Opening Cross: Thinking About Turning Over a New Leaf in 2014?
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According to the University of Scranton’s Journal of Clinical Psychology (via StatisticBrain.com), only eight percent of people who make New Year’s resolutions actually achieve them. Chances are your New Year’s resolutions include joining a gym, starting a diet, finishing long-delayed projects, or perhaps finally throwing out those old bell-bottoms and platform shoes from the 70s slowly disintegrating at the back of your closet.
Another 70s relic now finally being cleaned out is references to credit rating agencies in Securities and Exchange Commission rules, in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act. This removes any reliance on NRSROs (nationally recognized statistical rating organizations) from processes governing credit quality assessment and reporting, capital adequacy, account segregation and terms and conditions notifications. The significance of this—and an upcoming broader removal of reliance on credit ratings as mandated by Dodd-Frank—is that the investment industry’s decisions are no longer dictated by ratings that the credit crisis exposed as flawed.
“The NRSROs failed miserably in their ratings of asset-backed securities... in the years leading up to the crisis. These faulty ratings were a core cause of the financial crisis, and the incorporation of references to credit ratings into Commission rules… exacerbated the problem,” said commissioner Daniel M. Gallagher, commending the changes.
On the bright side, this frees investors up to use whatever inputs they deem most accurate and that provide the greatest edge over other firms. The downside is that it removes a check and balance. Whatever the flaws of the ratings themselves, at least the references ensured an extra compliance stage. Finding a replacement criteria could also be fraught with peril. Mandating a certain input creates a captive market and arguably stifles innovation (for a more in-depth discussion of innovation, see our roundtable Q&A), whereas leaving firms to select their own validating criteria means that providers must compete to win business based on their quality. Yet taking a step back from this seems unlikely, given the SEC’s stated examination priorities for 2014, which include plans to increase supervision of advisor businesses and models previously not examined by the SEC.
Also not taking a step back in 2014 is New York Attorney General Eric Schneiderman, who—having last year persuaded Thomson Reuters to suspend early access to its University of Michigan Consumer Sentiment Index survey data for high-frequency firms willing to pay extra—has now engineered the demise of asset manager BlackRock’s analyst survey program, which Schneiderman said gave an unfair advantage to technically-sophisticated traders. BlackRock’s program surveyed analysts for their opinions about specific companies in an effort to predict subsequent recommendation changes, allowing BlackRock to identify expected trends before the rest of the market, which would react to the analysts’ reports.
Under the deal with Schneiderman, BlackRock has terminated the program without admitting liability. The case hinges on whether BlackRock induced analysts to reveal early information that would be considered market-moving and should be released to all clients at the same time, whereas trying to “front-run” analyst recommendations by other means—say, by analyzing an analyst’s history of revisions, and by how much they change their recommendations—is not just legal, but a potential edge.
When you turn over a leaf, you might find fungus beneath it. But whether consuming it nourishes you or causes systemic failure depends on your ability to detect mushrooms from toxic toadstools. Whereas in the past some types of derived data have been subject to battles over intellectual property rights, depending on its source, they may also come under regulatory scrutiny.
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