MAS Consults on Regulating Credit Rating Agencies

The Monetary Authority of Singapore (“MAS”) has issued a consultation paper (“Consultation Paper”) on its proposal to regulate credit rating agencies (“CRAs”). MAS proposes to require CRAs to be licensed under the capital markets services (“CMS”) licensing regime under the Securities and Futures Act (“SFA”).

The move to require licensing of CRAs stems from the recent issue, by the International Organization of Securities Commission (“IOSCO”), of new principles recommending the regulation and supervision of CRAs. Since then, many countries worldwide have begun implementing regulatory regimes on CRAs, including the European Union, the United States, Australia, Japan, Canada and Hong Kong.

The closing date for submission of feedback for the consultation is 22 April 2011.

New regulated activity of “providing credit rating services” MAS proposes to regulate CRAs under Part IV of the SFA by stipulating that “providing credit rating services” is a regulated activity. Any person who carries on or holds himself out as carrying on the business of providing credit rating services will be required to hold a CMS licence. For this purpose, the Second Schedule of the SFA will be amended to include new definitions for “providing credit rating services”, “credit rating” and “rating category”. The proposed definitions are set out in Appendix A of the Consultation Paper.

Proposed scope of “providing credit rating services” In the proposed definitions, “credit rating” refers to an opinion regarding the creditworthiness of a rating target expressed using a defined ranking system of rating categories. The rating target could be a person (other than an individual), a government (including the Singapore Government), or securities. The term “securities” is already defined in the existing section 2 of the SFA, and includes debenture stock, bond notes and any other debt securities issued by a corporation or other entity.

The proposed definition of “providing credit rating services” covers the preparing (whether partly or wholly within Singapore) of credit ratings in relation to activities in the securities and futures industry for disseminating to the public or distributing by subscription in Singapore or elsewhere.

2
The following situations will be excluded from the definition of “providing credit rating services”: (i) preparation of private credit ratings for an individual order, which are not intended for public disclosure or distribution; (ii) operation of internal credit rating systems, such as those used by banks for assessing counterparty risks, and (iii) activities of entities engaged in providing consumer, commercial or industrial credit data, such as credit bureaus and reference agencies.

Registration of CRA representatives under the representative notification framework
CMS licensees providing credit rating services will be required to appoint and register their representatives under MAS’s representative notification framework. The CMS licensees will need to ensure that their representatives fulfil the fit and proper requirements in accordance with MAS’s Guidelines on Fit and Proper Criteria.
MAS proposes that representatives providing credit rating services must hold, at the minimum, a Bachelor’s degree in any discipline. This qualification will be in place of the requirement to pass a Capital Markets and Financial Advisory Services examination, as presently there are insufficient CRAs operating in Singapore to justify the development of specific Capital Markets and Financial Advisory Services modules for such representatives.
Maintaining a minimum base capital
MAS also proposes that a CMS licensee providing credit rating services maintain a minimum base capital of $250,000. This requirement is the same as that applicable to CMS licensees who advise on corporate finance. The rationale for this is that both CMS licensees who advise on corporate finance and those who provide credit rating services provide mainly advisory services and typically do not hold client assets.

Exemption from dispute resolution scheme
Under MAS’s (Dispute Resolution Schemes) Regulations 2007, all CMS licensees, except those whose licence relates only to the regulated activity of advising on corporate finance or those who are required by a condition of the licence to carry on the regulated activity in relation to accredited, expert or institutional investors, are required to be members of a specified alternative dispute resolution scheme.
Corporate finance advisors are exempted from this requirement as they do not deal with retail investors. As CRAs do not deal directly with retail investors either, MAS proposes that CMS licensees providing credit rating services be similarly exempted from the requirement to join a specified alternative dispute resolution scheme.
Code of Conduct for CRAs MAS proposes to prescribe a Code of Conduct for CRAs (“Code”) which applies specifically to CMS licensees providing credit rating services. The proposed Code is based largely on IOSCO’s Code of Conduct Fundamentals for Credit Rating Agencies.

3
enunciated by the Code cover the following areas: (i) quality and integrity of the rating process, (ii) independence and avoidance of conflict of interest, (iii) responsibility to the investing public and issuers, and (iv) communications with market participants and public. The Code also contains particular recommendations in relation to structured finance products, which have come under greater scrutiny since the recent financial crisis.
(i) Quality and integrity of rating process
The Code recommends that CRAs should use rating methodologies which are rigorous, systematic and can be subject to objective validation. The methodologies should be applied consistently. Written procedures should be maintained and records of credit ratings should be kept for not less than 6 years from the issue of the credit rating. A review function should be set up to review the methodologies used. Ratings should generally be monitored and updated on an ongoing basis.

CRAs should ensure that their representatives are held to high standards of integrity. They should deal fairly and honestly with investors, issuers and the general public. CRAs should implement policies and procedures for compliance with regulations and guidelines. These policies should include appointment of a compliance officer as well as providing for whistle-blowing within the organization.
(ii) Independence and avoidance of conflict of interest CRAs should not provide consultancy or advisory services to any rated entity or its related party. They should also not engage in businesses which would potentially give rise to conflicts of interest. A CRA should not forbear or refrain from preparing or revising a credit rating based on its potential effect on the CRA, an issuer, an investor or other market participant. It should also not enter into contingent fee arrangements when providing its services. Any actual or potential conflicts of interest should be publicly disclosed. CRAs should also implement policies and procedures to ensure that their representatives and employees maintain independence and observe conflicts of interest principles.
(iii) Responsibility to the investing public and issuers
A CRA should distribute its credit ratings, reports and updates in a timely manner. Credit ratings should contain stipulated information, such as when they were issued or updated and the names of the persons who prepared and approved them.

A CRA should adopt procedures and mechanisms to protect the confidential nature of information provided to it by rated entities, and use this confidential information only for purposes relating to its credit rating activities.
(iv) Communication with market participants and public CRAs should have an internal code of conduct and should disclose it to the public together with a description of how its provisions implement the provisions of the Code. They should also establish a department or function within their organisation which deals with communication with market participants and the public. Information on a CRA’s rating methodologies, historic performance data, its internal control mechanisms, quality control system, record keeping policy, and management and representative rotation policy should be made available to the public.

4
To view the contents of the draft Code in full, please refer to Appendix B of the Consultation Paper.

Transitional provision
To allow CRAs sufficient time to apply for the requisite CMS licence and comply with all applicable regulatory requirements, MAS intends to provide a transition period of 6 months during which these CRAs may operate without holding a CMS licence in respect of providing credit rating services. The transition period will commence from the effective date on which the new legislative and regulatory changes take place.