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CFA Institute Member Opinion Poll Confirms Support for CRA Reform

New York, July 7, 2008 – The results of a CFA Institute member opinion poll released today found that 11 percent of respondents had witnessed a credit rating agency (CRA) change its rating in response to pressure from an investor, issuer, or underwriter.

CFA Institute is the global association of investment professionals. CFA Institute distributes the “Question of the Month” poll to its global membership every month. Through the CFA Institute Centre for Financial Market Integrity, it promotes high ethical standards and investor protections via professional codes of conduct, guidance, and outreach.

“In the wake of the subprime crisis, we have met with several representatives from ratings firms,” said Kurt Schacht, CFA, managing director of the CFA Institute Centre. “They were concerned about the hype and insinuation that CRAs easily inflate their ratings in response to pressure from issuers and underwriters, implicating the integrity of their process and ratings. In exploring that topic, we were very surprised by the results of our member poll where some 211 of the 1,956 respondents said they have indeed witnessed a CRA change ratings in response to external pressures.”

“At the very least these results suggest that the CRAs have more than just a perception problem about their processes and integrity, which must be addressed,” said James Allen, CFA, director of the CFA Institute Centre’s Capital Markets Policy Group. “They should take prompt action to manage or eliminate conflicts in a comprehensive fashion and improve any practices that expose the CRA to ethical problems. And this may go beyond what has already been proposed by the SEC and other global regulators.”

Many respondents noted that the payment structure between CRAs and issuers presents the largest conflict of interest. One respondent said, “The fundamental flaw is that the agencies are paid by issuers, not by investors. No amount of regulation can fix that conflict of interest.” Another respondent anonymously said, “Exchanges are self-regulating. Ratings can be as well.  But the incentives should be established so that their interests are aligned with investors.”

In other results, 55 percent (1,070 responses) of all respondents agreed with the statement that CRAs should group themselves into an international standard-setting and monitoring self-regulatory body with enforcement powers, something the CFA Institute Centre has encouraged as part of any CRA industry reform package.

Finally, the issue of using different rating symbols for structured products showed that nearly half of all respondents, 47 percent (911 responses), were in favour. The concern is that not all AAA securities are created equal.  As demonstrated in the current credit crisis, structured products typically perform very differently from traditional corporate bonds, despite the identical symbols. As one of the respondents commented, whereas corporate default is typically related to one or two factors, “default on structured debt is dependent on hundreds or thousands of individual defaults [e.g. an underlying mortgage pool] that are estimated given some distribution. They are not the same analysis so they should not be the same ratings.”

“We feel that a different rating scale is an essential aid to trustees and fiduciaries, to help them evaluate and quantify the amount of structured product exposure they desire in their portfolios,” noted Allen. We have expressed this thought and others in responses to the ratings agencies themselves and in response to both domestic and international consultations from CESR and IOSCO on the topic.” The CFA Institute Centre is also preparing a response to the current U.S. Securities and Exchange Commission’s proposals on CRAs.

“Clearly the respondents to this survey raise some serious concerns about the integrity of the ratings process and support for further CRA reform.  We urge CRAs and regulators to consider the views expressed by our members and to consider such additional reforms as are warranted, both to the CRA process and to the ratings they apply to structured instruments,” concluded Allen.

CFA Institute
CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has more than 95,500 members, who include the world’s 82,400 CFA charterholders, in 134 countries and territories, as well as 135 affiliated professional societies in 56 countries and territories. More information may be found at www.cfainstitute.org. (Bloomberg users can find CFA Institute at 497458Z).