Rate Certain Issuances to Enable Rating Quality Comparisons: Rep. Bill Foster (D-IL) mentioned how there were proposals to require all bond rating agencies to rate a small fraction of all issuances. He commented that this proposal would enable market participants to better assess how bond rating agencies approached their work. Mr. Linnell stated however that there already existed significant overlap in terms of the issuances being rated across bond rating agencies.
  • References to Large Incumbent Bond Rating Agencies in Corporate Guidelines, Government Laws, and Government Regulations: Ms. Liang and Mr. Linnell noted how many investor guidelines, federal regulations, and federal facilities still referenced the incumbent bond rating agencies by name. They stated that this dynamic provided incumbent rating agencies with a monopoly over insurer financial strength ratings and discouraged insurers from purchasing securities in sectors that received limited ratings coverage from the incumbents. Mr. Linnell added that this dynamic would encourage insurers and securities issuers to select securities rated by the incumbent ratings agencies so as to not be penalized by notching methodologies.
  • Onerous Attestation Requirements for New Bond Rating Agencies: Ms. Liang and Ms. Schulp noted how the SEC’s current regulations required prospective new bond rating agency entrants to provide attestations from investors that had used the applicant rating agency’s ratings for three years in order to become NRSROs. They stated that it was difficult for applicant rating agencies to obtain such attestations because most investors had limited interest in obtaining ratings from non-NRSROs. Ms. Liang suggested that the SEC consider alternative ways for enabling new entrants to enter the market.
  • Ability of Bond Rating Agencies to Rate Issuances from Russia and Belarus: Subcommittee Chairman Sherman and Rep. French Hill (R-AR) expressed support for proposals to prevent bond rating agencies from rating the bonds coming out of Russia or Belarus. Of note, Mr. Le Pallec and Mr. Linnell testified that S&P Global Ratings and Fitch Ratings had stopped issuing ratings on Russian instruments following Russia’s invasion of Ukraine.
• Subcommittee Republican Concerns regarding the SEC’s Rulemaking Agenda: In addition to addressing policy issues impacting the bond rating agency, Subcommittee Republicans and Ms. Schulp used the hearing to raise concerns regarding the SEC’s current rulemaking agenda. They criticized Full Committee and Subcommittee Democrats for failing to hold oversight hearings with SEC leadership in light of the Agency’s robust rulemaking agenda. They also raised concerns that the SEC’s rules under consideration could undermine capital formation efforts and limit investment opportunities for retail investors.
  • Ambitious Rulemaking Agenda: Subcommittee Republicans and Ms. Schulp criticized the SEC for proposing nearly 60 “far reaching” proposals during the Biden administration. Subcommittee Ranking Member Bill Huizenga (R-MI) and Ms. Schulp expressed concerns that this ambitious agenda was contributing to the current high levels of market volatility. Ms. Schulp further stated how this large number of proposed rules meant that many stakeholders would reduce the number of proposals that they submitted comments on.
  • Short Comment Periods: Subcommittee Republicans and Ms. Schulp raised concerns over how many of the SEC’s current rules under consideration had very limited comment periods. They stated that these limited comment periods could result in inferior rules that failed to fully consider all relevant issues.
  • Approach to Materiality: Rep. Bryan Steil (R-WI) and Ms. Schulp raised concerns with how the SEC appeared to be moving away from its materiality principle in their climate-related disclosure rule under consideration. They noted how SEC Chairman Gary Gensler and SEC Commissioner Allison Herren Lee had argued that there was an investor demand for climate-related disclosures, which therefore necessitated SEC action on the issue. Ms. Schulp noted that while investor demand could be a component of whether something could be considered material to an investor, she stated that the SEC’s climate-related disclosure rule relies solely on demand from large institutional investors that have worked climate risk into their modeling. She expressed concerns that the SEC was only focused on large investors in this proposed rule rather than considering the perspectives of all market participants.

Hearing Witnesses:

1. Mr. Yann Le Pallec, Executive Managing Director, Head of Global Ratings Services, S&P Global Ratings
2. Ms. Angela Liang, General Counsel and Executive Committee Member, Kroll Bond Rating Agency
3. Mr. Ian Linnell, President, Fitch Ratings
4. Ms. Mariana Gomez-Vock, Senior Vice President of Policy and Legal, American Council of Life Insurers
5. Ms. Jennifer J. Schulp, Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives, Cato Institute

Member Opening Statements:

Subcommittee Chairman Brad Sherman (D-CA):

• He discussed how roughly $3.5 trillion in commercial paper, asset-backed securities, and corporate bonds flowed each year based on the ratings provided by bond rating agencies.
  • He noted that these ratings directly influenced bond interest rates, which could play a determining factor in terms of whether a project were to proceed.
• He explained how bond rating agencies rated both insurance companies that purchase bonds and the bonds themselves.
• He noted how S&P Global Ratings had recently developed a notching proposal that could penalize the ratings of insurance companies for not purchasing bonds rated by S&P Global Ratings.
  • He indicated however that S&P Global Ratings just withdrew the notching proposal two days prior to the hearing and commended the bond rating agency for this withdrawal.
• He asserted however that Congress ought to pass legislation to prohibit the practice of notching moving forward.
  • He noted how current law only prohibited this practice with respect to asset-backed securities and called for extending this prohibition to corporate bonds and other issuers.
• He then remarked that the Subcommittee ought to consider whether bond rating agencies should be permitted to rate the bonds coming from Russia or Belarus.
  • He also stated that the Subcommittee should consider whether U.S. bond issuers should be permitted to pay for ratings from foreign bond rating agencies that continue to rate the bonds coming from these countries.
• He further discussed how the tiers of bond ratings were not always straightforward, which could make it difficult for consumers to make sense of the ratings.
  • He suggested that these bond rating tiers could be made clearer to consumers so that they could easily determine which ratings were the best.
• He lastly raised concerns over how bond rating agencies often possessed incentives to provide bond issuers their desired ratings in order to obtain business from the bond issuers.
  • He commented that this dynamic raised concerns about the integrity of the bond ratings.
• He noted that bond rating agencies were the only professional group that were not subject to professional liability for malpractice.

Subcommittee Ranking Member Bill Huizenga (R-MI):

• He first called the hearing’s focus on the U.S.’s credit rating agencies “misguided.”
• He recounted how S&P Global Ratings had just withdrawn its proposed changes to their risk-based adequacy methodology for insurers and commented that this withdrawal rendered the hearing moot.
  • He asserted that Congressional involvement on the issue would be premature given how stakeholders had already addressed the issue.
• He contended that U.S. capital markets were “under attack” and criticized the SEC for proposing nearly 60 “far reaching” proposals.
  • He highlighted how the SEC had proposed 16 rules in the first quarter of 2022 alone and commented that these rules often had very limited comment periods.
  • He specifically criticized the SEC’s recently proposed climate-related disclosures rule, which he asserted would impose significant compliance burdens on companies.
• He lambasted both Full Committee and Subcommittee leadership for its failure to hold oversight hearings with SEC leadership in light of the Agency’s robust regulatory agenda.
  • He mentioned how the SEC had recently acknowledged a “very significant” breach in protocols between the SEC’s adjudicatory and enforcement functions and raised concerns that this breach had implications regarding the fairness of prior SEC enforcement actions.
  • He further suggested that the Committee or Subcommittee hold hearings on the SEC’s actions related to digital assets and the Jumpstart Our Business Startups (JOBS) Act.

Full Committee Chairman Maxine Waters (D-CA):

• She applauded the Subcommittee for its oversight efforts with regard to bond rating agencies and noted how these oversight efforts had led S&P Global Ratings to recently withdraw its notching proposal.
• She expressed her continued support for robust oversight of bond rating agencies and stated that the financial industry’s overreliance on these agencies had directly contributed to the 2008 Financial Crisis.
• She called for providing investors and other market participants with an abundance of accurate information and for having the Subcommittee address anticompetitive practices (such as the aforementioned notching proposal).
  • She raised concerns that bond rating agencies might be pursuing other types of anticompetitive practices.

Witness Opening Statements:

Mr. Yann Le Pallec (S&P Global Ratings):

• He expressed the commitment of his bond rating agency, S&P Global Ratings, to providing the financial markets with timely, transparent, and high-quality credit ratings.
• He discussed how credit ratings were forward looking opinions about the ability and willingness of debt issuers (such as corporations and governments) to meet their debt obligations on time and in full.
  • He commented that the opinion-based nature of credit ratings made them non-fungible, which meant that there existed analytical differences in methodologies across credit rating agencies.
• He stated that credit ratings and credit rating methodologies can and do evolve over time.
• He testified that S&P Global Ratings published all new proposed rating methodologies and proposed material updates to its in-use methodologies in advance so that market participants could review and comment on the proposals.
  • He indicated that this publishing was due to regulation and the bond rating agency’s own policy.
• He stated that S&P Global Ratings considered comments that it received from the market and made these comments publicly available upon the publication of its final criteria.
• He highlighted how SEC regulations and the policies of S&P Global Ratings prevented employees participating in the development and/or approval of its procedures and methodologies for determining credit ratings from being influenced by sales or marketing considerations.
  • He testified that S&P Global Ratings maintained a “strict separation” between analytical and commercial activities within its ratings.
• He mentioned how S&P Global Ratings had published a RFC in December 2021 on proposed changes to their methodology and assumptions for analyzing the risk-based capital adequacy for insurance companies.
  • He explained that an insurer’s risk-based capital adequacy considered the amount of capital that an insurance company might need in order to cover its different losses across its different exposures
• He remarked that risk-based capital adequacy was one of the key factors in his bond rating agency’s framework for assessing insurers.
• He stated that S&P Global Ratings’s RFC process provided the market with an opportunity to give feedback and voice concerns regarding their proposals prior to their finalization and implementation.
  • He commented that S&P Global Ratings’s recent proposed methodology change was meant to improve the bond rating agency’s ability to differentiate risk, enhance the methodology’s global consistency, improve the methodology’s transparency and usability, and account for more recent data and experience since its last update in 2010.
• He noted that S&P Global Ratings had recently announced that it would withdraw parts of its proposed changes in response to stakeholder comments.
  • He asserted however that many of the criticisms of their proposal were based on misconceptions.
• He indicated that his written testimony provided more details regarding the withdrawn parts of its proposed changes and expressed his willingness to elaborate on these parts during the Congressional question period.
  • He testified that S&P Global Ratings was currently considering alternatives for the withdrawn elements of its proposed criteria and intended to issue a subsequent RFC.
  • He further expressed S&P Global Ratings’s commitment to engage in high levels of transparency and interaction with the market in its follow-up work.

Ms. Angela Liang (Kroll Bond Rating Agency):

• She noted that while S&P Global Ratings had temporarily withdrawn certain sections of its proposed risk-based capital methodology, she stated that this proposal had caused “immense” concern and confusion amongst market participants in all sectors.
  • She commented that this proposal would have resulted in decreased competition amongst NRSROs.
• She stated that while the 2010 entrance of her bond rating agency, Kroll Bond Rating Agency (KBRA), to the market had been “extremely positive” for investors, she asserted that KBRA and other small- and medium-sized NRSROs continued to face barriers to competition.
• She discussed how the largest three NRSROs still commanded approximately 95 percent market share and remarked that these NRSROs were “woven into the fabric” of the U.S. financial system.
  • She highlighted how many investor guidelines still only referenced the incumbent NRSROs, how certain key bond indices required that a security be rated by one of the incumbent NRSROs, and how government regulations and facilities still referenced the incumbent NRSROs by name (rather all NRSROs).
• She also noted how many investors benchmarked to the S&P Bond Index or Bloomberg Fixed Income Indices.
  • She commented that this benchmarking meant that these investors were not able to purchase bonds that were not rated by the incumbent NRSROs because such bonds were not index eligible.
• She remarked that the continued lack of open competition amongst NRSROs was the biggest problem facing the credit rating industry and asserted that the entrenchment of the incumbent NRSROs disadvantage the financial markets, investors, and the public.
• She stated that the impact that S&P Global Ratings’s mere proposal had on the market demonstrated the bond rating agency’s significant market power and its ability to impede competition using that power.
  • She raised concerns that S&P Global Ratings would continue to consider approaches with similar anticompetitive effects.
• She noted how S&P Global Ratings’s proposed methodology would have allowed S&P Global Ratings to notch down KBRA’s ratings from AAA to as low as CCC.
  • She commented that this proposed methodology would establish disparate and arbitrary treatment of ratings from other bond rating agencies across all asset classes held in S&P-rated insurance company portfolios.
• She recounted how market participant opposition to S&P Global Ratings’s proposed methodology change was swift, clear, and widespread and mentioned how the U.S. Department of Justice (DoJ) had submitted a comment that identified how the proposed methodology change could violate antitrust laws.
  • She noted that it took S&P Global Ratings five months to withdraw its proposed methodology changes, despite this widespread opposition.
• She stated that many of the NRSRO provisions of Dodd-Frank had been “highly successful” and had “meaningfully” improved the credit rating agency industry.
  • She specifically highlighted Dodd-Frank’s requirement that NRSROs publicly publish their methodology and substantive changes to them and commented that this requirement was “key” in getting S&P Global Ratings to withdraw their recent proposed methodology change.
• She remarked however that the U.S. could strengthen its laws to bolster competition and increase disclosure within the NRSRO space.
• She expressed KBRA’s support for legislative efforts to prohibit the practice of notching and to prohibit credit rating agencies from taking anticompetitive actions.
  • She called on Congress, the SEC, and the DoJ to continue scrutinizing S&P Global Ratings’s proposed methodology and to address anticompetitive actions within the credit rating agency market.

Mr. Ian Linnell (Fitch Ratings):

• He contended that S&P Global Ratings was seeking to employ anticompetitive notching practices in its proposed insurer capital adequacy methodology in order to further its market dominance.
• He expressed his pleasure regarding how S&P Global Ratings had just withdrawn its proposed insurer capital adequacy methodology.
  • He expressed the hope of his bond rating agency, Fitch Ratings, that both S&P Global Ratings and Moody’s Investors Service would not consider alternatives to notching in local government investment pools (LGIPs), money market funds, bond funds, and collateralized loan obligations (CLOs).
• He recounted how Congress had passed the Credit Agency Reform Act of 2006 in order to foster accountability, competition, and transparency within the credit rating agency industry.
• He indicated that while the Credit Agency Reform Act of 2006 addressed the notching conducted by both S&P Global Ratings and Moody’s Investors Service in the period prior to the law’s passage, he stated that both bond rating agencies had continued to engage in the activity.
  • He added that the SEC had failed to stop these bond rating agencies from engaging in this activity.
• He remarked that credit rating agencies played an important role in the efficient allocation of capital through providing the capital markets with an independent view of credit risk.
  • He asserted that any measure that reduces competition within the credit rating agency space would be harmful to the market.
• He contended that S&P Global Ratings’s proposed methodology was fundamentally anticompetitive because it incorporated the practice of notching into its assessment of insurer capital adequacy.
  • He explained that notching occurs when a bond rating agency 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.
• He stated that S&P Global Ratings’s proposed methodology would have disadvantaged all non-S&P-rated investments held by insurance companies.
• He argued that S&P Global Ratings had withdrawn this proposed methodology because it was unable to justify it.
  • He suggested that S&P Global Ratings had pursued this methodology to leverage its dominant market position in insurance to increase its market share in the securities commonly purchased by insurers.
• He discussed how ratings from S&P Global Ratings were “hardwired” into many insurance broker systems and noted how insurance brokers typically have criteria for recommending insurers to clients that only refer to ratings from S&P Global Ratings and AM Best.
  • He commented that this dynamic provided S&P Global Ratings with a monopoly over insurer financial strength ratings and discouraged insurers from purchasing securities in sectors that received limited ratings coverage from S&P Global Ratings.
  • He added that this dynamic would encourage insurers and securities issuers to select securities rated by S&P Global Ratings so as to not be penalized by the notching methodology.
• He noted how Fitch Ratings was not alone in criticizing S&P Global Ratings’s recently proposed methodology and highlighted how many market participants and the DoJ had raised concerns with the proposal.
• He called on Congress to ban the practice of notching in all market sectors and called on the SEC to start enforcing this ban.

Ms. Mariana Gomez-Vock (American Council of Life Insurers):

• She first discussed how 90 million U.S. families depended on the life insurance industry to protect their financial futures.
  • She specifically highlighted how the life insurance industry had helped many families and businesses to weather the COVID-19 pandemic and indicated that the industry had paid out a record amount in benefits in 2020.
• She also testified that life insurers invested $7.4 trillion in the U.S. economy, which made life insurers one of the U.S.’s largest sources of investment capital.
• She then discussed how insurer capital models (such as the one proposed by S&P Global Ratings) often influenced the long-term capital investment and capital management strategies of insurers.
  • She noted how a bond rating agency’s notching of an investment signaled a belief that the asset had a higher risk of loss or default and that the insurer should thus hold more capital against the investment.
• She remarked that S&P Global Ratings had proposed to notch (and in some cases disregard) credit ratings from competitors and designations from the National Association of Insurance Commissioners’s (NAIC) Securities Valuation Office (SVO).
  • She commented that the notching would assign a 100 percent capital charge in some cases to an investment grade asset without any clear reason for the notching (other than the fact that the asset was rated by a competitor of S&P Global Ratings).
• She expressed the appreciation of her organization, the American Council of Life Insurers (ACLI), for S&P Global Ratings’s decision to revisit their notching proposal and commented that this proposal could have compromised the integrity of financial strength ratings and disrupted capital markets.
• She discussed how competition and diversity amongst NRSROs benefited the insurance industry, the economy, and ultimately consumers.
• She contended that automatic notching was not harmless and stated that this notching created a fundamental disconnect between an asset’s value and an asset’s charge.
  • She commented that large swaths of the bond portfolios of insurers would have been notched and structured products not rated by S&P Global Ratings Products would have been treated as junk under S&P Global Ratings’s proposed methodology change.
• She also stated that the S&P Global Ratings’s proposal’s disregard for the NAIC’s designations was counterintuitive given how these designations were designed for and overseen by state regulators.
  • She elaborated that the mission of state regulators was to preserve the solvency of insurers and protect insurers, which meant that there did not exist a conflict of interest.
• She remarked that automatic notching would inflate asset charges through forcing insurers to choose between holding artificially inflated levels of capital or to avoid high quality and high yield assets (simply because these assets were rated by a competitor to S&P Global Ratings).
  • She commented that both outcomes were bad.
• She then discussed how some elements of S&P Global Ratings’s recent proposal would disadvantage U.S. regulatory and accounting regimes, which she stated would undermine the ability of U.S. insurers to offer key products to consumers (including variable annuities and whole life insurance).

Ms. Jennifer J. Schulp (Cato Institute):

• She noted how the SEC’s most recent report to Congress had described the NRSRO industry as being highly concentrated and highlighted how the three largest NRSROs accounted for approximately 95 percent of all outstanding ratings as of the end of 2020.
• She noted however that the SEC had also indicated that smaller NRSROs had increased their total number of ratings outstanding and had increased their share in some ratings categories.
• She remarked that it was difficult to draw conclusions from the aforementioned figures alone and suggested that several factors may explain the long-term tendency for the ratings industry to be comparatively concentrated.
  • She added that regulatory barriers could play a role in decreasing competition.
• She stated that legislative solutions should focus on lowering regulatory barriers for NRSROs and decreasing the artificial demand for NRSRO ratings.
• She noted that while notching proposals (such as the recent proposal from S&P Global Ratings) might raise competition concerns, she asserted that legislative action to address these notching proposals would be premature.
• She highlighted how S&P Global Ratings had withdrawn its recent proposed methodology change and had indicated that it would issue a new RFC.
  • She commented that it would be prudent to delay consideration of potential legislative action until the issue becomes clearer.
• She also noted how there already existed federal laws and regulations that prohibited anticompetitive behavior within the bond rating agency industry, including federal antitrust laws, Section 15E of the Securities Exchange Act of 1934, and SEC rules.
  • She asserted that additional legislation might therefore not be required to address anticompetitive concerns within the NRSRO space.
• She further remarked that rushed judgments of rating agency methodology changes might harm the quality of ratings through limiting NRSROs from considering the creditworthiness of instruments rated by other ratings agencies or by substantively regulating credit ratings and rating methodologies.
• She then suggested that the Subcommittee devote its attention to other topics, including the SEC’s ambitious agenda.
  • She raised particular concerns with the SEC’s short comment periods for its proposed rules.

Congressional Question Period:

Subcommittee Chairman Brad Sherman (D-CA):

• Chairman Sherman discussed how bond rating agencies played a critical role in terms of influencing the compositions of bond portfolios. He also highlighted how nine Republicans had joined his letter to S&P Global Ratings regarding the bond rating agency’s proposed methodology change. He commented that the Subcommittee had already been effective in influencing S&P Global Ratings to withdraw their proposal. He asked Mr. Le Pallec to indicate whether S&P Global Ratings was permanently withdrawing the proposal or was merely spending additional time to consider it.
  • Mr. Le Pallec mentioned how S&P Global Ratings had published a frequently asked questions (FAQ) document on May 9, 2022 that announced the withdrawal of one particular section of its proposed methodological change. He elaborated that this proposed change was meant to deal with how to approach assessing the thousands of securities held by insurers.
• Chairman Sherman interjected to note that the U.S. possessed an anti-notching statute that addressed asset-backed securities. He asked Mr. Le Pallec to indicate whether the U.S. ought to extend this statute to all bond issuances.
  • Mr. Le Pallec commented that he did not have a view on that particular issue.
• Chairman Sherman interjected to state that the extension of the federal anti-notching statute to all bond issuances was the major legislative proposal under consideration by the Subcommittee. He called it notable that Mr. Le Pallec was not expressly opposing the proposal.
  • Mr. Le Pallec noted how S&P Global Ratings had an open and ongoing RFC and commented that S&P Global Ratings was pursuing its RFC process in a transparent manner.
• Chairman Sherman called for new legislation to address the practice of notching. He then discussed how there was a legislative proposal under consideration to prevent U.S. bond rating agencies from rating any new instruments coming out of Russia and Belarus. He noted that the U.S. could also impose secondary sanctions through preventing foreign bond rating agencies that rated new instruments coming out of Russia and Belarus from rating new instruments coming out of the U.S. He asked Mr. Linnell to discuss the effect that denying bond ratings to all future issuances by Belarus and Russia would have on the ability of these countries to raise capital.
  • Mr. Linnell mentioned how Fitch Ratings had announced the suspension of commercial operations in Russia on March 7, 2022. He also mentioned how Fitch Ratings had later announced its intention to withdraw its ratings in Russia on March 23, 2022.
• Chairman Sherman interjected to ask Mr. Le Pallec to indicate whether S&P Global Ratings was still engaged in rating activities within Russia.
  • Mr. Le Pallec testified that S&P Global Ratings had withdrawn its ratings on Russian entities.
• Chairman Sherman asked Mr. Le Pallec to indicate whether foreign-based bond rating agencies were rating instruments that came out of Russia.
  • Mr. Le Pallec indicated that he did not know whether foreign-based bond rating agencies were rating instruments that came out of Russia.
  • Mr. Linnell noted how the European Union (EU) had passed a law requiring European-based rating agencies that endorsed international ratings to withdraw their ratings of Russian instruments by April 15, 2022.
• Chairman Sherman then discussed how the hierarchies of bond rating were not always straightforward. He asked Ms. Liang to address why bond rating agencies could not provide their ratings in a more straightforward manner that clearly indicated the order of performance. He acknowledged however that his question period time had expired and requested that Ms. Liang respond to his question in writing.

Subcommittee Ranking Member Bill Huizenga (R-MI):

• Ranking Member Huizenga contended that the current pace of the SEC’s rulemaking was unprecedented and expressed concerns with how the SEC was proposing rules with very short comment periods. He stated that the SEC was failing to assess how their proposed rules might interact with each other. He specifically highlighted how SEC securities lending, short disclosure, and swaps rules would impact similar markets.  He asked Ms. Schulp to address whether the SEC had clearly articulated how these rules would interact with each other.
  • Ms. Schulp remarked that the SEC had not clearly articulated how its securities lending, short disclosure, and swaps rules would interact with each other. She stated that a similar problem existed regarding the SEC’s rules on 10b5-1 plans and stock repurchases.
• Ranking Member Huizenga asked Ms. Schulp to indicate whether the SEC fully understood the cumulative effect of all of their new rules.
  • Ms. Schulp answered no.
• Ranking Member Huizenga stated that the SEC was releasing its proposed rules during a period of extreme market volatility. He asked Ms. Schulp to indicate whether these rules could add to this market volatility.
  • Ms. Schulp stated that while it was difficult to ascertain exactly what was contributing to the market’s volatility, she asserted that the uncertainty caused by these rules could be disruptive to both the economy and the financial industry.
• Ranking Member Huizenga reiterated his call for the Subcommittee to hold more oversight hearings regarding the SEC. He then noted how there were criticisms that the proposed methodology change from S&P Global Ratings would diverge significantly from the U.S.’s regulatory framework. He expressed concerns that this divergence would have a material impact on insurers and their offered products. He indicated that S&P Global Ratings’s proposal could especially impact long-term guarantee products, such as variable annuity offerings. He commented that this proposal could unnecessarily raise the costs and limit the availability of these products. He asked Ms. Gomez-Vock to comment on this situation.
  • Ms. Gomez-Vock remarked that the recent proposal from S&P Global Ratings could adversely impact the availability, accessibility, and affordability of variable annuities. She expressed concerns with how this proposal would diverge significantly from the U.S.’s regulatory framework and remarked that it was very difficult for insurers to manage two different capital standards. She explained how the U.S.’s regulatory framework involved a book value approach and was more cash flow based while the S&P Global Ratings approach would have involved a market-consistent framework. She commented that market-consistent frameworks tended to be “unfriendly” toward long-term financial products.
• Ranking Member Huizenga then expressed interest in S&P Global Ratings’s recent decision to publish environmental, social, and governance (ESG) indicators for U.S. states. He asked Mr. Le Pallec to address whether such ratings ought to be solely based on a state’s financial indicators and items that are material to the creditworthiness of the rated entity.
  • Mr. Le Pallec remarked that S&P Global Ratings had always accounted for ESG risks in credit ratings whenever these risks had an impact on creditworthiness. He stated that the ESG indicators constituted an additional element of transparency and disclosure and noted how S&P Global Ratings had published these indicators for corporations and financial institutions. He indicated that investors were demanding this ESG information.
• Ranking Member Huizenga interjected to ask Mr. Le Pallec to address whether S&P Global Ratings considered diversity, equity, and inclusion (DEI) measures in its ratings of entities.
  • Mr. Le Pallec remarked that S&P Global Ratings considered DEI issues to the extent that they impacted a company’s creditworthiness.
• Ranking Member Huizenga interjected to note that his question period time had expired.

Full Committee Chairman Maxine Waters (D-CA):

• Chairman Waters mentioned how S&P Global Ratings had withdrawn its proposed methodology change following the announcement of the Subcommittee’s hearing. She noted how many market observers had asserted that this proposed change would be anticompetitive and highlighted how the DoJ had warned S&P Global Ratings that the proposed change would violate federal antitrust laws. She contended that S&P Global Ratings should never have proposed this change to their methodology. She also stated that S&P Global Ratings and Moody’s Investors Service had previously made other notching proposals and commented that this most recent proposal had brought attention to the anticompetitive practices of the bond rating agencies. She specifically highlighted how S&P Global Ratings and Moody’s Investors Service had previously stipulated that they would only provide a credit rating for CLOs and bond insurers if they also rated all of the underlying securities issued by the CLO or bond insurer. She commented that this stipulation was meant to prevent smaller rating agencies from rating the underlying securities for CLOs and bond insurers. She asked Mr. Le Pallec to indicate whether the rating criteria of S&P Global Ratings still stipulated that S&P Global Ratings would only provide ratings for bond insurers if S&P Global Ratings rated every underlying issuance of that bond insurer.
  • Mr. Le Pallec stated that S&P Global Ratings did not make such a stipulation anymore.
• Chairman Waters asked Ms. Liang to discuss how the notching policies of S&P Global Ratings and Moody’s Investors Service impacted KBRA’s ability to rate securities.
  • Ms. Liang noted how KBRA was a smaller NRSRO and asserted that notching policies from the larger NRSROs would diminish competition within the NRSRO space.
• Chairman Waters highlighted how Moody’s Investors Service had declined the Subcommittee’s invitation to appear at the hearing. She recounted how a Wall Street Journal report in 2015 had found that Moody’s Investors Service had threatened to release an unsolicited rating on a Pennsylvania bank that had contracted with KBRA. She indicated that this unsolicited rating from Moody’s Investors Service was lower than the rating from KBRA. She asked Ms. Liang to discuss how this action from Moody’s Investors Service had impacted KBRA.
  • Ms. Liang discussed how Moody’s Investors Service was not rating community banks during the period when KBRA was engaged in this particular contract with the Pennsylvania bank. She testified that KBRA had perceived Moody’s Investors Service’s publishing of an unsolicited rating in this instance as a means of discouraging KBRA’s entrance into to bond rating market and as undermining KBRA’s viability as a bond rating agency.
• Chairman Waters then mentioned how S&P Global had recently acquired IHS Markit, which was previously one of the world’s largest data and analytics firms. She commented that bond rating agencies needed data in order to conduct their analyses. She mentioned how there existed concerns that S&P Global Ratings might now limit the provision of IHS Markit’s data to competitors. She asked Mr. Linnell to indicate whether he shared these concerns.
  • Mr. Linnell stated that while S&P Global’s recent acquisition of IHS Markit did indirectly benefit their ratings business, he asserted that this acquisition did not necessarily reinforce S&P Global Ratings’s duopoly. He contended that the Subcommittee should instead focus on notching practices within the bond rating agency. He suggested that the Subcommittee look into S&P Global Ratings’s CLO, bond fund, and money market fund practices and commented that these practices had adversely impacted the reinsurance sector.
• Chairman Waters stated that S&P Global Ratings and Moody’s Investor Services were engaged in various notching and anticompetitive practices. She commended the Subcommittee for looking into this issue.

Full Committee Vice Ranking Member Ann Wagner (R-MO):

• Vice Ranking Member Wagner asked Ms. Schulp to indicate whether the SEC’s current rulemaking agenda included any proposals to support capital formation. She also asked Ms. Schulp to address why the SEC ought to be focused on reducing burdens for companies seeking to access capital.
  • Ms. Schulp stated that the SEC’s agenda currently did not have any specific capital formation items on it. She expressed concerns that many of the SEC’s current agenda items would instead impose burdens on capital formation efforts (such as the proposed ESG and private fund disclosure rules).
• Vice Ranking Member Wagner contended that the SEC ought to be focused on reducing burdens to capital formation.
  • Ms. Schulp expressed agreement with Vice Ranking Member Wagner’s contention.
• Vice Ranking Member Wagner remarked that the Subcommittee must also be focused on supporting retail investors. She criticized Subcommittee Democrats and the SEC for their emphasis on climate change disclosures for public companies and other initiatives that she contended would discourage companies from going and remaining public. She then raised concerns with how the SEC was providing short comment periods for its various proposals. She asked Ms. Schulp to discuss how these short comment periods would impact market participants and to address how these short comment periods impacted the SEC’s rulemaking process.
  • Ms. Schulp noted that while large banks might be able to employ or retain large numbers of attorneys that could help them to understand the proposals, she remarked that short comment periods would still limit the ability of these banks to fully consider the unintended consequences of the proposals. She also suggested that short comment periods harmed the SEC’s ability to fully consider the potential effects of their proposed rules. She further stated that short comment periods tended to result in fewer comments and fewer in-depth analyses within the comments that identified potential problems, which ultimately resulted in inferior rules. She remarked that the SEC should be able to gather as much information as possible in order to develop the best possible rules.
• Vice Ranking Member Wagner interjected to state that these shorter comment periods adversely impacted smaller investors and smaller companies. She asked Ms. Schulp to identify regulatory barriers that Congress could remove to help these smaller investors and smaller companies.
  • Ms. Schulp recommended that Congress open up the accredited investor definition to include more investors. She stated that the SEC was currently working to narrow this definition.

Rep. David Scott (D-GA):

• Rep. Scott raised concerns over the state of competition within the credit rating agency industry and how market concentration could adversely impact banks, insurers, financial companies, and other financial industry participants. He commented that the credit rating agency industry currently resembled an oligopoly with entrenched incumbents. He stated however that competitive dynamics (even among a small number of rating agencies) had been shown to lead to higher quality ratings and could potentially mitigate the inherent conflict of interest in the industry’s issuer-pay model. He asked Mr. Linnell to provide his assessment regarding the state of competition within the credit rating agency market. He also asked Mr. Linnell to address how this competition was distinct from other markets.
  • Mr. Linnell remarked that competition in the credit rating agency industry had intensified since the passage of Dodd-Frank. He noted how there had been an increasing number of new credit rating agency entrants into this market and highlighted how this trend was particularly evident within the U.S. structured finance market. He stated however that S&P Global Ratings and Moody’s Investors Service still benefited from institutional barriers to competition and commented that notching constituted one such barrier.
• Rep. Scott asked Mr. Linnell to indicate whether robust competition for the credit rating agency industry was the best way for promoting the continued integrity, reliability, and quality of their ratings.
  • Mr. Linnell answered affirmatively and stated that this competition must be combined with transparency. He asserted that transparency was needed surrounding rating performance, rating development, and rating justifications.
• Rep. Scott asked Mr. Linnell to assess the current level of transparency for the credit rating agency industry.
  • Mr. Linnell remarked that the credit rating agency industry’s transparency was “pretty good.” He noted how post-2008 Financial Crisis regulatory reforms in both the U.S. and Europe had promoted greater levels of consistency in how credit rating agencies provided information to the financial markets.
• Rep. Scott then noted how Ms. Liang’s testimony had discussed the challenges associated with entering the credit rating agency market, including the SEC’s registration process. He asked Ms. Liang to identify specific changes that the SEC should consider making to increase the number of new credit rating agency registrants.
  • Ms. Liang noted how the SEC’s current regulations required prospective new credit rating agency entrants to provide attestations from investors that had used the applicant rating agency’s ratings for three years. She stated that it was difficult for applicant rating agencies to obtain such attestations because most investors had limited interest in obtaining ratings from non-NRSROs. She suggested that the SEC consider alternative ways for enabling new entrants to enter the market.

Rep. French Hill (R-AR):

• Rep. Hill first thanked Subcommittee Chairman Brad Sherman (D-CA) for working with him on efforts to impose economic penalties on Russia for its recent invasion of Ukraine. He then expressed concerns with the Commercial Credit Rating Reform Act, which proposed to change the rating assignment model process. He recounted how Dodd-Frank had tasked the SEC with implementing a ratings assignment model, which would have involved the creation of a quasi-governmental board to assign qualified rating agencies to provide ratings. He noted how market participants had raised concerns that this potential quasi-governmental board would hold significant influence over the capital markets through being the sole party to select and assign ratings for the entire market (rather than relying on market checks and balances, competition, and investors). He mentioned how the SEC had ultimately decided to abandon the board and to not mandate any structural changes to the issuer-pay model. He noted how credit rating agencies possessed potential conflicts of interest, regardless of whether issuers, investors, or governments paid for those ratings and/or assigned those ratings. He stated that policymakers ought to work to manage and mitigate these potential conflicts of interest. He remarked that the issuer-pay approach produced a stronger and less biased signal for market participants. He asked Mr. Le Pallec to address whether a rating assignment model would discourage independent competition, which could ultimately harm the quality of ratings and future innovation within the credit rating agency industry.
  • Mr. Le Pallec expressed reservations regarding the Commercial Credit Rating Reform Act. He stated that this legislative proposal would treat credit ratings as a commodity and would prevent investors from deciding which ratings they would consider. He asserted that the credit rating agency market ought to compete based on the quality of their ratings. He also suggested that policymakers consult with corporate issuers on this proposal given how the corporate market was the second biggest segment of the U.S. bond market (behind U.S. Treasuries).
• Rep. Hill asked Mr. Linnell to comment on the merits of a rating assignment model.
  • Mr. Linnell remarked that competition amongst credit rating agencies constituted the best means of ensuring high quality credit ratings. He stated that a rating assignment model would remove incentives for competition. He also asserted that such a model would introduce new conflicts, costs, and bureaucracies.
• Rep. Hill requested that Ms. Liang follow-up on this topic in writing. He then asked Ms. Schulp to address whether a ratings assignment approach could create a conflict of interest.given the significant influence that a quasi-governmental ratings assignment board would have.
  • Ms. Schulp answered affirmatively. She remarked that competition amongst credit rating agencies was the best way to reduce conflicts of interest from materializing and to promote innovation. She stated that a quasi-governmental board that assigned ratings would remove the incentives for credit rating agencies to compete with one another.

Rep. Van Taylor (R-TX):

• Rep. Taylor asked Mr. Linnell to discuss the changes that had been made to Fitch Ratings’s business model since the 2008 Financial Crisis.
  • Mr. Linnell remarked that Fitch Ratings’s business model had remained an issuer-pay model since the 2008 Financial Crisis. He stated however that Fitch Ratings had made several changes in response to Dodd-Frank. He noted how Dodd-Frank had introduced a formal control framework around the determination of ratings, a formal legal attestation around the controls being adequate to manage risks, requirements for credit agency boards to independently approve all of their criteria, the establishment of a formal compliance officer role, increased regulatory oversight of credit rating agencies, and requirements for greater credit rating agency transparency and disclosure. He added that the EU had adopted similar requirements for credit rating agencies after the 2008 Financial Crisis. He remarked that the aforementioned changes were meant to more effectively manage conflicts of interest. He further stated that credit rating agencies had increased their disclosures following the 2008 Financial Crisis and commented that the disclosure standards were “pretty robust.”
• Rep. Taylor asked Mr. Linnell to discuss how Fitch Ratings’s underwriting policies have changed over the previous decade.
  • Mr. Linnell remarked that Fitch Ratings continually considered new ways to assess a company’s risk and to identify new and emerging risks. He indicated that these new and emerging risks included ESG risks, cybersecurity risks, and conduct risks. He stated that Fitch Ratings was thus working to strengthen its access to information, data analysis capabilities, and internal control functions. He mentioned how Fitch Ratings maintained a credit policy group, which he explained was an independent internal task force that looked at the quality of its ratings. He remarked that the aforementioned efforts had translated into improved rating performance.
• Rep. Taylor asked Ms. Schulp to identify any regulatory barriers that could be removed that would help to improve the bond rating agency market.
  • Ms. Schulp remarked that the current SEC requirement that bond rating agencies seeking to become NRSROs obtain attestations from investors that had used their ratings for three years served as a barrier to entry within this space. She also stated that existing laws and regulations that recognized particular NRSROs by name fostered an anticompetitive environment that disadvantaged smaller NRSROs.

Rep. Bryan Steil (R-WI):

• Rep. Steil stated that the SEC was currently engaged in an ambitious rulemaking agenda and providing “unusually” short comment periods for its proposals. He expressed concerns that these short comment periods were designed to limit substantive public comments. He asked Ms. Schulp to indicate how long it typically took to draft substantive comments on a significant proposed rule.
  • Ms. Schulp testified that it generally took her a “couple of weeks” to draft a substantive comment on a significant proposed rule.
• Rep. Steil asked Ms. Schulp to indicate whether short comment periods made it “incredibly difficult” for stakeholders to provide substantive comments to the SEC’s proposed rules.
  • Ms. Schulp answered affirmatively. She also stated that the SEC’s current ambitious rulemaking agenda had forced her to limit which proposals she would comment on.
• Rep. Steil asked Ms. Schulp to indicate whether the SEC’s short comment periods could lead the SEC to issue final rules that did not fully consider all relevant issues.
  • Ms. Schulp answered affirmatively.
• Rep. Steil then mentioned how Ms. Schulp had written a 2021 article that characterized the SEC’s regulatory approach as “paternalistic.” He noted how this article had contended that the SEC was imposing “excessive” restrictions and burdens on retail investors, which limited the ability of these investors to participate in capital markets. He suggested that these SEC rules could be exacerbating the problem of wealth inequality. He asked Ms. Schulp to provide examples of SEC proposals that were paternalistic in nature.
  • Ms. Schulp called the SEC’s ESG and climate-related risk disclosure rules problematic. She contended that these rules would encourage companies to either go or remain private, which would reduce investment opportunities for retail investors.
• Rep. Steil remarked that a decrease in the number of public companies would advantage private equity firms and wealthy Americans over retail investors.
  • Ms. Schulp expressed agreement with Rep. Steil’s remark.
• Rep. Steil then discussed how the principle of materiality served as the basis for the U.S.’s disclosure-based system for securities. He explained how current law required companies to disclose material information to their investors. He stated that the SEC appeared to be moving away from this materiality principle in their climate-related disclosure rule under consideration. He noted how SEC Chairman Gary Gensler and SEC Commissioner Allison Herren Lee had argued that there was an investor demand for climate-related disclosures, which therefore necessitated SEC action on the issue. He asked Ms. Schulp to discuss how the SEC’s interpretation of materiality and their arguments in support of the proposed climate-related disclosure rule differed from the traditional definition of materiality.
  • Ms. Schulp asserted that the connection between required disclosures and financial materiality was “tenuous at best” in the SEC’s proposed climate-related disclosure rule. She added that this connection was completely absent in some areas. She also noted that while investor demand could be a component of whether something could be considered material to an investor, she stated that the SEC’s climate-related disclosure rule relies solely on demand from large institutional investors that have worked climate risk into their modeling. She expressed concerns that the SEC was only focused on large investors in this proposed rule rather than considering the perspectives of all market participants.
• Rep. Steil expressed concerns that the SEC was moving away from traditional definitions of materiality in their recent rulemakings, as well as the expedited nature of these rulemakings.

Rep. Bill Foster (D-IL):

• Rep. Foster noted how Dodd-Frank had required the SEC staff to study and publish a report on whether the credit rating system would benefit from requiring NRSROs to adopt uniform ratings scales and rating symbols. He mentioned how the SEC staff’s report had found that standardizing credit rating terminology may facilitate comparisons of credit ratings across credit rating agencies and may result in fewer opportunities for manipulating credit rating scales to give the impression of accuracy. He indicated however that the SEC staff had ultimately recommended that the SEC not take further action to increase standardization due to feasibility concerns. He noted how there was discussion draft legislation under consideration at the hearing that would direct the SEC to issue rules to require all NRSROs to use a uniform set of credit ratings for each of the six categories of credit ratings recognized under the Securities Exchange Act of 1934. He stated that S&P Global Ratings, KBRA, and Fitch Ratings used an identical set of ratings symbols for corporate issuers. He asked Mr. Le Pallec, Ms. Liang, and Mr. Linnell to address whether uniformity in the ratings scales of their bond rating agencies would enable investors to more quickly and easily understand their ratings.
  • Mr. Le Pallec remarked that investors benefited from a diversity of views with regard to ratings. He stated that treating credit ratings with common definitions could lead investors to treat the ratings as commodities, which could lead to a convergence of methodologies. He commented that this dynamic could limit competition on quality within the market.
  • Mr. Linnell remarked that policymakers would need to differentiate between standardized criteria and the actual nomenclature of the scales. He noted that while a common scale could facilitate transparency and comparability, he asserted that policymakers should avoid enforcing a uniform criterion across the bond rating agencies. He commented that such an approach would undermine the independent integrity and the diversity of views amongst bond rating agencies.
  • Ms. Liang expressed agreement with Mr. Le Pallec and Mr. Linnell regarding the importance of preserving the diversity of perspectives amongst bond rating agencies. She suggested that the U.S. could require more disclosure from bond rating agencies about their rating scales in order to provide clarity to consumers.
• Rep. Foster mentioned how there were proposals to require all bond rating agencies to rate a small fraction of all issuances. He commented that this proposal would enable market participants to better assess how bond rating agencies approached their work. He asked Mr. Le Pallec, Ms. Liang, and Mr. Linnell to comment on this proposal.
  • Mr. Linnell commented that this proposal could be interesting. He stated however that there already existed significant overlap in terms of the issuances being rated across bond ratings agencies. He also mentioned how Fitch Ratings conducted unsolicited ratings when they believed that their ratings would differ from other ratings agencies. He stated that the current competition between bond rating agencies enabled investors to compare the works of the agencies.
• Rep. Foster asked Mr. Linnell to indicate whether Fitch Ratings was rewarded by the market in the instances where they issued unsolicited ratings that turned out to be correct.
  • Mr. Linnell stated that these unsolicited ratings helped to build the long-term reputation of Fitch Ratings.
• Rep. Foster also commented that it was only possible to assess the quality of a bond rating agency’s ratings during periods of distress.

Rep. Anthony Gonzalez (R-OH):

• Rep. Gonzalez noted how the U.S. Federal Reserve’s recent Financial Stability Report had highlighted low liquidity levels in cash, U.S. Treasuries, securities, and index futures. He called these low liquidity levels a major issue and commented that these low levels diminished the U.S. financial system’s ability to respond to large shocks. He contended that the Subcommittee ought to focus on these issues. He then discussed the proposed Commercial Credit Rating Reform Act and noted how it included a provision that would establish a credit rating agency assignment board. He explained that this board would assign NRSROs to provide ratings for corporate issuers. He asked Ms. Liang to discuss her concerns with this legislative proposal.
  • Ms. Liang remarked that an automatic assignment approach would provide guaranteed business to bond rating agencies, which would create a disincentive for these agencies to engage in quality research. She commented that this lack of incentive for quality research would ultimately harm investors and the market at large.
• Rep. Gonzalez expressed agreement with Ms. Liang’s concerns regarding the proposal to establish a credit rating agency assignment board. He then mentioned how S&P Global Ratings had just announced that it would withdraw its notching proposal and that it was considering alternatives for the withdrawn proposal. He asked Mr. Le Pallec to indicate whether S&P Global Ratings expected to release an alternative proposal in 2022. He also requested that Mr. Le Pallec provide any available information about the alternative proposals under consideration.
  • Mr. Le Pallec testified that S&P Global Ratings’s RFC process remained ongoing and that S&P Global Ratings was continuing to solicit stakeholder feedback. He stated that S&P Global Ratings intended to release an updated proposal by the end of 2022. He also stated that S&P Global Ratings would provide updates to the market as it advanced through the RFC process.
• Rep. Gonzalez then mentioned how Ms. Liang’s testimony had discussed the importance of increasing competition within the NRSRO market. He asked Ms. Liang to identify the key barriers that the Subcommittee ought to explore in order to promote competition within the credit rating agency market.
  • Ms. Liang noted how many investor guidelines, federal regulations, and federal facilities still referenced the incumbent rating agencies by name. She suggested that addressing these references would be helpful in promoting competition within the credit rating agency market. She also called on policymakers to provide continued attention to S&P Global Ratings’s proposed risk-based adequacy methodology.

Rep. Warren Davidson (R-OH):

• Rep. Davidson stated that the hearing had already been successful in terms of influencing S&P Global Ratings’s decision to withdraw their notching proposal. He then called on the Subcommittee to perform more oversight over the SEC. He asserted that SEC Chairman Gary Gensler was exceeding the authority that Congress had granted to the Agency and was engaging in regulation by enforcement. He commented that these actions were adversely impacting capital formation within the U.S. He further criticized the SEC for limiting investment opportunities for retail investors. He then asked Mr. Le Pallec to explain the process of mapping ratings given by other firms and factoring them into the ratings from S&P Global Ratings.
  • Mr. Le Pallec discussed how mapping constituted one approach for assessing the creditworthiness of the assets held by insurers. He stated that S&P Global Ratings performed mapping on credit rating agencies that had many common ratings and commented that this approach enables S&P Global Ratings to make sense of the ratings from other agencies.
• Rep. Davidson asked Mr. Le Pallec to address whether S&P Global Ratings’s use of mapping could make S&P Global Ratings vulnerable to groupthink problems.
  • Mr. Le Pallec asserted that S&P Global Ratings’s use of mapping did not make it vulnerable to groupthink problems. He remarked that mapping was simply a statistical study that looked at default and performance statistics published by all of the credit rating agencies. He reiterated that mapping enabled S&P Global Ratings to make sense of common ratings from competitor credit rating agencies. He described mapping as a “translation exercise.”
• Rep. Davidson then remarked that the COVID-19 pandemic had provided a real-world stress test for every aspect of the financial industry, including for the credit rating agencies. He asked Mr. Le Pallec, Ms. Liang, and Mr. Linnell to indicate the percentage of corporate defaults during the pandemic that had received credit ratings of speculative grade prior to the pandemic.
  • Mr. Le Pallec testified that most of the companies that had defaulted during the pandemic had received credit ratings of speculative grade from S&P Global Ratings prior to the pandemic. He remarked that the pandemic was the financial industry’s greatest stress test since the 2008 Financial Crisis. He stated that S&P Global Ratings’s credit ratings had performed in line with their definitions and expectations since the pandemic’s commencement.
  • Mr. Linnell stated that the default rates of companies since the pandemic were lower than expected. He attributed these lower default rates to the policy responses from governments throughout the world.
  • Ms. Liang indicated that she did not have information regarding KBRA’s performance during the pandemic readily available and expressed KBRA’s willingness to follow-up with Rep. Davidson on his inquiry.