Philadelphia Reflections: What is an NRSRO?

What is an NRSRO?

Congress created the concept of a "Nationally Recognized Statistical Rating Organization" in 1976. As an aftermath of the Sarbanes Oxley movement, in 2005 credit derivatives were also required to be rated by the Credit Rating Agency Reform Act. A government stamp of approval was thus placed on a handful of rating agencies, and some argue it would be better to increase competition rather than constrain it by an approval process. Others are fearful of political influence. The ratings agencies themselves have expressed concern that efforts to increase transparency will impair confidentiality, and point out the existing system has seemed to work well for a century.

Nevertheless, defaults and paralysis of the credit system did occur, made worse by over-reliance on NRSRO ratings . Very likely, increased experience with this new debt security market will lead to a more accurate correspondence between predicted default rates and actual ones. No doubt, bond underwriters will make greater effort to stratify risk within the tranches with their own resources, using the opinion of independent rating agencies more as a check. Meanwhile, there may be a need to modify prevailing approaches. When evaluating a simple bond issue for a municipality or a corporation, only the financial strength of that entity is important. With the tranching approach, however, it is possible that risk estimation within each individual tranche might be perfect, but somehow be undermined by misjudgment of risk premiums to be assigned to each tranche. When risk premiums are generally compressed, there may not be enough to go around to all of the tranches.