Statement on the Adoption of Rule 939A Amendments to Regulation M

Thank you, Chair Gensler, and thank you to the staff for your presentation. Today, the Commission considers whether to adopt amendments to implement Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”).[1] Section 939A requires that the Commission remove references in its rules to credit ratings and to substitute alternative standards of credit worthiness. Today’s amendments would remove certain credit rating references relating to exceptions under Regulation M for nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities.[2]

Last year’s proposal was the Commission’s third attempt to remove credit rating references from Regulation M. The first proposal in 2008 pre-dated the Dodd-Frank Act and would have replaced the reference to credit ratings for nonconvertible securities with the well-known seasoned issuers concept from Rule 405 under the Securities Act of 1933. For asset-backed securities, the Commission would have required that these securities be registered on Form S-3.[3]

The second proposal in 2011 would have replaced the credit ratings requirements with trading requirements based on liquidity, market interest rates and yield spreads, and fungibility with securities of similar characteristics and interest rate yield spreads.[4] The 2011 proposal also would have required the person seeking to rely on the exception to use reasonable factors of evaluation in determining that the security met these criteria and that an independent third party must also verify the determination.

The third proposal in 2022 – and its adoption that we are considering today – would replace Regulation M’s reference to credit ratings with a probability of default standard for nonconvertible securities.[5] Under the final amendments, nonconvertible securities that have a probability of default of 0.055% or less, as measured over a certain period of time and as determined and documented using a “structural credit model,” among other requirements, would be eligible for Regulation M’s exception. In addition, asset-backed securities that are offered pursuant to an effective shelf registration statement filed with the Commission on Form SF-3 would be eligible for Regulation M’s exception.

The removal of Regulation M’s reference to credit ratings is long overdue. I strongly support removing all reliance on credit ratings from our rulebook and today’s action will complete the Commission’s efforts to fully implement Section 939A. In fact, I worked on the Division of Investment Management’s initial efforts to remove credit rating references from the investment company disclosure rules over a decade ago. Completing the implementation of Section 939A is a matter of sound policy, as the Commission should not delegate regulatory eligibility criteria to third parties with profit-making interests and motivations. The substantial problems with this approach for credit ratings have been well documented, and we should be wary of any similar efforts in the future.

The amendments being considered today, while long overdue and part of the third attempt, may not be the perfect solution. As the Commission acknowledges, a probability of default standard of 0.055% for nonconvertible securities is an imperfect measure for evaluating creditworthiness.[6] However, this standard was better received than the other standards previously proposed and vastly better than retaining credit rating references in Regulation M. That said, I encourage the Commission and the staff to periodically re-evaluate whether this specific default standard captures the appropriate set of nonconvertible securities that are traded on the basis of yield and creditworthiness and are consistent with Regulation M’s principles.

For the foregoing reasons, I support today’s adoption. I am pleased that with today’s adoption, the Commission will have removed all references to credit rating reliance in its rules. In this regard, I want to recognize the efforts of the staff in bringing this proposal to its long-awaited finalization. My thanks to the Divisions of Trading and Markets and Economic and Risk Analysis, as well as the Offices of the General Counsel and Credit Ratings, for their hard work and persistence.