Shift In Fee Practices For Major Bond-Rating Firms

The three major bond-rating firms, according to reports from the WSJ – are set to overhaul the way they collect fees as part of a settlement that could be announced as soon as this week with New York Attorney General Andrew Cuomo.

An agreement with Moody’s Corp.’s Moody’s Investors Service (MCO), McGraw-Hill Cos.’ Standard & Poor’s unit (MHP) and Fimalac SA’s Fitch Ratings would mark a significant step in the heightening investigations into why the gatekeepers of the bond market failed to predict that risky subprime mortgages would fall victim to a declining housing market, sparking billions of dollars in losses.

Under current practice, investment banks that pool mortgages into securities hire rating firms to rate those securities. That makes the securities easier to sell to pension funds, mutual funds, insurance companies and other investors. Often, more than one rating firm reviews a deal, but the investment bank or issuer of the bonds ultimately decides which rating firms will issue a rating and get paid for the services.

Mr. Cuomo’s plan envisions that the rating firms would collect payments both for rating the deal and their preliminary work reviewing loans and bond structures, even when firms aren’t selected to provide a rating.

The aim would be to remove some of the power of investment banks have over selecting which rating firms get paid to rate deals.

The firms would be instructed to charge more than a nominal fee for the preliminary work and bond issuers would still have a say over which rating firms published the final rating and on which ones were invited to look over a pool of loans in the first place.

The plan, which still requires final agreement by Mr. Cuomo’s office and the rating firms, stops short however, of dictating the exact fees rating firms would charge.

Mr. Cuomo’s plan attacks what many describe as the core problem with ratings, namely that they’re paid for by the entities being rated.

The New York Attorney General and other regulators scrutinizing the $5 billion-a-year bond-ratings industry view the chance to reform ratings as a way to start restoring confidence in the way investors buy and sell structured finance bonds.