The Canadian Securities Administrators (the “CSA”) have recently released for comment proposed National Instrument 25-101 Designated Rating Organizations (the “Proposed Rule”). The Proposed Rule is the first attempt to regulate credit rating organizations (“CROs”) in Canada. The CSA have, apparently, decided to extend a degree of regulatory oversight to CROs in the wake of the credit crisis and in view of similar initiatives being adopted outside of Canada. Although the Proposed Rule imposes a number of requirements on a CRO that wishes to become a “Designated Rating Organization” (a “DRO”) under the Proposed Rule, it does not enable regulators to interfere with the methodology employed by DROs to rate a security or the content or presentation of any particular rating.
The Proposed Rule enables a CRO to apply for designation as a DRO by filing an application that includes certain required information. The significance of this is that, as a result of consequential amendments being made to various National Instruments, only ratings by those CROs that qualify as DROs will be eligible to be included in Canadian prospectuses and certain continuous disclosure material.
The Proposed Rule requires that, once a CRO becomes a DRO, it must establish, and ensure that it complies with, a code of conduct. The code of conduct is based on the I0SCO Code of Conduct Fundamentals for Credit Rating Agencies (the “I0SCO Code”). The code of conduct of the DRO must address, among other things, the following:
- conflicts of interest;
- misunderstandings by investors about what ratings mean;
- adequate staffing of agencies;
- the quality of information used to make rating decisions;
- the ability to rate novel products;
- differentiation of ratings for different securities; and
- public disclosure of historical ratings performance information.
A DRO may only deviate from the I0SCO Code if it explains the deviation and indicates how its own code achieves the objectives of the I0SCO Code in spite of the deviation.
In addition to the code of conduct requirement, the Proposed Rule requires DROs to:
- have policies and procedures to identify and manage conflicts of interest arising from credit ratings issued;
- appoint a compliance officer to monitor and assess compliance with the code and the Proposed Rule;
- have policies and procedures to prevent inappropriate use or dissemination of material non-public information, including a pending undisclosed rating action; and
- file an annual form under the Proposed Rule, which is required to include information concerning the identity and net revenues realized from its 20 largest customers, among other things.
Certain consequential amendments will be made to National Instruments 41-101 General Prospectus Requirements, 44 101 Short Form Prospectus Requirements and 51-102 Continuous Disclosure Obligations in order to require issuers to disclose certain information regarding their dealings with the ratings industry, including amounts paid by an issuer to a DRO to obtain a rating for any of its outstanding securities.