Rating agencies seen weathering regulatory storm

NEW YORK/WASHINGTON (Reuters) - The three big credit rating agencies are being shaken by a host of new regulations designed to correct shortcomings and curb their influence on investors.

But after the dust settles, they most likely will continue to dominate Wall Street.

The biggest threat comes from reforms put forward by the U.S. Securities and Exchange Commission, including one to wean investors and Wall Street off the risk-assessment reports provided by Standard & Poor's (MHP.N), Moody's Investors Service (MCO.N) and Fitch Ratings (LBCP.PA).

The three agencies are blamed for failing to spot the pitfalls in the mortgage securities market, contributing to massive losses for global banks and crippled credit markets.

But with SEC Chairman Christopher Cox and European Union Internal Market Commissioner Charlie McCreevy both expected to leave office early next year, analysts wonder if regulators have the time and authority to implement meaningful reforms.

"I don't think much is going to change. They will keep making money ... because some guy in Oklahoma wants a Moody's or S&P rating," said Philippe Stephan, former director of product development at Moody's KMV, a unit that assesses companies' credit quality.

For decades, S&P, Moody's and Fitch have dominated the landscape. Wall Street turned to them to rate their products and investors relied on them to determine the quality of companies and securities.

Now, the SEC reforms such as eliminating a requirement that money market funds hold highly rated securities means investors may turn to other avenues to evaluate a security's credit worthiness.

The SEC is also proposing prohibiting credit-rating agencies from structuring the same products that they rate, and to bar anyone who helps determine a rating from negotiating fees. The agency's comment period for the proposal closes in early September and the SEC's Cox has signaled that new rules are a priority.

Some say the SEC's plan has the potential to revolutionize the securities market by opening up the rating business and allowing broker dealers, investors and banks to find alternate ways of evaluating credit.

But others believe the opinions of the big three raters will still be valued.

"Rating agencies will adapt their businesses and investors and intermediaries will still value their opinion," said Stuart Kaswell, a partner at Bryan Cave who specializes in compliance and broker-dealer issues.

"The basic idea of going to someone who is more knowledgeable than you are and getting another opinion ... that will continue."

BIG THREE RATERS UNDER PRESSURE

That is not to say that Standard & Poor's, Moody's Investors and Fitch Ratings are not in trouble.

A substantial portion of their revenue has disappeared -- at least temporarily -- as investors shun many of the complex financial products at the center of the credit crisis. Global sales of complex debt known as Collateralized Debt Obligations have shrunk to less than $47 billion in the year-to-date from a record $442 billion last year, according to Thomson Reuters data. At the same point last year, global sales stood at $379 billion, eight times more than this year.

Ratings agencies' costs are also rising as they deal with changes in regulations, and they have all been accused by investors and regulators of stamping high quality ratings on bond products that later crashed and burned.

"Profits may be hurt for a number of reasons," said Jerome Fons, former managing director of credit policy with Moody's Investors. "It may restrict activity and it will increase costs, particularly compliance costs."

Moody's Corp, parent of Moody's Investors Service, said its quarterly profit also fell 48 percent for the three months ending June 30. Standard & Poor's parent McGraw-Hill Cos posted a 23 percent drop in second-quarter earnings, as revenue from its bond rating business declined.

Fimalac, the French holding company that owns Fitch Ratings, said operating profit fell 10.6 percent to 65.7 million euros in the first half of its fiscal year, and revenue at Fitch may fall 20 percent for the year ending September 30.

And tiny rivals are starting make inroads. Egan-Jones Ratings' business has grown 30 percent so far this year on increased demand from institutional investors and hedge funds.

But even though the firm's Managing Director Sean Egan said the big three firms' influence is waning, he said they are going to continue to be a major force.

"I don't think any of the credit rating proposals will have an impact, because the (big three firms) can adjust to it," Egan said. "The core issue is assuring the issuance of timely accurate ratings. I don't think that was the focus of the proposed rules."

S&P, Fitch and Moody's have been blamed for not correctly assessing risks in the mortgage credit markets and then being late to downgrade the related securities.

Compliance officers at the three major rating firms did not return calls or declined to comment.

Press officers said they agreed in principle with greater transparency efforts put forth by the SEC, European Union, the Financial Stability Forum, the International Organization of Securities Commissions (IOSCO) and New York Attorney General Andrew Cuomo.

"The small guys will have a hard time building the track record and building the name that will stick in people's brains," said Stephan, now global head of business development for Sophis, a derivatives technology company that works with many of the world's largest banks.

(Editing by Maureen Bavdek and Jan Paschal)