    [House Hearing, 117 Congress]
    [From the U.S. Government Publishing Office]

                          A NOTCH ABOVE? EXAMINING THE
                              BOND RATING INDUSTRY

    =======================================================================

                                 HYBRID HEARING

                                   BEFORE THE

                      SUBCOMMITTEE ON INVESTOR PROTECTION,

                     ENTREPRENEURSHIP, AND CAPITAL MARKETS

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                        ONE HUNDRED SEVENTEENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                  MAY 11, 2022

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 117-83

    [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                                   __________

                        U.S. GOVERNMENT PUBLISHING OFFICE
    47-650 PDF                 WASHINGTON : 2022

    -----------------------------------------------------------------------------------

                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                     MAXINE WATERS, California, Chairwoman

    CAROLYN B. MALONEY, New York         PATRICK McHENRY, North Carolina,
    NYDIA M. VELAZQUEZ, New York             Ranking Member
    BRAD SHERMAN, California             FRANK D. LUCAS, Oklahoma
    GREGORY W. MEEKS, New York           BILL POSEY, Florida
    DAVID SCOTT, Georgia                 BLAINE LUETKEMEYER, Missouri
    AL GREEN, Texas                      BILL HUIZENGA, Michigan
    EMANUEL CLEAVER, Missouri            ANN WAGNER, Missouri
    ED PERLMUTTER, Colorado              ANDY BARR, Kentucky
    JIM A. HIMES, Connecticut            ROGER WILLIAMS, Texas
    BILL FOSTER, Illinois                FRENCH HILL, Arkansas
    JOYCE BEATTY, Ohio                   TOM EMMER, Minnesota
    JUAN VARGAS, California              LEE M. ZELDIN, New York
    JOSH GOTTHEIMER, New Jersey          BARRY LOUDERMILK, Georgia
    VICENTE GONZALEZ, Texas              ALEXANDER X. MOONEY, West Virginia
    AL LAWSON, Florida                   WARREN DAVIDSON, Ohio
    MICHAEL SAN NICOLAS, Guam            TED BUDD, North Carolina
    CINDY AXNE, Iowa                     DAVID KUSTOFF, Tennessee
    SEAN CASTEN, Illinois                TREY HOLLINGSWORTH, Indiana
    AYANNA PRESSLEY, Massachusetts       ANTHONY GONZALEZ, Ohio
    RITCHIE TORRES, New York             JOHN ROSE, Tennessee
    STEPHEN F. LYNCH, Massachusetts      BRYAN STEIL, Wisconsin
    ALMA ADAMS, North Carolina           LANCE GOODEN, Texas
    RASHIDA TLAIB, Michigan              WILLIAM TIMMONS, South Carolina
    MADELEINE DEAN, Pennsylvania         VAN TAYLOR, Texas
    ALEXANDRIA OCASIO-CORTEZ, New York   PETE SESSIONS, Texas
    JESUS ``CHUY'' GARCIA, Illinois
    SYLVIA GARCIA, Texas
    NIKEMA WILLIAMS, Georgia
    JAKE AUCHINCLOSS, Massachusetts

                       Charla Ouertatani, Staff Director
            Subcommittee on Investor Protection, Entrepreneurship,
                              and Capital Markets

                       BRAD SHERMAN, California, Chairman

    CAROLYN B. MALONEY, New York         BILL HUIZENGA, Michigan, Ranking
    DAVID SCOTT, Georgia                     Member
    JIM A. HIMES, Connecticut            ANN WAGNER, Missouri
    BILL FOSTER, Illinois                FRENCH HILL, Arkansas
    GREGORY W. MEEKS, New York           TOM EMMER, Minnesota
    JUAN VARGAS, California              ALEXANDER X. MOONEY, West Virginia
    JOSH GOTTHEIMER. New Jersey          WARREN DAVIDSON, Ohio
    VICENTE GONZALEZ, Texas              TREY HOLLINGSWORTH, Indiana, Vice
    MICHAEL SAN NICOLAS, Guam                Ranking Member
    CINDY AXNE, Iowa                     ANTHONY GONZALEZ, Ohio
    SEAN CASTEN, Illinois, Vice Chair    BRYAN STEIL, Wisconsin
    EMANUEL CLEAVER, Missouri            VAN TAYLOR, Texas

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        May 11, 2022.................................................     1
    Appendix:
        May 11, 2022.................................................    31

                                   WITNESSES
                            Wednesday, May 11, 2022

    Gomez-Vock, Mariana, Senior Vice President, Policy Development,
      American Council of Life Insurers (ACLI).......................     9
    Le Pallec, Yann, Executive Managing Director and Head of Global
      Ratings Services, S&P Global Ratings...........................     5
    Liang, Angela, General Counsel and Executive Committee Member,
      Kroll Bond Rating Agency (KBRA)................................     6
    Linnell, Ian, President, Fitch Ratings...........................     8
    Schulp, Jennifer J., Director, Financial Regulation Studies,
      Center for Monetary and Financial Alternatives, Cato Institute.    11

                                    APPENDIX

    Prepared statements:
        Gomez-Vock, Mariana..........................................    32
        Le Pallec, Yann..............................................    41
        Liang, Angela................................................    51
        Linnell, Ian.................................................    61
        Schulp, Jennifer J...........................................    67

                  Additional Material Submitted for the Record

    Sherman, Hon. Brad:
        Written statement of Creative Investment Research............    73
        NRSRO Corporate Issuer Ratings Scores........................    83
    Davidson, Hon. Warren:
        Letter to Financial Services Committee Chairwoman Waters from
          Financial Services Committee Ranking Member McHenry and
          IPECM Subcommittee Ranking Member Huizenga requesting a
          hearing with the full SEC, dated May 5, 2022...............    84
    Le Pallec, Yann:
        Written responses to questions for the record from
          Representatives Hill and Huizenga..........................    86

                          A NOTCH ABOVE? EXAMINING THE
                              BOND RATING INDUSTRY

                                  ----------

                            Wednesday, May 11, 2022

                 U.S. House of Representatives,
                   Subcommittee on Investor Protection,
                 Entrepreneurship, and Capital Markets,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 10:05 a.m., in
    room 2128, Rayburn House Office Building, Hon. Brad Sherman
    [chairman of the subcommittee] presiding.
        Members present: Representatives Sherman, Maloney, Scott,
    Foster, Vargas, Gottheimer, Axne; Huizenga, Wagner, Hill,
    Emmer, Davidson, Gonzalez of Ohio, Steil, and Taylor.
        Ex officio present: Representative Waters.
        Chairman Sherman. The Subcommittee on Investor Protection,
    Entrepreneurship, and Capital Markets will come to order.
        Without objection, the Chair is authorized to declare a
    recess of the subcommittee at any time. Also, without
    objection, members of the full Financial Services Committee who
    are not members of the subcommittee are authorized to
    participate in today's hearing, pursuant to committee rules.
        Today's hearing is entitled, ``A Notch Above? Examining the
    Bond Rating Industry.''
        I will now recognize myself for 4 minutes for an opening
    statement. I will then recognize the ranking member of the
    subcommittee, Mr. Huizenga, for 5 minutes, followed by the
    Chair of the full Financial Services Committee, Chairwoman
    Waters, for 1 minute.
        Each year, roughly $3 trillion worth of money flows based
    upon the ratings of the bond rating agencies, in commercial
    paper, asset-backed securities, and corporate bonds. If the
    rating is good, the interest rate is low and the project can go
    forward. If the rating is low, well, it doesn't pencil out. It
    is like when you get a bad credit score and you don't buy a
    home, or, in this case, a business doesn't build a factory.
        Earlier this year, S&P Global Ratings, the largest of the
    rating agencies, came up with a proposal which triggered these
    hearings, and that proposal was described as, ``notching,''
    because the bond rating agencies play two roles: they rate the
    insurance companies that buy the bonds; and then, they rate the
    bonds the insurance companies buy. And the notching proposal,
    in effect, told insurance companies that if you buy bonds that
    weren't rated by S&P, that when S&P went to grade your
    insurance company, you could be notched downward. That is what
    triggered this hearing.
        And I am pleased to say that this is the most successful
    hearing I have had as Chair of this subcommittee, because S&P,
    just 2 days before the hearing, announced that they were
    withdrawing the proposal. Thank you for being here, thank you
    for doing that, but I still believe that we should pass
    legislation to prohibit notching. Current statutes prohibit
    notching with regard to asset-based securities, and we now need
    to extend that to corporate bonds and other issues.
        There are other issues that this hearing will also deal
    with, one of which is relatively new to our subcommittee, and
    that is whether our bond rating agencies should be allowed to
    rate the bonds of Russia or Belarus, and whether we should
    allow our issuers to pay for bond ratings from foreign bond
    rating agencies that choose to continue to provide services,
    that is to say, whether we should impose secondary sanctions
    designed to prevent the rating of Russian and Belarusian bonds.
        Another issue is whether the bond rating agencies will be
    forced to do something that they haven't chosen to do, which is
    to speak English to the 320 million Americans who don't
    understand that the 12th highest rating, Ba2, unless the 12th
    highest rating is BB, which, I might add, is better than B+/2
    ratings. There are those who think that maybe we should tell
    people what is the highest rating, what is the second-highest
    rating, what is the third-highest rating, et cetera. There are
    others who believe that bond rating agencies ultimately paid
    for by the American people should speak in a language
    understandable to those not initiated to Wall Street.
        A final issue comes up, and that is the incentives for the
    bond rating agency to give the rating that the people who
    select the bond rating agencies, the issuers of the bond,
    prefer. This is the only game where the umpire is selected by
    one of the teams. Trust me, if the Dodgers got to pick the
    umpire, Kershaw would never throw another ball. So, whether or
    not bond rating agencies should continue to be the only
    professionals in our society not subject to professional
    liability for malpractice, and at the same time, should be
    selected by the issuer, which means all of the incentives are
    to please the issuer and there is no risk of liability for
    giving too strong a rating, those are the issues that this
    hearing will address, in addition to whatever other issues
    Members wish to bring up.
        I now recognize the ranking member of the subcommittee, Mr.
    Huizenga, for 5 minutes.
        Mr. Huizenga. Thank you, Chairman Sherman. While the title
    for this morning's hearing, ``A Notch Above? Examining the Bond
    Rating Industry,'' gets an A for creativity, I sadly have to
    give the subcommittee's work and agenda a failing grade.
    Unfortunately, hearings for the subcommittee have become very
    rare in leaving precious time and resources to focus on issues
    that are actually timely. In fact, Democrats have failed to
    hold a meaningful hearing on our capital markets in over a
    year. I know that it is called the Subcommittee on Investor
    Protection, Entrepreneurship, and Capital Markets. I have seen
    a lot of discussion about investor protection, a little bit of
    conversation about entrepreneurship, not a whole lot, and it
    has been a big fat zero on the capital markets side. So, let me
    be very clear. I have my own concerns about S&P's recently-
    rescinded proposal, but to hold yet another hearing on our
    nation's credit rating agencies is, at the very least,
    misguided.
        Earlier this week, as you noted, Mr. Chairman, S&P pulled
    back on proposed changes to the risk-based adequacy methodology
    for insurers, which begs the question, why is this hearing
    moving forward in this fashion? At the very least, pushing
    Congress to engage on this issue seems premature, given that
    stakeholder input had seemed to move that ball. So, let us be
    clear: Our capital markets are under attack. Since the
    gentleman from California has become Chair, the SEC released a
    rulemaking agenda that contains nearly 60 far-reaching
    proposals. And what is even more alarming from that list is
    that the Agency has proposed 16 rules in the first quarter, the
    first 3 months of this year alone, often leaving a scant 30-day
    window to comment.
        So, since the start of the calendar year, the only time
    Democrats have cared to comment on the SEC's agenda was to
    congratulate them on their proposed climate disclosure rule. A
    500-page rule, I might add, which, SEC's own analysis, will
    cost billions of dollars to comply, with most of that cost
    being passed down to hardworking Americans. In contrast,
    Republicans have continued to sound the alarm on a number of
    these harmful proposals. So, let me ask the question: What will
    prompt Democrats on this committee to get serious about
    oversight? In the 116th Congress, with a Republican in the
    White House, Chairwoman Waters held a hearing with the entire
    SEC Commission, but has repeatedly ignored requests from myself
    and Ranking Member McHenry to hold one this year. Why is that?
    Are they hiding something?
        Given the breadth of issues before the Commission, and
    given the size and importance of our markets, I am sure Members
    on both sides of the aisle would appreciate a hearing to
    understand the Commission's ongoing deliberations, given their
    aggressive agenda. I would hope my Democrat colleagues would
    also appreciate a hearing to explore why the Commission is
    ignoring its mission to facilitate capital formation. If you
    don't want to bring the full Commission in to testify, how
    about an oversight hearing with the the SEC's Division of
    Enforcement? Last month, the SEC acknowledged a very
    significant breach in protocols between the SEC's adjudicatory
    and enforcement functions, with potential ramifications
    regarding the fairness over prior SEC enforcement actions. How
    about a hearing on digital assets?
        Last week, the SEC announced an expansion of its crypto
    enforcement team, which nearly doubled the size of the unit.
    Why is this significant and timely? Well, given the Chair's
    inability to provide clarity and transparency to the $3
    trillion digital asset ecosystem, I would be interested in
    knowing what prompted his decision to move forward on that. To
    quote Commissioner Hester Peirce, ``The SEC is a regulatory
    agency with an enforcement division, not an enforcement
    agency.'' So, why are we leading with enforcement in crypto?
    What about a hearing on the impact of the bipartisan Jobs Act,
    which just had its 10th anniversary last month, or maybe we
    could focus on legislative proposals to help fuel capital and
    growth on Main Street? Just because the SEC has zero capital
    formation items on its agenda, doesn't mean we can't focus on
    it; it does not mean we should be ignoring our job.
        These are the timely topics for the hearings, and, by the
    way, ones that Republicans held while we were last in the
    Majority, yet, again, today's hearing topic is not. So this
    subcommittee, and we as lawmakers, should focus and prioritize
    issues that will expand opportunity for retail investors and
    promote capital formation for small businesses, all while we
    are protecting those investors. I look forward to hearing from
    our witnesses today in how we can best accomplish that.
        Mr. Chairman, I yield back.
        Chairman Sherman. Without objection, I will put in the
    record a letter dated April 14th, signed by 13 Democratic
    Members of this committee and 9 Republican Members of the Full
    Committee, asking the SEC to intervene to stop the
    anticompetitive S&P notching proposal, which was withdrawn just
    2 days ago.
        Without objection, it is so ordered.
        And with that, I will now recognize the Chair of the Full
    Committee, Chairwoman Maxine Waters, for 1 minute.
        Chairwoman Waters. Thank you so very much, Chairman
    Sherman, for holding this very timely hearing. I am so pleased
    with the leadership that you are providing for this
    subcommittee, and I am so pleased today that we have oversight
    on bond rating agencies, and that what you have done has caused
    them to pull back something that would have been grossly
    unfair, and so you have done a great job. And as for the
    gentleman from Michigan, I think he does not understand that we
    are in charge, and I am the Chair of this committee. You are
    one of the subcommittee Chairs. He does not dictate to us what
    our agenda is. We develop that agenda, and if he is trying to
    draw attention away from the oversight on bond rating agencies,
    that is not going to happen.
        Mr. Huizenga. It will be remembered.
        Chairwoman Waters. I have long called for robust oversight
    of the bond rating agencies, particularly after Wall Street's
    and the financial market's overreliance on the often-erroneous
    credit ratings of just three agencies directly contributed to
    the 2008 financial crisis. It has been my goal to empower
    investors and other market participants with an abundance of
    accurate information, and anti-competitive practices, like the
    S&P's latest proposal, run counter to those--
        Mr. Huizenga. Mr. Chairman--
        Chairwoman Waters. While S&P may have withdrawn this
    proposal, I am concerned it and other credit rating agencies--
        Mr. Huizenga. Mr. Chairman, we are 30 seconds over time.
        Chairwoman Waters. --have other anti-competitive practices
    that, if allowed to fester--
        Mr. Huizenga. Mr. Chairman, we are 30 seconds over time.
        Chairwoman Waters. --will harm our market and the American
    public investing their hard-earned dollars.
        Mr. Huizenga. [Inaudible].
        Chairwoman Waters. Thank you for holding this hearing, and
    I yield back the balance of my time.
        Chairman Sherman. Today, we welcome the testimony of our
    distinguished witnesses.
        I now recognize our first witness, Yann Le Pallec, who is
    the executive managing director and head of global ratings
    services for S&P Global Ratings. You are recognized for 5
    minutes.

     STATEMENT OF YANN LE PALLEC, EXECUTIVE MANAGING DIRECTOR AND
          HEAD OF GLOBAL RATINGS SERVICES, S&P GLOBAL RATINGS

        Mr. Le Pallec. Mr. Chairman, Mr. Ranking Member, Madam
    Chairwoman, and members of the subcommittee, good morning. My
    name is Yann Le Pallec. I am an executive managing director and
    head of global ratings services at S&P Global Ratings, and a
    member of the S&P Global Ratings Operating Committee. I oversee
    a group of approximately 1,400 credit analysts present in 28
    countries and covering more than 1 million outstanding ratings
    on entities and securities across a wide range of sectors,
    including governments, corporations, financial institutions,
    and structured finance. I appreciate the opportunity to testify
    as part of today's hearing.
        S&P Global Ratings is committed to providing the financial
    markets with timely, transparent, and high-quality credit
    ratings. Credit ratings are forward-looking opinions about the
    ability and willingness of debt issuers, like corporations or
    governments, to meet their financial obligations on time and in
    full. As opinions, credit ratings are not fungible, meaning
    that there are true analytical differences among the credit
    ratings and credit ratings' methodologies on different credit
    rating agencies. And just like how opinions evolve, our credit
    ratings and our credit rating methodologies can and do evolve
    over time.
        By regulation and S&P policy, we publish all new proposed
    rating methodologies and proposed material updates to our in-
    use methodologies in advance so that market participants can
    review and comment on our proposals. We consider comments
    received from the market, and we make those comments publicly
    available upon the publication of our final criteria. By SEC
    regulation and S&P policy, employees participating in
    developing or approving our procedures and methodologies used
    for determining credit ratings cannot be influenced by sales or
    marketing considerations. And we maintain a strict separation
    between analytical and commercial activities within S&P Global
    Ratings.
        On December 6, 2021, we published a request for comment, or
    RFC, on certain proposed changes to our methodology and
    assumptions for analyzing the risk-based capital adequacy of
    insurance companies. An insurer's risk-based capital adequacy
    considers the amount of capital that an insurance company may
    need to cover any losses across its different exposures and is
    one of the key factors in our framework for rating all
    insurers. Our RFC process gives the market the opportunity to
    provide feedback and voice any concerns about our proposals
    prior to the finalization and implementation of our final
    criteria. We thank market participants for the extensive
    engagement and high volume of comments they have provided in
    response to our December 2021 RFC. We take the market's
    comments and feedback seriously.
        As set out in our RFC publications, our proposed
    methodology change was intended to improve our ability to
    differentiate risk, enhance the global consistency of our
    methodology, improve the transparency and usability of our
    methodology, and account for more recent data and experience
    since our last update of our insurance capital model criteria
    in 2010. However, given the nature of some of the concerns
    raised in the comments that we received through our RFC
    process, on May 9, 2022, we announced to the market that we
    have withdrawn parts of the proposed approach and we are
    considering alternatives. While we believe certain of the
    criticisms made to date in the press misconstrued our proposal
    and are unfounded, we have heard the markets' concerns.
        My submitted testimony goes into more depth on the proposed
    application and the intent of the withdrawn sections of our
    RFC, but I am happy to address any questions you may have on
    these issues. As I mentioned, we are considering alternatives
    for the withdrawn elements of the proposed criteria. After we
    have had sufficient time to consider the high number of
    comments received, we intend to issue a subsequent RFC and then
    will finalize the criteria article in its entirety, consistent
    with our criteria development process.
        Throughout our RFC process, we have engaged in high levels
    of transparency and interaction with the market, and we are
    committed to maintaining that transparency and interaction as
    we move forward to the next phase of our process. Thank you,
    and I look forward to your questions.
        [The prepared statement of Mr. Le Pallec can be found on
    page 41 of the appendix.]
        Chairman Sherman. Thank you. Next, we have Angela Liang,
    who is the general counsel at the Kroll Bond Rating Agency.

       STATEMENT OF ANGELA LIANG, GENERAL COUNSEL AND EXECUTIVE
           COMMITTEE MEMBER, KROLL BOND RATING AGENCY (KBRA)

        Ms. Liang. Thank you. Chairman Sherman, Ranking Member
    Huizenga, Chairwoman Waters, and distinguished members of the
    subcommittee, thank you for the opportunity to testify today. I
    am Angela Liang, KBRA's general counsel and Executive Committee
    member. I am grateful for the subcommittee's strong bipartisan
    interest in issues being discussed today. This hearing is
    particularly critical and timely given the impact of S&P's
    proposed risk-based capital methodology. While S&P temporarily
    withdrew certain sections of its methodology a mere 2 days
    before this hearing, the proposal caused immense concern and
    confusion among market participants in all sectors as they
    grappled with the likely negative effects of the proposal and
    decreased competition among nationally recognized statistical
    rating organizations (NRSROs).
        KBRA was founded in 2010, and it is a full-service credit
    rating agency. It is one of the five largest rating agencies
    globally, and the largest rating agency established after the
    2008 financial crisis. Mr. Chairman, we believe that KBRA's
    entry into the market has been extremely positive for
    investors. We offer a diverse perspective and have restored
    transparency and analytical rigor to credit analysis. However,
    we and other small and medium-sized NRSROs continue to face
    barriers to competition. Despite KBRA's success over the past
    12 years, the Big Three still command approximately 95 percent
    market share and are woven into the fabric of our financial
    system. For example, many investor guidelines still refer to
    only the incumbent NRSROs. Certain key bond indices require
    that its security be rated by at least one of the Big Three.
    Government regulations and recent government facilities still
    reference the largest NRSROs by name, rather than all NRSROs.
        I would also like to highlight the importance of bond
    indices. Many investors benchmark to the S&P Bond Index or
    Bloomberg's Fixed Income Indices and, therefore, are not able
    to purchase bonds not rated by the Big Three because they are
    not index-eligible. We believe that the continued lack of open
    competition is by far the biggest problem facing the credit
    rating industry today. KBRA has been successful because of its
    relentless focus on transparent, thorough research and investor
    feedback, but it has not been easy.
        In our view, entrenchment of the Big Three disadvantages
    the financial markets, investors, and the public writ large.
    The impact that a mere proposal had on the market demonstrates
    S&P's significant market power and its ability to impede
    competition using that power. While S&P withdrew for the time
    being the anti-competitive sections of its proposal, we are
    concerned that S&P will continue to consider approaches with
    similar anti-competitive effects.
        In addition to already-significant systemic barriers to
    competition, S&P's proposed methodology would have allowed S&P
    to notch down KBRA's ratings from AAA to as low as CCC. If
    S&P's methodology had been implemented, it would have further
    reinforced S&P's position as the most-dominant credit rating
    agency by establishing disparate and arbitrary treatment of
    non-S&P ratings on bonds across all asset classes held in S&P-
    rated insurance company portfolios.
        The negative market reaction to S&P's proposal was swift,
    clear, and widespread. We are aware that many diverse market
    participants submitted comments and provided feedback to S&P
    beginning in early January. In addition to the concerns raised
    by this committee, the Department of Justice submitted a
    comment identifying potential violations of antitrust laws
    stemming from S&P's proposal, and yet it took S&P 5 months to
    withdraw the problematic sections of the proposal.
        What can we do to prevent the aversion of fair competition
    among NRSROs? Mr. Chairman, in our view, many components of the
    NRSRO provisions of the Dodd-Frank Act have been highly
    successful and have meaningfully improved the credit rating
    industry. The requirement that NRSROs publicly post their
    methodologies and substantive changes to them allows investors
    to analyze methodologies in advance of implementation. This
    requirement was key in S&P's withdrawal of proposed changes
    that would have had further negative effects on the market and
    NRSRO competition. Still, we believe there is room to
    strengthen Federal law to bolster competition and increase
    disclosure. We support current legislative efforts to prohibit
    notching and to prohibit credit rating agencies from taking
    actions that have an anti-competitive effect while maintaining
    credit rating agencies' ability to determine their rating
    methodologies.
        We encourage Congress, the Department of Justice, and the
    SEC to continue to scrutinize S&P's proposed methodology, and
    to take swift and decisive action to prevent anti-competitive
    behavior such as notching, or any feature that includes
    disparate treatment of other NRSROs.
        Mr. Chairman, I thank the subcommittee for the opportunity
    to testify today, and I look forward to your questions.
        [The prepared statement of Ms. Liang can be found on page
    51 of the appendix.]
        Chairman Sherman. Now, I recognize Ian Linnell, the
    president of Fitch Ratings.

           STATEMENT OF IAN LINNELL, PRESIDENT, FITCH RATINGS

        Mr. Linnell. Chairman Sherman, Ranking Member Huizenga, and
    distinguished members of the subcommittee, I appreciate the
    invitation to appear before you to discuss the anti-competitive
    practice called notching, and how S&P is, in our view, using
    this practice in its proposed insurer capital adequacy
    methodology to further its market dominance.
        While we are pleased that on Monday, S&P effectively
    admitted that they had no basis for the proposed methodology,
    we hope that both S&P and Moody's will now consider
    alternatives to notching in local government investment pools,
    money market funds, bond funds, and collateralized loan
    obligations (CLOs), which fund U.S. small companies where
    either one or both of them are currently engaged in this
    behavior.
        In 2006, Congress passed the Credit Rating Agency Reform
    Act to foster accountability, transparency, and competition in
    the credit rating agency industry. Although the Reform Act
    addressed the notching conducted by both S&P and Moody's in the
    period before its passage, both agencies have continued to
    engage in this activity, and the SEC has failed to stop it.
        Fitch Ratings is a global rating agency located in over 25
    countries. During the last 3 decades, Fitch has become the only
    credible challenger to the duopoly of Moody's and S&P in the
    credit rating industry. Credit ratings play an important role
    in the efficient allocation of capital by providing the
    financial markets with an independent view of credit risk. Any
    measure that reduces competition in the credit rating agency
    industry hurts the marketplace.
        S&P's methodology is fundamentally anticompetitive because
    it incorporates the practice of so-called notching into S&P's
    assessment of insurer capital adequacy. Notching occurs when an
    agency either insists on rating most, if not all, of the assets
    owned by an entity and/or significantly reducing the ratings
    that other agencies have assigned to assets that they have not
    rated.
        The proposed methodology applies significant haircuts to
    all non-S&P-rated investments held by insurance companies. As a
    result, securities held by an insurer rated AAA by Fitch or
    Moody's could have their credit rating lowered to AA- by S&P,
    while securities rated AAA by other agencies or by the National
    Association of Insurance Commissioners (NAIC) could be rated
    CCC. We believe that S&P withdrew the methodology and continues
    to fail to explain its methodology because no explanation
    exists. The methodology was a pretext by S&P to use its
    dominant market position in insurance to increase its market
    share in the securities commonly purchased by insurers,
    including areas where S&P has a low market share.
        S&P's ratings are hardwired into many insurers' broker
    systems and brokers typically have criteria for recommending
    insurers to clients that only refer to S&P or AM Best ratings.
    This market power gives S&P a monopoly on insurer financial
    strength ratings and makes insurers hostages to S&P. As
    insurers are focusing on maintaining their S&P ratings, they
    would be discouraged from purchasing securities in those
    sectors where S&P rates relatively few securities. Insurers and
    the issuers of securities that insurance companies purchase
    would select S&P to avoid the punitive notching of the
    methodology and the negative impact on insurance financial
    strength ratings.
        Fitch was not alone in criticizing the methodology. Many
    market participants have condemned S&P's proposals. In
    addition, the Department of Justice recently commented that
    S&P's methodology has the potential to suppress competition
    from rival rating agencies.
        S&P and Moody's have been engaging in notching for over 20
    years. It is time for Congress to ban notching in all market
    sectors and for the SEC to start enforcing this ban.
        Thank you for your time and your attention on this critical
    matter. I welcome any questions that you may have.
        [The prepared statement of Mr. Linnell can be found on page
    61 of the appendix.]
        Chairman Sherman. Next, we have Mariana Gomez-Vock, who is
    the senior vice president for policy development at the
    American Council of Life Insurers.

    STATEMENT OF MARIANA GOMEZ-VOCK, SENIOR VICE PRESIDENT, POLICY
         DEVELOPMENT, AMERICAN COUNCIL OF LIFE INSURERS (ACLI)

        Ms. Gomez-Vock. Good morning. Thank you, Chairwoman Waters,
    Chairman Sherman, and Ranking Member Huizenga, for having me
    here today. My name is Mariana Gomez-Vock, and I am proud to be
    here today representing the American Council of Life Insurers.
    Before I dive too much into the details, I would like to
    briefly touch on the big picture, because I think it
    demonstrates why we care about this issue so much.
        The big picture is that 90 million American families,
    people you represent, depend on the life insurance industry to
    protect their financial future. Life insurance annuities,
    disability insurance, paid medical leave, and other products
    make certain that they can care for themselves and their loved
    ones in good times and bad. Our policies often stay with
    families for decades, and our promise to them is that we will
    be there no matter what, and we are. When the pandemic hit,
    life insurers were there. The pandemic hit many industries
    hard--retail, restaurants, airlines--but we were the industry
    that was writing checks and paying out to families. We were
    there when the worst came for too many. Benefits paid in 2020
    were the highest in history. The industry paid over $90 billion
    in life insurance benefits, and it is our long-term investments
    that are the bedrock of our commitments to be there when we are
    called.
        We invest $7.4 trillion in the U.S. economy. That is $572
    million every day. That makes life insurers one of the largest
    sources of investment capital in the nation, and our
    investments do more than protect policyholders. They drive
    economic growth in every corner of the country. Steady slow-
    growth investments make it possible to keep our promises while
    providing business owners, farmers, school systems, and
    communities with the working capital that they need to open
    their doors, fund infrastructure, and grow their workplace.
    That is the big picture. Now, let us dig deeper.
        Insurer capital models like the one proposed by S&P are so
    critical to insurers that they will often shape their long-term
    investment and capital management strategies to align with
    them. When a rating agency notches an investment, it is
    signaling that it believes the asset has a higher risk of loss
    or default, and the insurer should hold more capital against
    it. S&P has proposed a notch, and, in some cases, disregarded
    credit ratings from competitors and designations from the NAIC
    Securities Valuation Office. In some cases, the notching would
    assign a 100-percent capital charge to an investment-grade
    asset without any clear reason for the notching, other than it
    is rated by an S&P competitor. We appreciate S&P's decision to
    revisit that part of their proposal because notching assets
    just because they are rated by a competitor will compromise the
    integrity of financial strength ratings and could disrupt
    capital markets. That is a bad outcome for consumers and the
    economy.
        Before I conclude, I would like to make three brief points.
    The first is that ACLI supports robust competition. Competition
    and diversity among the NRSROs benefits the insurance industry,
    the economy, and ultimately, consumers.
        The second point is that automatic notching is not
    harmless. It creates a fundamental disconnect between the
    asset's value and the asset's charge. Large swathes of
    insurance bond portfolios would have been notched, and
    structured products not rated by S&P would have been treated as
    junk under the S&P's original proposal.
        We look forward to exchanging views with S&P on the
    appropriate treatment of NAIC-designated securities. The
    proposal's disregard of these designations is counterintuitive,
    given that the NAIC designations are designed for and overseen
    by State regulators whose mission is to preserve the solvency
    of insurers and protect consumers. There is no conflict of
    interest there. Automatic notching essentially inflates asset
    charges. It would force insurers to choose between holding
    artificially-inflated levels of capital or to avoid high-
    quality, high-yield assets just because they are rated by a
    competitor. Both outcomes are bad.
        The third point addresses the proposal's impact on the
    competitive global insurance market. Some of the changes were
    designed to promote global consistency, an understandable goal,
    but some elements of the proposal appear to disadvantage
    American regulatory and accounting regimes. This could
    disadvantage U.S. insurers' ability to offer key products to
    consumers, like variable annuities and whole life. We look
    forward to continuing the dialogue on this issue.
        One final observation. Much of this is highly technical,
    but the details matter. They matter because individuals and
    families all across this country are seeking certainty, and we
    are in the business of providing certainty. We are there for
    our policyholders when they need us. We are there for
    communities who rely on our economic investments in our towns,
    suburbs, and cities so they can feel America's commerce and
    ingenuity. A change by the world's largest rating agency will
    have an impact. Those changes should be transparent and
    supported by data. We urge you to think of those details and
    the impact that they will have.
        Thank you for the opportunity to share our view. I look
    forward to answering any questions you may have.
        [The prepared statement of Ms. Gomez-Vock can be found on
    page 32 of the appendix.]
        Chairman Sherman. And finally, we will hear from our last
    witness, Jennifer Schulp, the director of financial regulation
    studies at the Cato Institute.

    STATEMENT OF JENNIFER J. SCHULP, DIRECTOR, FINANCIAL REGULATION
     STUDIES, CENTER FOR MONETARY AND FINANCIAL ALTERNATIVES, CATO
                               INSTITUTE

        Ms. Schulp. Chairman Sherman, Ranking Member Huizenga, and
    distinguished members of the Subcommittee on Investor
    Protection, Entrepreneurship, and Capital Markets, my name is
    Jennifer Schulp, and I am the director of financial regulation
    studies at the Cato Institute's Center for Monetary and
    Financial Alternatives. Thank you for the opportunity to take
    part in today's hearing.
        The state of competition within the bond rating industry is
    a perennial question. The Security and Exchange Commission's
    most recent report to Congress describes the concentrated
    NRSROs industry, with the three largest NRSROs accounting for
    approximately 95 percent of all outstanding ratings as of the
    end of 2020, but such broad statistics can be deceptive. As the
    Commission points out, smaller NRSROs have increased their
    total number of ratings outstanding, and have increased their
    share in some ratings categories. Moreover, drawing conclusions
    about competition from these numbers alone is difficult. A
    number of factors may explain the long-term tendency for the
    ratings industry to be comparatively concentrated. And,
    importantly, regulatory barriers can decrease competition.
    Legislative solutions should focus on lowering regulatory
    barriers and decreasing the artificial demand for NRSRO
    ratings.
        The subject of today's hearing relates to a recent proposal
    now withdrawn by S&P Global Ratings to notch down ratings of
    non-S&P-rated securities when applying its methodology to rate
    life insurers' investment portfolios. While such notching may
    raise concerns about its effect on competition, legislative
    action is premature.
        First, the proposal has been withdrawn in response to
    critical comments. S&P has indicated that it will issue a new
    request for comment which may ameliorate any potential anti-
    competitive concerns or raise different ones. It would be
    prudent to delay consideration of potential legislative action
    until the issue becomes more clear.
        Second, other laws already prohibit anti-competitive
    behavior. In addition to the antitrust laws that apply without
    regard to industry, Section 15E of the Exchange Act, and the
    Commission's rules, prohibit unfair, coercive, or abusive NRSO
    behavior. Additional legislation may not be required.
        Finally, rushing to judgment on the methodology change
    proposed may itself harm ratings quality by limiting NRSROs
    from considering the creditworthiness of instruments rated by
    another agency, or by substantively regulating credit ratings
    and rating methodologies.
        Given this committee's hearing on NRSROs less than a year
    ago, I respectfully suggest that there are other issues more
    suited to the investment of this committee's limited resources.
    For example, the Commission's agenda may be the most ambitious
    in its history. It is being undertaken at breakneck speed and
    with an unprecedented disregard for the importance of public
    comment to the rulemaking process. While short comment periods
    have the potential to limit public comment on proposed rules,
    particularly where those rules are complex, public input is
    limited even further when commenters are unable to analyze the
    interrelationship of a large number of proposed rules,
    including their unintended consequences.
        The Commission's recent announcement that it would extend
    the time period for its climate risk disclosure proposal, and
    reopen comment on two other proposed rules, is welcome, but
    does little to alleviate broader concerns where short comment
    periods have predominated and continue to do so. The ability of
    the public to comment on proposed rules and the effect of
    limited public comment on the quality of rulemaking should be
    of concern to this committee.
        The Commission's agenda also raises a number of issues
    relevant to this committee's interests in investor protection,
    entrepreneurship, and capital markets, including the
    Commission's proposed rules on climate risk disclosure and
    private fund disclosure. What is missing from the Commission's
    agenda is also notable. There is little that arguably
    constitutes a plan for supporting capital formation, and many
    of the Commission's proposed rules and agenda items may operate
    to deter entrepreneurship. The Commission's agenda also lacks
    items relevant to the regulation of digital assets, except
    where rule proposals may have effects the Commission has
    declined to discuss. The Commission has instead chosen to lead
    with enforcement actions over rulemaking in this space.
        These are just a few of the issues in connection with the
    Commission's current agenda that are more deserving of this
    committee's time and attention than additional focus at this
    time on NRSRO regulation. Thank you, and I welcome any
    questions that you may have.
        [The prepared statement of Ms. Schulp can be found on page
    67 of the appendix.]
        Chairman Sherman. Thank you. We have heard from our
    witnesses. I will now recognize myself for 5 minutes for
    questions.
        This is known as the Capital Markets Subcommittee. Our last
    hearing was on the stock markets. This hearing is about the
    most critical part of the bond markets. It is hard to say that
    we are not focusing on our capital markets. Though as a
    philatelist, I believe that perhaps we are leaving out the
    market for collectible stamps. So, we are covering the bond
    market. We are covering the stock market.
        The critical role that the bond rating agencies play is
    exemplified by the fact that if you are putting together a
    portfolio, and you generate a 5.7 percent return on bonds rated
    either AA or AAA, you look good compared to somebody else who
    puts together a portfolio meeting the same requirements, who is
    only getting 5.6 percent. The fact is, whether you are putting
    together a portfolio for an insurance company and trying to
    please your boss there, or whether you are putting together a
    portfolio for a mutual fund, the ratings determine what you
    need to put into that portfolio.
        As to the problem that is focused on in this hearing, we
    are being told by some that it is not an important problem.
    Nine Republican Members signed the letter urging that this
    problem be dealt with, and I think our witnesses have
    illustrated how important this problem is. And as I say, I
    think this subcommittee hearing was remarkably effective and
    that the proposal has been withdrawn, but that raises the
    question for our witness from S&P, Mr. Le Pallec, is this
    proposal dead or just sleeping for a while?
        Mr. Le Pallec. Thank you, Mr. Chairman, and I appreciate
    you giving me the opportunity to give more information on the
    ongoing request for comment process. On Monday, the 9th of May,
    we published a FAQ that announced the withdrawal of one
    particular section that was describing the way we were
    proposing to deal with a fairly complex technical issue, which
    is how to assess the thousands of securities held by insurers.
        Chairman Sherman. I am going to interrupt you there. We
    have an anti-notching statute that deals with asset-based
    securities. Is there any reason we shouldn't extend that to all
    bond issuances?
        Mr. Le Pallec. I have no particular view about that. What I
    am trying to say is that--
        Chairman Sherman. Well, that is the major proposal being
    considered by this subcommittee, and on our list of proposals,
    and the fact that you aren't here to oppose that proposal
    commends it to all of our colleagues.
        Mr. Le Pallec. We have an open request for comment that
    continues. We will continue to take in comments. There were
    serious concerns raised. We took them into account. It is out
    there for everyone to see.
        Chairman Sherman. I thank you for doing that, and knowing
    that this issue could come up in the months and years ahead, I
    think that we need legislation. Why don't I ask the gentleman
    from Fitch? One proposal before us is that we prevent the bond
    rating agencies of the United States from rating any new
    instruments coming out of Russia and Belarus more particularly,
    or we might limit it to certain state-affiliated firms. We
    could go further with secondary sanctions and turn to the
    foreign-based bond rating agencies and say, if they rated such
    bonds, they could not rate bonds here in the United States, or
    at least American issuers couldn't pay them to do so. What
    effect would denying bond ratings to all future issuances by
    Belarus and Russia have on their ability to raise capital? Mr.
    Linnell?
        Mr. Linnell. For us, in Russia, the ship has already
    sailed. We announced the suspension of commercial operations in
    Russia on March 7th. We announced on March 23rd our intention
    to withdraw the ratings in Russia. Towards the end of March,
    several banks--
        Chairman Sherman. Thank you. I will ask the gentleman from
    S&P, Mr. Le Pallec, are you still rating Russia?
        Mr. Le Pallec. No, we don't. We withdrew all our ratings on
    Russian entities--
        Chairman Sherman. Are foreign-based bond rating agencies
    rating them, the Japanese, the Europeans? You don't know?
        Mr. Linnell. I'm sorry to just interrupt. The EU passed a
    law that for any rating agency based in Europe that endorses
    international ratings, they have to withdraw their ratings by
    April 15th.
        Chairman Sherman. Okay. Next, I will ask our representative
    from Kroll, Ms. Liang, we have a system of different ratings.
    Instead of saying first-best, second-best, third-best, fourth-
    best, all the way up to 18th-best, we have weird combinations
    of plus and minus signs, and capital and small letters, which
    are absolutely unintelligible. What would be the harm to the
    bond rating agency if you just said, first-best, second-best,
    third-best? Would it be a great harm to our society if my
    constituents could understand what you are saying?
        Ms. Liang. Thank you for your question, Chairman Sherman. I
    don't think it would be any harm to your--
        Chairman Sherman. I see that my time has expired. I am
    going to ask you to respond for the record.
        Ms. Liang. Okay.
        Chairman Sherman. I now recognize the ranking member of the
    subcommittee, the gentleman from Michigan, Mr. Huizenga, for 5
    minutes.
        Mr. Huizenga. Thank you. Ms. Schulp, the pace and substance
    of the SEC rulemaking is unlike anything I have seen as well in
    the 6 terms that I have been here doing this. And as you had
    pointed out, coupled with those short comment periods, they are
    releasing rules really without articulating how they are going
    to interact or potentially contradict some of their other
    proposals. For instance, SEC securities lending, short
    disclosure, and swaps rules impact similar markets without
    specifying how the rules will interact with one another. Do you
    believe that the SEC has clearly articulated how these rules
    are supposed to work together?
        Ms. Schulp. No, I don't believe they have. A similar
    problem exists with respect to the 10b5-1 plans and the share
    repurchase disclosure as well.
        Mr. Huizenga. Okay. And you have sort of articulated this
    in your opening statement. You would agree that the common
    effect of all of their rules really isn't understood by the
    Commission, much less those that they are actually regulating,
    correct?
        Ms. Schulp. Correct.
        Mr. Huizenga. Okay. It should be noted that these rules are
    being released during a period of extreme market volatility as
    well. And I am curious, in your view, do you think these rules
    could be potentially adding to some of that volatility that we
    are currently seeing?
        Ms. Schulp. It is difficult to say what exactly is adding
    to the market's volatility, but the uncertainty caused by these
    rules can be disruptive, both to the economy, as well as the
    financial industry generally.
        Mr. Huizenga. We have lots of reasons to talk to the SEC
    and other regulators. I guess we will have to get to those
    hearings in about 7 months, but trust me, it is going to be
    busy, so buckle up and hang on everybody.
        Ms. Gomez-Vock, one of the overreaching criticisms of the
    S&P proposal is that it diverges significantly from the U.S.
    regulatory framework. As I noted in my opening remarks, some of
    my original concerns remain, and I certainly would like to see
    S&P address those in any forthcoming proposals. My concern is
    that the divergence from the U.S. system will have material
    impact on insurers and their products that they offer in the
    financial marketplace. For instance, it appears that long-term
    guarantee products, such as variable annuities, which our U.S.
    companies offer, will be especially impacted by this proposal,
    unnecessarily raising costs, limiting availability, et cetera,
    and I am just wondering if you could comment on that?
        Ms. Gomez-Vock. Yes, products like variable annuities and
    their availability, accessibility, and affordability, which
    help people live and retire with predictable income, could be
    particularly impacted. And we are concerned with the S&P's
    proposal, the fact that it does diverge significantly.
        Mr. Huizenga. What is the management issue there? What is
    going to make it more difficult to manage that and put you at a
    competitive disadvantage?
        Ms. Gomez-Vock. I think there are a number of different
    reasons, given the complexity of the actual formula itself. But
    the big-picture issue is that for insurers, it is very
    difficult, if not impossible, to manage two different capital
    standards, and the U.S. system is the NAIC risk-based capital
    system. It is a book value-type approach that uses reserves and
    is more cash flow-based. The S&P global capital model is more
    similar to Solvency II and the ICS. It is more of a market-
    consistent framework which tends to be unfriendly to long-term
    products.
        Mr. Huizenga. Okay. Thank you. Mr. Le Pallec, I would like
    to take a moment and discuss S&P's recent decision to publish
    ESG indicators for U.S. States. Do you agree that these
    ratings, whether they are done by S&P or, frankly, any other
    credit rating agency, should be based solely on financial
    indicators within the State and items that are material to the
    creditworthiness of the rated entity, or are you looking at
    something else?
        Mr. Le Pallec. We have taken into account ESG risks in
    credit ratings all along, whenever those risks have had an
    impact on creditworthiness, and we have published that in our
    rating rationale--
        Mr. Huizenga. Let me stop you right there. So, materiality.
        Mr. Le-Pallac. The indicators that you are talking about
    are an additional element of transparency and disclosure that
    we have been publishing on corporations, financial
    institutions, and more--
        Mr. Huizenga. Is that for everybody, whether it is material
    or not?
        Mr. Le Pallec. That is for all entities we rate, because
    investors for the past 2 years around the world have been
    asking us constantly the same question, tell us whether ESG
    risks have had an impact on creditworthiness or if they have,
    and why? And those indicators--
        Mr. Huizenga. How about D&I? How about D&I issues or some
    of those other, maybe not the ``E'' side of the ESG? Is
    diversity and inclusion now also part of how you rate a company
    or--
        Mr. Le Pallec. To the extent that it has an impact on
    creditworthiness, we have to take any ratings--
        Mr. Huizenga. Again, only if it is material.
        Mr. Le Pallec. The ``S'' would typically be aging
    population in any municipality or State that has an impact on
    cash flows--
        Mr. Huizenga. My time has expired. I appreciate it. Thank
    you.
        Chairman Sherman. The Chair of the Full Committee,
    Chairwoman Waters, is recognized for 5 minutes.
        Chairwoman Waters. Thank you very much. Mr. Le Pallec,
    shortly after this hearing was announced, S&P withdrew a
    controversial proposal that many market observers have
    suggested was anticompetitive. In fact, S&P was warned by the
    Justice Department that the proposal would violate antitrust
    laws. S&P deserves no praise, however, for withdrawing a
    proposal it never should have put forward. Notably, this wasn't
    the first time S&P proposed notching down its competitors'
    ratings. In 2007, just before the financial crisis, S&P was
    trying to increase the market's reliance on its own ratings by
    similarly proposing to undermine its competition. One positive
    outcome of S&P's latest proposal has been to draw attention to
    other anti- competitive practices by the largest bond rating
    agencies.
        Before the 2008 economic crisis, for example, it was a
    common practice among the largest two rating agencies, S&P and
    Moody's, to stipulate that they would only provide a credit
    rating for collateralized loan obligations (CLOs), and bond
    insurers if they also rated all of the underlying securities
    issued by that CLO or the bond insurer, aiming to prevent
    smaller rating agencies from rating any of the underlying
    securities. A decade later, does S&P's rating criteria still
    stipulate that S&P will only provide ratings for bond insurers
    if S&P also rates every underlying issuance of that bond
    insurer? Yes or no?
        Mr. Le Pallec. No, we don't.
        Chairwoman Waters. I beg your pardon?
        Mr. Le Pallec. We don't.
        Chairwoman Waters. Ms. Liang, as a smaller rating agency,
    what is the effect of this policy on KBRA and your ability to
    rate securities?
        Ms. Liang. Thank you, Madam Chairwoman. The effect on KBRA
    as a smaller and medium-sized NRSRO would be the same as what
    S&P proposed recently. I will note that the CLO market and the
    bond insurer market is smaller, and so the effect may not be as
    great as it would be in the insurance industry, but the effect
    would be anticompetitive in practice.
        Chairwoman Waters. Thank you. In 2015, Moody's, whom we
    invited to today's hearing but declined to come, drew criticism
    when a Wall Street Journal article reported that after a
    Pennsylvania bank contracted with KBRA for a rating, Moody's
    threatened to release an unsolicited rating that was lower than
    the KBRA rating. Ms. Liang, from your perspective at KBRA, what
    was the effect of this action by Moody's?
        Ms. Liang. Thank you, Madam Chairwoman. At the time, we had
    just started rating community banks, and Moody's and the larger
    rating agencies were not rating that space because their
    methodology had a size bias and did not permit the rating of
    the smaller banks. And so, when we published our rating and
    heard that Moody's was going to publish an unsolicited rating
    with a lower rating, we took that to mean that they were trying
    to discourage our entry into the market and also to undercut
    the viability of KBRA as a rating agency.
        Chairwoman Waters. More recently, S&P purchased IHS Markit,
    which at the time was one of the largest data and analytical
    firms in the world, for $44 billion. Rating agencies need data
    to conduct their analysis. Some have raised concerns that now
    that S&P is in control over IHS Markit, it may limit the
    provision of this data to its competitors.
        Mr. Linnell, do you share these concerns about S&P owning
    such a trove of data and analytical capabilities?
        Mr. Linnell. I think there is a broad benefit from groups
    having and offering a broader range of credit and risk
    products. It does indirectly help their core ratings business,
    but I don't think you can draw a line one-for-one saying that
    this reinforces their duopoly. I think the issue on the table
    today around notching and anti-competitive practices is more
    important, and it is a shame you didn't ask the colleague from
    S&P about their CLO bond fund money market funds. The
    reinsurance sector is not really a big sector anymore.
        Chairwoman Waters. I have only asked you about a few of
    these practices, but the list is longer. For example, S&P's
    exclusion of non-S&P-rated securities from its mixed-income
    indexes, S&P's notching practices in money market funds, S&P's
    and Moody's heavy engagement with institutional investors to
    maintain investment guidelines that favor S&P and Moody's,
    among others. Investors need a diversity of ratings opinions,
    and I am glad that this committee is shining a light on how
    incumbent large rating agencies employ various anti-competitive
    practices--
        Chairman Sherman. Thank you.
        Chairwoman Waters. I yield back the balance of my time.
        Chairman Sherman. Yes. The gentlelady from Missouri, Mrs.
    Wagner, is recognized for 5\1/2\ minutes.
        Mrs. Wagner. Thank you, Mr. Chairman. I hope you can watch
    the clock a little more closely here in respect to everyone,
    our witnesses and our Members.
        Ms. Schulp, does the Commission's rulemaking agenda include
    any proposals to help facilitate capital formation? And further
    to that, why should the SEC be focused on reducing burdens for
    companies to access capital?
        Ms. Schulp. First, the Commission's agenda does not have a
    specific rulemaking or capital formation agenda items on it.
    And, in fact, I am concerned, because many of the agenda items
    that are on the Commission's agenda go towards putting
    additional burdens on capital formation themselves, such as the
    ESG disclosure rules.
        Mrs. Wagner. And what else? Please elaborate.
        Ms. Schulp. The ESG disclosure rules are private fund
    disclosure rules where the SEC is beginning to insert itself
    further into private markets, where the SEC has previously not
    done so before, which puts additional costs on capital
    formation in those spaces as well. There are a number of places
    where the SEC's proposed rules can harm entrepreneurship and
    harm the efficient allocation of capital.
        Mrs. Wagner. And certainly, one would think that we should
    be focused, at the SEC in particular, on reducing those burdens
    to capital formation, correct?
        Ms. Schulp. I agree. Part of the SEC's tripartite mission,
    as they are happy to say, is to facilitate capital formation.
        Mrs. Wagner. We will get to that. Our priorities in this
    committee should be, I think, as I stated, reducing the cost of
    capital for companies, and helping investors, our retail
    investors, real people out in Missouri's 2nd Congressional
    District who are trying to make both ends meet, helping those
    investors grow their savings, especially during these very
    difficult inflationary times. Instead, I have to say that
    committee Democrats and the Commission are focused on climate
    disclosure requirements for public companies and other
    initiatives, as you have outlined some, Ms. Schulp, that will
    ultimately discourage companies from going or staying public,
    which means fewer investment options for Main Street Americans.
        Ms. Schulp, there has been much discussion surrounding the
    impact of the SEC's short comment periods, especially when it
    comes to the multitude of potentially interconnected proposals.
    Will you discuss the impact that short comment periods have on
    market participants and how these historically short comment
    periods impact the Commission's rulemaking process as its
    ability to uphold the three-part mission as you meant--
        Ms. Schulp. First, I think it is important to clarify that
    market participants really mean all of us, when we are talking
    about market participants here, all the way down from your
    retail investor who might have opinions about how the SEC
    should be regulating here, all the way up through your largest
    Wall Street banks. Your largest Wall Street banks may very well
    have an army of lawyers who can spend their time reading
    through these proposals. But even at that, being able to
    determine how these proposals interrelate, to really sit down
    and think about the unintended consequences of these proposals,
    short comment periods, harm that. And they harm the SEC's
    ability to really understand and weigh the potential effects of
    the rules that they have proposed. Short comment periods also
    result in fewer comments. They likely result in fewer
    complicated comments that bring some of these deeper issues to
    light. That is less for the SEC to deal with when they are
    finalizing rules under the Administrative Procedure Act, and I
    think that is a negative. The SEC should be able to gather as
    much information as possible in order to create quality
    rulemakings that benefit the American people, benefit the
    markets, and will also be able to stand the test of time--
        Mrs. Wagner. And obviously, the smaller investors and the
    smaller capital formation companies are greatly hindered by
    this. Ms. Schulp, there has been no discussion on removing
    barriers for everyday investors from my Democrat colleagues.
    Are there any regulatory barriers you see that we in Congress
    could work to remove today?
        Ms. Schulp. One of the easiest is to open up the accredited
    investor definition to more investors. In fact, that is on the
    SEC's agenda, but not with the intention of opening it up
    further, but rather taking a look at it again to close it down
    and to make private market investments less available to
    average individuals.
        Mrs. Wagner. Barriers, barriers, barriers, when we have to
    be concentrating on growing capital, capital formation, and
    helping our investors grow their savings. I thank you for your
    input, and I yield back the balance of my time.
        Chairman Sherman. The gentleman from Georgia, Mr. Scott,
    who is also the Chair of the House Agriculture Committee, is
    recognized for 5 minutes.
        Mr. Scott. Mr. Linnell, let me start with you. I am very
    concerned about competition in the credit rating agency
    industry and the impact that market domination could have on
    banks, insurers, financial companies, and other industry
    participants. And about the ratings market, there are some who
    feel that they should remain as they are, which really looks
    like an oligopoly where only a small number of participants
    compete in order to safeguard their reputations of the ratings.
    However, studies that have been brought to my attention have
    shown that competitive dynamics, even amongst a small number of
    rating agencies, can result in higher-quality ratings and
    potentially mitigate the inherent conflict of interest in the
    issue-payers model.
        Mr. Linnell, tell me, how would you assess competition
    amongst the credit rating agencies, and how is this competition
    distinct from other markets?
        Mr. Linnell. I think since the passing of the Dodd-Frank
    Act after the financial crisis, competition in the rating
    agency industry in general has intensified. We are seeing more
    and more new entrants. I think a good example of that is what
    we are talking about today, really one aspect of it, which is
    the U.S. structured finance market. There, back around 2010,
    you really had the Big Three firms competing with each other:
    Fitch; Moody's; and S&P. But since then, you have had the new
    entrants. We have Kroll, and then you have had DBRS expanding
    with the merger with Morningstar, and their market share has
    increased significantly. They are up to about 20, 25 percent of
    the market each, while the Big Three have come down quite
    steadily to around about 45 percent, and we are about 30
    percent.
        What you have there is a market that has gone from three
    large players to one, where there are five agencies competing
    with each other, and there are new agencies coming up all the
    time. So I think competition is good, but there are still
    problems in the industry, and S&P and Moody's benefit from
    institutional barriers, but some due to their own policies
    which they have put in place, such as notching, which is what
    we are here to discuss today.
        Mr. Scott. Okay. Do you believe that robust competition for
    the credit rating industry is the absolute best way to promote
    the continued integrity, reliability, and quality of their
    ratings?
        Mr. Linnell. Yes, as long as it is combined with
    transparency. As long as you have transparency around the
    performance of those ratings, how those ratings have been
    developed, what analysis and what issues support those ratings,
    then, yes, absolutely, competition tends to produce--
        Mr. Scott. How would you rate transparency in the industry
    right now?
        Mr. Linnell. I think it is pretty good. The agencies
    generally had a high level of transparency going into the
    financial crisis, but regulatory reforms around Dodd-Frank and
    similar regulations in Europe promoted a much greater level of
    consistency in the way that agencies provide information to the
    market. I think the level of transparency is--
        Mr. Scott. Yes. I want to get to Ms. Liang with this
    question. Ms. Liang, you cited in your testimony how difficult
    it is to even enter the credit rating agency market, and
    highlighted the Securities and Exchange Commission's
    registration process as a barrier to new entrants. What
    specific changes would you suggest that the SEC consider making
    to increase the number of new credit rating agency registrants?
        Ms. Liang. Thank you for your question. Currently, the SEC
    regulation requires new entrants to the market to basically
    provide attestations from investors who have used that
    applicant rating agency's ratings for 3 years. This is a very
    difficult bar to achieve because most investors have little use
    for ratings from non-NRSROs. So, I think it might be helpful
    for the SEC to look at different ways that new entrants could
    enter the market. I leave it to them in their research on how
    best to do that, but I would be happy to continue the
    conversation.
        Mr. Scott. Thank you, Ms. Liang. I am done with my
    questions, Mr. Chairman, relatively on time.
        Chairman Sherman. Thank you. Relatively. I now recognize
    the gentleman from Arkansas, who is also the Republican lead on
    the Russia and Belarus Financial Sanctions Act, Mr. Hill, for 5
    minutes.
        Mr. Hill. First, let me thank the Chair for our
    collaboration together on economic cost, raising the economic
    cost on Putin and the Kremlin for their illegal invasion of
    Ukraine. And yesterday, we had excellent work on that on a
    bipartisan basis to send the signal to our transatlantic
    partners that the U.S. speaks with one voice on raising the
    economic, diplomatic, and military costs of Putin's illegal
    invasion. So today, thanks for having this hearing to talk
    about our rating agencies, and I couldn't help but notice a
    number of the bills that were noticed and attached to this
    hearing. One was of particular concern to me, which is the
    Commercial Credit Rating Reform Act, that proposes to change
    the rating assignment model process.
        After the financial crisis, as we have talked about this
    morning, Dodd-Frank tasked the Democrat-led SEC at the time
    with implementing a ratings assignment model, which meant the
    creation of a quasi-governmental board to assign qualified
    rating agencies to provide ratings. The SEC thoroughly
    considered a range of business models, and many other market
    participants raised concerns that the writing assignment
    model's quasi-governmental board would hold significant
    influence over the capital markets by being the sole party to
    select and assign ratings for the entire market rather than
    relying on market checks and balances, competition, and
    investors.
        And after a thorough review and public feedback, the
    Commission decided not to mandate any structural changes to
    what is known as the issuer pay model. We have talked about
    this now for over a decade, and we certainly recognize that
    credit rating agencies have potential conflicts of interest,
    regardless of whether issuers, investors, or governments pay
    for those ratings or assign those ratings. Our goal as
    policymakers should be to ensure that these potential conflicts
    are managed and mitigated. That is the whole secret to the
    capital market system, is, of course, it has built-in conflicts
    of interest in it. And the whole question about public policy
    is, can those be transparent? Can they be managed in the right
    way? Can they be subject to the checks and balances of those
    market forces? So, despite those potential conflicts of
    interest, issuer pay produces a stronger and, I think, less
    biased signal for market participants. My thoughts are, we had
    these conflicts, and they are not going to be solved, in my
    view, by turning more power over to the government.
        Let me start with you, Mr. Le Pallec, and I will, in turn,
    ask the other rating agencies present to comment. Would you
    agree that a rating assignment model would discourage
    independent competition and risk that would end up
    deteriorating the quality and future innovation in the credit
    rating industry?
        Mr. Le Pallec. Thank you for your question. Certainly, we
    have reservations about this proposal. We think it treats
    ratings as a commodity, and prevents investors from making
    their own choices. Investors may have very different use cases,
    and they rely on the diversity of view in the market, and we
    want the market to be competing on the quality of our ratings.
        Mr. Hill. Thank you
        Mr. Le Pallec. Also, in terms of the feasibility,
    particularly for the corporate market, it would be very
    important to consult with the corporate issuers. Apart from
    Treasuries, that is the biggest section of the market in the
    United States.
        Mr. Hill. Right. Mr. Linnell, what do you think?
        Mr. Linnell. Just a moment ago, we talked about the
    benefits of competition, and what is the best way to provide
    high-quality credit ratings to the market. A board or some sort
    of selection process is essentially a government subsidy and
    just removes that incentive. We continue to think it is a bad
    idea. It just introduces new potential conflicts, new costs,
    and new bureaucracy, and isn't needed.
        Mr. Hill. Good. Thank you. I would like to invite the other
    agencies here to send me a written answer to that question.
        Let me switch gears to Ms. Schulp from Cato. Given the
    significant influence that this quasi-governmental board would
    have for a ratings assignment model, doesn't this approach in
    and of itself carry its own conflict of interest?
        Ms. Schulp. It absolutely does.
        Mr. Hill. Tell me more. Tell me why you think that is just
    a bad idea in search of a challenge?
        Ms. Schulp. I think we have recognized, and as Congress has
    recognized before, by promoting and seeking to promote
    competition in the rating space, that competition is the way to
    keep these conflicts within check. And in order to encourage
    the additional development of new methodologies, refinement of
    methodologies, and continuing to innovate in the credit rating
    space, the government, a quasi-governmental board, or a
    governmental board assigning ratings in that way removes the
    incentives for all of that development and the focus on quality
    in the same way.
        Mr. Hill. Thank you. And, Mr. Chairman, thank you for the
    hearing, and I yield back.
        Chairman Sherman. Thank you. The gentleman from Texas, Mr.
    Taylor, is recognized for 5 minutes.
        Mr. Taylor. Thank you, Mr. Chairman. I appreciate that. Mr.
    Linnell, I wanted to hear from you about what changes have been
    made in your business model over the last decade since the
    financial crisis?
        Mr. Linnell. The business model itself is unchanged, the
    issuer pay model. But since the financial crisis, particularly
    after the passing of Dodd-Frank, we put in a number of
    different changes to reflect the legislative requirements but
    also just to continue to invest and grow and improve our own
    risk management infrastructure.
        The Dodd-Frank Act, in particular, introduced a formalizing
    control framework around the determination of ratings, formal
    legal attestation around those controls being adequate to
    manage those risks. It requires the board now to independently
    approve all criteria. It created a formal compliance officer
    role and also strengthened the regulatory oversight of the
    rating agencies for the creation of the credit ratings unit
    within the SEC. And it also encouraged greater transparency and
    disclosure around things like key rating drivers and
    standardization, of how agencies talk about key risks in their
    ratings. And these regulations, which, as we all know, run many
    hundreds of pages, are echoed as well in the EU regulation
    around the credit rating issue, Directives Number 2 and 3.
        So, there has been a significant strengthening of the
    control infrastructure, all designed to more effectively manage
    this conflict of interest that we all talk about. And then, in
    addition, disclosures have been significantly stepped up across
    the industry. And I think there is a general acceptance, or at
    least that is what I hear, that disclosure standards are pretty
    robust.
        Mr. Taylor. And in terms of your underwriting, how has that
    changed over the last decade?
        Mr. Linnell. Essentially, we are trying to predict the
    future with credit ratings, right? Is the company going to
    honor their obligations in 10, 15, 20 years' time? We continue
    to think about new ways of how we can analyze risks, how we can
    look at new and emerging risks. There is a discussion on ESG
    risks but cybersecurity risks, conduct risk, all new risks are
    starting to come and play a greater prominence.
        We continue to strengthen things like different access to
    information, the way that we look at data and using new
    technologies around machine learning, artificial intelligence,
    and also strengthening internal control functions, such as our
    credit policy group, which is not aligned to any particular
    group. It is an independent internal task force, if you like,
    that looks at the quality of our ratings. And we continue to
    think about how we can improve our methodologies and criteria
    to reflect the ever-changing risk environment in which we
    operate. And I think overall, you can see that in the
    performance of the ratings that continue to be very strong
    since the financial crisis.
        Mr. Taylor. Ms. Schulp, just to switch to you, are there
    any regulatory barriers that you think could be removed, that
    would help improve the markets?
        Ms. Schulp. Sure, and it has been discussed before, but I
    think the--
        Mr. Taylor. Why don't you just add on new information--
        Mr. Schulp. Yes. The registration, the letters from
    investors for 3 years in order to become an NRSRO has been
    cited time and again as a barrier to entry into the NRSROs
    space. And regulations and legislation across the government
    that recognize particular NRSROs for recognition for investment
    and other purposes itself creates an anti-competitive
    environment where the smaller ratings agencies are
    disadvantaged. I think those are places to focus on.
        Mr. Taylor. Okay. Thank you. Mr. Chairman, I yield back the
    balance of my time.
        Chairman Sherman. Thank you. I now recognize the gentleman
    from Wisconsin, Mr. Steil, for 5 minutes.
        Mr. Steil. Thank you very much, Mr. Chairman. Ms. Schulp,
    as we have discussed today, the SEC has been rushing out new
    significant rulemakings and setting unusually short comment
    periods. I am concerned with the substance of many of these
    rules, but I am also worried about the SEC's pace, that is
    designed to limit substantive public comment. I know you have
    authored multiple public comments for rules. Is this correct?
        Ms. Schulp. Correct.
        Mr. Steil. How long does it typically take to draft
    substantive comments on a significant rule proposal?
        Mr. Schulp. Quite a bit of time. It depends on the rule
    proposal, but it is a solid--
        Mr. Steil. Give me a range.
        Ms. Schulp. A couple of weeks' work for me, while I am not
    focused on other things--
        Mr. Steil. So from the moment you start, it is a couple of
    weeks of full-time work, from the moment you start to getting
    those rules out. In that context, if you have other things
    going on, which most people do, when we have unusually short
    periods of time, it makes it incredibly difficult for
    individuals, companies, and stakeholders to provide substantive
    comments to SEC rules. Is that correct?
        Ms. Schulp. It does, and I will say that the pace has
    caused me to pick and choose what I would comment on in ways
    that I would otherwise not do.
        Mr. Steil. So you pick and choose, but it also limits
    others who are able to provide comments, meaning it limits
    those who might want to provide comments from providing those
    comments?
        Ms. Schulp. Absolutely.
        Mr. Steil. And what does it do to the quality of our
    regulations? Is the SEC at risk of having blind spots because
    they are not going to have the opportunity to receive comments
    from stakeholders?
        Ms. Schulp. I think that is true.
        Mr. Steil. Let me shift gears slightly. You wrote an
    article last year criticizing the SEC's paternalistic attitude.
    And in many ways, I share some of the concerns you put forward
    in that article, in particular as it relates to excessive
    restrictions and burdens on retail investors, reducing
    opportunities for millions of American families to be able to
    participate in our capital markets. And my colleagues are
    concerned about wealth inequality. I think one of the areas
    that we have an opportunity to push back on is some of the SEC
    rules and regulations we see being put forward in a
    paternalistic manner.
        I would like you to just, tightly here because I want to
    jump to another question as well, identify some of the
    proposals or general beliefs that you think the SEC exemplifies
    with this paternalistic approach?
        Ms. Schulp. The ESG rules that are coming out, the climate
    risk disclosure rules, those in particular are problematic
    because they are going to encourage companies either to not be
    public or to go private as the situation depends. And that will
    remove the ability of average investors to invest in those
    companies that are having important roles in our economy.
        Mr. Steil. I think that is really important. So, your
    average mom-and-pop retail investor, when companies leave the
    public markets, go into the private markets, it gives an
    advantage to private equity firms. It gives an advantage to
    some of the biggest players on Wall Street, and removes the
    opportunity for Main Street mom-and-pop kind of investors to be
    able to invest and take advantage of U.S. capitalist
    structures.
        Ms. Schulp. Absolutely.
        Mr. Steil. Let me shift gears with you for a moment. I want
    to talk about one of the core principles of securities law that
    seems to continually come up in this hearing, or in this
    committee, and that is materiality. As you know, this principle
    underpins our disclosure-based system. And it served investors
    quite well for decades, and under current law, if information
    is material to investors, it needs to be disclosed. Is that
    correct?
        Ms. Schulp. Within the broad categories that the law
    already requires disclosure on, correct.
        Mr. Steil. Correct. And the SEC, in my opinion, appears to
    be moving away from this traditional interpretation of
    materiality, in particular as it relates to the climate
    disclosure rule that they are working on. SEC Chairman Gensler
    and Commissioner Lee have argued that there is an investor
    demand for climate disclosures, so the SEC should be required
    to act on that. Can you talk about how the SEC's interpretation
    of materiality in their argument supporting the climate
    disclosure rules differs from the traditional understanding of
    the term?
        Ms. Schulp. When looking at the climate risk disclosure
    rules, the connection between so many of the things that are
    disclosed and financial materiality is tenuous at best, and, in
    some cases, completely absent. What is also important to know
    is that investor demand can be a component of whether something
    is material to an investor. The SEC relies, in its climate risk
    disclosure rules, solely on demand from large institutional
    investors who have worked climate risk into their modeling.
    While that is not unimportant, they are focused solely on the
    largest investors rather than on what the whole market and
    perhaps what individual investors might want in an investment.
        Mr. Steil. Thank you very much. Mr. Chairman, I remain
    concerned about where the SEC is headed as it relates to
    shifting away from materiality, and, in particular, the rush of
    some of these rulemakings. Cognizant of time, Mr. Chairman, I
    yield back.
        Chairman Sherman. I now recognize the gentleman from
    Illinois, Mr. Foster, who is also the Chair of our Task Force
    on Artificial Intelligence, and has recently arrived from his
    important work at the Science Committee, and he is recognized
    for 5 minutes.
        Mr. Foster. Thank you, Mr. Chairman. The Dodd-Frank Act
    required SEC staff to study and publish a report, and one that
    the credit rating system would benefit from requiring NRSROs to
    adopt uniform rating scales and rating symbols. In the final
    report published in September of 2012, the Commission found
    that, ``Standardizing credit rating terminology may facilitate
    comparing credit ratings across rating agencies and may result
    in fewer opportunities for manipulating credit rating scales to
    give the impression of accuracy.'' However, the SEC staff
    ultimately recommended the Commission not to take further
    action, to require increased standardization, primarily because
    of concerns over feasibility. A discussion draft attached to
    this hearing would direct the SEC to issue rules to require all
    NRSROs to use a uniform set of credit ratings for each of the 6
    categories of credit ratings recognized under the Securities
    and Exchange Act.
        So, Mr. Le Pallec, Mr. Linnell, Ms. Liang, all three of
    your firms use an identical set of rating symbols for corporate
    issuers. Do you feel that uniformity in your rating scales
    allows investors to more quickly and easily understand your
    ratings?
        Mr. Le Pallec. What we know from investors is that they
    benefit from a diversity of views, and we don't think that
    treating ratings with common definitions across the piece could
    lead to handling them like commodities, and would lead to
    convergence of methodologies, and would, therefore, limit
    competition on quality in the market.
        Mr. Linnell. Yes. I would just add that you have to
    differentiate between the two issues of the standardized
    criteria and the definitions of those ratings versus the actual
    nomenclature of the scale. You could, if you wanted to, propose
    and argue for a standard scale. In fact, there are some pieces
    the same at Fitch, and Moody's is pretty similar. It uses 21
    gradations. And I figured that as an industry, we should be
    open to positive feedback or criticism that a common scale
    itself may be facilitate little transparency and comparability.
    But you don't want to undermine the independent integrity and
    the diversity these agencies have by putting and enforcing the
    same criteria across the agencies.
        Mr. Foster. Yes. Ms. Liang? About those--
        Mr. Liang. Thank you. I would agree with my colleagues
    regarding preserving the diversity of perspectives, and better
    serving the market. Another way we could come at it is perhaps
    requiring more disclosure, because I have heard you and your
    colleagues talk about the difficulty in understanding rating
    scales, and perhaps increasing disclosure on those rating
    scales might help with clarity and understanding.
        Mr. Foster. Yes. Another mechanism that I have heard
    suggested is that a small fraction, say 1 percent, of all
    issuance would have to be rated by everyone, all major players
    in the market. So that, combined with standard ratings, and you
    could actually have an interesting discussion when you saw a
    wide divergence of ratings for a single issue. Is that
    something you would have any comments on as a possible way to
    get it part of the whole conflict-of-interest problem in this?
        Mr. Linnell. Maybe I will take a stab at that. It could be
    an interesting way of doing it. But I think in reality, if you
    look in most markets and you did the Venn diagram of coverage
    of the agencies and even at the new agencies, you probably have
    plenty of examples where they are already covering 1, 2, 5
    percent of similar rating. You may already have that in play.
    And indeed, part of our approach has been to do unsolicited
    ratings where we believe our ratings are different from the
    existing ones of S&P and Moody's on some of the major issuers
    that are of interest to investors. Again, the competition
    between the agencies creates that comparability in many of the
    industries and sectors we are talking about.
        Mr. Foster. So, when you issue an unsolicited rating, and
    in some sense you turn out to be right, does the market reward
    you for making a correct objection to one of your competitors'
    ratings?
        Mr. Linnell. I would hope, but I figure it is more in the
    long term. It is about building your reputation and your
    franchise for the quality of the work that you do, and that is
    what everybody should be striving for, to compete on the
    quality of their analytics and the quality of their ratings.
    Over the long term, you hope that kind of action would result
    in that benefit.
        Mr. Foster. That is right. Of course, one of the big
    challenges is that you only see in times of distress, whose
    ratings are not as solid as they might have been.
        Well, my time is up now, and when you figure all this stuff
    out, let me know. We have been struggling with it for a decade.
    Thank you, and I yield back.
        Chairman Sherman. And longer. The gentleman from Ohio is
    recognized for 5 minutes.
        Mr. Gonzalez of Ohio. Which one?
        Chairman Sherman. Mr. Gonzalez.
        Mr. Gonzalez of Ohio. Thank you, Chairman Sherman, and
    thank you to our witnesses for being here today. I want to
    start by echoing some of the comments of Mr. Huizenga and other
    colleagues expressing concern with the direction of the
    subcommittee. Just recently, the financial stability report
    came out from the Federal Reserve. This is the Capital Markets
    Subcommittee, and one of the things being highlighted is low
    liquidity and cash, Treasury securities, and equity-indexed
    futures. That is a major issue. If we have liquidity
    challenges, if the depths of our markets all of a sudden are
    impaired, the ability of the financial system to respond to
    large shocks is severely diminished. And I hope at some point,
    we will start taking up some of these, what I would consider
    more pressing issues, and certainly ones that could really harm
    the financial system.
        That aside, Ms. Liang, I want to start with you. As part of
    this hearing, the Majority attached a discussion draft called
    the Commercial Credit Rating Reform Act. A provision within
    this legislation would establish a newly-created credit rating
    agency assignment board that would assign NRSROs to provide
    ratings for corporate issuers. Can you discuss some of the
    concerns that you have with this sort of approach?
        Ms. Liang. Absolutely. Thank you very much for the
    question. I think some of these topics have already been
    touched on, but I feel that an automatic assignment would be to
    guarantee business for rating agencies and would create a
    disincentive to provide quality research. I think, ultimately,
    the market investors, and the investing public at large would
    suffer from that lack of quality research.
        Mr. Gonzalez of Ohio. Thank you. I couldn't agree more. I
    know that there are obviously some challenges in this
    particular market, but to just assign them at the Federal
    level, I think is a little bit absurd.
        Mr. Le Pallec, earlier this week, S&P announced that it was
    going to withdraw the notching proposal, but said that, ``We
    are considering alternatives for the withdrawal elements.'' Do
    you expect this alternative proposal to come out in 2022, and
    do you have any more information that you could share on what
    is being considered?
        Mr. Le Pallec. Thank you for your question. Yes, the
    request for comment process continues. As we said last Monday,
    we are going to go back to the market with proposals on how to
    handle the technical issue at hand, and we plan to come out
    with a final criterion by the end of this year. We will update
    the market as we know more and as we treat more comments. We
    want to maintain the same high level of transparency we have
    applied up until now, and we will continue to do so.
        Mr. Gonzalez of Ohio. Thank you. I think that is very, very
    important.
        Ms. Liang, back to you. In your testimony you, sort of
    related to the first question, discuss the importance of
    increasing competition in the NRSRO market. What are the key
    barriers this committee should further explore to promote that
    competition in the credit rating market?
        Ms. Liang. Thank you for your question. I highlighted a few
    instances where there continue to be systemic barriers to
    competition. Many investor guidelines still require the
    incumbent rating agencies by name, and certain Federal
    regulations and facilities require and refer to the larger
    NRSROs by name, rather than all NRSROs. I think taking a look
    at those references and requirements would be helpful in
    promoting competition, and certainly, I think that continued
    attention to S&P's proposed methodology would benefit
    competition in the credit rating industry.
        Mr. Gonzalez of Ohio. Thank you. I couldn't agree more.
    Again, sort of basic stuff: more competition, more choice,
    deeper markets, less government dictating and interventions, I
    think, is usually the direction we want to go. This is
    certainly no exception. Again, I want to reiterate, I hope we
    spend more time on some more pressing issues than this, but
    with that, I yield back.
        Chairman Sherman. For the record, I believe the gentleman
    from New Jersey has asked that we waive him and go on to the
    next Member, unless that is incorrect. And so, we will go to
    the second gentleman from Ohio, Mr. Davidson, for 5 minutes.
        Mr. Davidson. Thank you, Mr. Chairman, and thanks for
    convening this hearing. I think it is useful. It is a good
    hearing, and of the fact, as you highlighted in your opening
    remarks, Mr. Chairman, part of the purpose was already
    achieved. I look forward to the discussion with our witnesses,
    and thank you for being here, but I really want to kind of join
    the urgency of getting the Securities and Exchange Commission
    here. We really need to weigh the weighty matters. And frankly,
    my colleagues, Mr. McHenry and Mr. Huizenga, sent a letter to
    Chairwoman Waters on May 5th. Since we weren't here in town,
    perhaps it has escaped notice. And, Mr. Chairman, I wouldn't
    want it to escape your notice, so I ask unanimous consent to
    submit that letter for the record.
        Chairman Sherman. Without objection, it is so ordered.
        Mr. Davidson. What that calls for is a hearing of the full
    Securities and Exchange Commission, because it is very clear
    that Chairman Gensler is exceeding the authority that Congress
    has granted to the Securities and Exchange Commission. He is
    acting outside of the scope of the authority. And certainly,
    even within the authority, there has been some ongoing concern
    for regulation by enforcement and the harm that is causing to
    capital formation here in the United States. And, frankly, when
    they say they are protecting investors, obviously their view of
    protection sometimes means preventing investors from even
    participating in markets and owning certain assets, and there
    are huge consequences for that, no more so than in fintech and
    digital assets. I hope that, frankly, the letter will not just
    be submitted for the record, but that it will be read and fully
    supported, because this kind of accountability ought to be
    overwhelmingly bipartisan. It will certainly happen with a
    Republican Majority, but we might as well get it underway now.
        Mr. Le Pallec, can you explain the process of mapping
    ratings given by other firms and factoring them into S&P
    ratings? How does it work?
        Mr. Le Pallec. Mapping is one of the options that we have
    to get to a view on the creditworthiness of assets held by
    insurers as per the withdrawal methodology, so we don't
    consider everything is junk. Actually, we do mapping by
    exception. And we do mapping for credit rating agencies for
    whom we have common ratings, a lot of ratings in common so that
    we can translate, if you will, their ratings into our own. This
    is what mapping tries to do.
        Mr. Davidson. Is it similar to crowdfunding,
    crowdsourcing--the wisdom of crowds, and to some, is it
    vulnerable to groupthink?
        Mr. Le Pallec. No. It is a statistical study that just
    looks at default and performance statistics published by all of
    the credit rating agencies. And wherever we have ratings in
    common, we translate their ratings into our own because, as we
    said, rating definitions differ from one credit rating agency
    to the other. This is what mapping tries to do.
        Mr. Davidson. It basically translates how you score versus
    somebody else?
        Mr. Le Pallec. It is a translation exercise.
        Mr. Davidson. Okay. I would like to ask an open-ended
    question to the three witnesses representing credit rating
    agencies today. The COVID-19 pandemic provided a real-world
    stress test within every aspect of the financial industry. This
    includes credit ratings, since access to Federal emergency
    lending facilities is tied directly to an applicant's credit
    rating--not in every case, but often. My question for the
    rating agencies is, of all the defaults that you saw among
    companies that you provided ratings for, what percentage of
    them were of speculative grade?
        Mr. Le Pallec. Most of those that defaulted were of
    speculative grade because the definition of a, ``speculative
    rating,'' is that it is more likely to default than an
    investment-grade rating. But COVID was the biggest stress test
    for the industry that we had since the great financial crisis,
    and now, if you look at rating's performance through COVID, you
    will see that they are completely in line with rating
    definitions and expectations built in the rating. So we can say
    that, in our case, COVID pressure tested our ratings and they
    performed as expected, which, for us, makes us very proud.
        Mr. Linnell. Can I just add to that? Actually, I think the
    default way of companies is actually quite low and lower than
    what you would expect in a typical stress test. And the reason
    why was because of the unprecedented policy response by
    governments around the world, which offensively created a
    bridge from a stressed COVID world to a post-COVID world. And
    the performance of companies and, therefore, the performance of
    credit ratings benefited from that.
        Mr. Davidson. Thank you. Any other comments on that?
        Ms. Liang. I apologize. I don't have those statistics at my
    fingertips, but I would be happy to follow up with you and the
    committee on that.
        Mr. Davidson. Thank you, and we certainly hope that stress
    test is behind us, and hopefully, the lessons learned can help
    us in the future, so that we can keep pandemic risk and
    minimize the political risk. Governments around the world laid
    a pretty heavy hand on industry, certainly helpful in some
    cases, and so, thank you for highlighting that positive aspect.
        My time has expired, and I yield back.
        Chairman Sherman. I want to thank the Members and,
    particularly, the witnesses, for participating in this
    important hearing today.
        The Chair notes that some Members may have additional
    questions for these witnesses, which they may wish to submit in
    writing. Without objection, the hearing record will remain open
    for 5 legislative days for Members to submit written questions
    to these witnesses and to place their responses in the record.
    Also, without objection, Members will have 5 legislative days
    to submit extraneous materials to the Chair for inclusion in
    the record.
        This hearing is now adjourned.
        [Whereupon, at 11:41 a.m., the hearing was adjourned.]

                                A P P E N D I X

                                  May 11, 2022

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