A common complaint by participants in the recent credit collapse is they did not understand what they were buying, rating or selling. Part of the reason for this lack of clarity is that the structured debt products CDO (Collateralized Debt Obligations) and related derivates products were themselves convoluted, consisting of large volumes of mortgages and other forms of debt which were aggregated and sliced into tranches with varying risk profiles.
However, the developers of the CDOs presented mathematical calculations that argued they were fairly risk free. The issuer calculations impressed rating agencies enough to grant many CDOs Triple-A Ratings (highest rating) and as a result investors bought. Unfortunately, the mathematical assumptions were flawed and most of these products were based on loans made to borrowers who had no means to repay and the CDO values soon collapsed.
In order to mitigate a recurrence of this financial collapse the SEC wants to bring greater transparency to the rating of structured debt products. The SEC has asked arrangers of these products (generally large investment banks) to retain all information submitted to rating agencies in a password protected website. Here is a summary of the new requirements written by TD Waterhouse: https://research.tdwaterhouse.ca/research/public/Markets/NewsArticle/1314-WLB1445-1
In my opinion, these are the relevant clauses:
to disclose, on a password protected website, all the information provided to the hired NRSRO both for determining the initial credit rating and for ongoing surveillance; and
When arrangers hire an NRSRO to rate a structured finance security, they must provide written representation to the NRSRO that they will make this information available on a password protected website, that any NRSRO can access this website and that all information will be posted that covers both initial credit ratings as well as surveillance. An NRSRO cannot rate a structured finance security unless it receives this written representation.
Arrangers have until June 2, 2010 to comply. Firmex offers a turnkey solution where each arranger of structured debt products can have a private-label, password protected website to securely share confidential documents. This setup will enable arrangers to share confidential documents while complying with the SEC rule 240-17g-5 and thus the process will have improved oversight and transparency.