Nationally Recognized Statistical Rating Organization

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In the United States, the Securities and Exchange Commission (SEC) permits the use of credit ratings from certain credit rating agencies for certain regulatory purposes. The credit rating agencies whose ratings are permitted to be used for these regulatory purposes are referred to "Nationally Recognized Statistical Rating Organizations" (or "NRSROs"). The use of the term NRSRO began in 1975 when the SEC promulgated rules regarding bank and broker-dealer net capital requirements. The idea is that banks and other financial institutions should not need to keep in reserve the same amount of capital to protect the institution against (for example) a run on the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies). The safety of these securities, under this approach, is reflected in their credit ratings, as determined by certain highly respected credit rating agencies. At one time, there were seven NRSROs, but, due to mergers, this number dropped to three during the 1990s. Recently, the SEC, arguably as a result of political pressure and/or concern about concentration in the industry, added to this number, first with Dominion Bond Rating Service (a Canadian CRA) in 2003, and A.M. Best (considered highly regarded in particular for its ratings of insurance firms) in 2005.

The five organizations currently designated as NRSROs are:

Today, ratings by NRSRO are also used for other regulatory purposes in the United States as well. The SEC, for example, permits certain bond issuers to use a shorter prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimick the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings from NRSROs to ascertain the strength of the reserves held by insurance companies.

NRSRO recognition is granted by the SEC through a "No Action Letter" sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker-dealer) were interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would research the market to determine whether ratings from that particular CRA are widely used and considered "reliable and credible." If the SEC staff determines that this is the case, it sends a letter to the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff will not recommend enforcement action against that entity. These "No Action" letters are made public and can be relied upon by other regulated entities, not just the entity making the original request. The SEC has since sought to further define the criteria it uses when making this assessment, and in March 2005 published a a proposed regulation to this effect.

Currently, according to the SEC, the SEC staff use several criteria when determining whether a CRA publishes ratings that the market considers reliable and credible. According to the SEC's Concept Release:

The single most important factor in the Commission staff’s assessment of NRSRO status is whether the rating agency is “nationally recognized” in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings. The staff also reviews the operational capability and reliability of each rating organization. Included within this assessment are: (1) the organizational structure of the rating organization; (2) the rating organization’s financial resources (to determine, among other things, whether it is able to operate independently of economic pressures or control from the companies it rates); (3) the size and quality of the rating organization’s staff (to determine if the entity is capable of thoroughly and competently evaluating an issuer’s credit); (4) the rating organization’s independence from the companies it rates; (5) the rating organization’s rating procedures (to determine whether it has systematic procedures designed to produce credible and accurate ratings); and (6) whether the rating organization has internal procedures to prevent the misuse of nonpublic information and whether those procedures are followed. The staff also recommends that the agency become registered as an investment adviser.

Many private users (pension funds, banks) of ratings data now demand that ratings be from an NRSRO. Consequently, there is some debate that, by "recognizing" certain CRAs, the SEC has bestowed a competitive advantage on them. This view is supported by the vigor by which many non-NRSRO CRAs seek NRSRO recognition. On the other hand, historically, many private users of ratings data have "defaulted" to Standard and Poor's and Moody's when specifying which ratings must be used for their own purposes. (S&P and Moody's are the oldest, most widely respected, and by far the largest of the CRAs.) Accordingly, it is conceivable that the NRSRO designation has actually increased competition in the industry by providing an unintended government "seal of approval" on certain smaller CRAs (such as Fitch, DBRS and, now, A.M. Best). If true, this, of course, raises the question of whether this is something the government should (or even intends) to do, and whether the NRSRO recognition process is the best mechanism to achieve this goal.

In July 12, 2006, the U.S. House of Representatives passed the "Rating Agency Duopoly Relief Act of 2006". This bill, if it were to become law, would require a CRA to register with the SEC in order to become an NRSRO, and would require the SEC to establish clear criteria for determining which CRAs can qualify as NRSROs.