Monitoring Ratings Monitoring

Today's "Administrative Action" announced against Standard & Poor’s Ratings Japan K.K. hones in on just the sorts of problems our transparent ratings "drive" would protect against. 

For those of you who haven't been following, PF2 consultant Marc Joffe's open-source PSCF model has been gaining widespread attention, with Marc being recently commissioned by the California State Treasurer's office to further develop the PSCF default probability model for municipal bonds. 

Japan's FSA makes a strong case for promoting ratings transparency.  Having a transparent model allows others to catch ratings errors before they become too problematic - a positive feedback loop that lends to market stability and to investor confidence. 

It also encourages (or forces) rating agencies to keep current their ratings, minimizing the possibilities for larger rating changes (mostly downgrades) if and when raters notice their ratings are out of sync. 

An excerpt from the Japanese FSA's Administrative Release reads as follows (emphasis added):

"[S&P failed] to properly confirm important information that affects Synthetic CDO ("SCDO") credit ratings
 ...

[S&P] did not properly take stock of the cumulative loss amount pertaining to the reference obligations that affects the credit rating of SCDOs. The Company did not take measures such as confirming with arrangers of SCDOs whether there had been any credit events relating to the reference obligations.

Therefore, some cases were identified where incorrect credit ratings had been assigned to certain SCDO products for a significant period of time until just before the withdrawal of the credit ratings due to the redemption of those SCDO products.
 ...

The Company has continued publishing the credit ratings of the relevant SCDOs without confirming whether there were any credit events.
... 

The Company incorrectly maintained until October 2010 a credit rating of a SCDO product that should have been downgraded in January and further in February of that year. This is due to input to the Company’s system of incorrect notional amount data in relation to the reference obligations in the monitoring process of the SCDO credit rating.

The Company has not implemented a verification process whereby a second person checks the accuracy of the data input."