A conflict addressed?

Bloomberg reports that IOSCO is starting to address one of the most severe conflicts of interest in structured finance: the payment of the ratings agencies for rating structured notes by the issueing bank.

Regulators may restrict Moody's Investors Service and Standard & Poor's from advising banks on structured debt securities after criticism the firms failed to downgrade subprime-related notes as investor losses mounted.

Ratings firms may face a code of conduct prohibiting ``advice on the design of structured products which an agency also rates,'' the International Organization of Securities Commissions in Madrid said today. IOSCO, the forum of securities regulators, also called on financial institutions to disclose their risk of losses from structured finance.

Regulators including Michel Prada, France's chief securities official and chairman of IOSCO's Technical Committee, have rebuked ratings companies for being involved in creating the securities responsible for at least $146 billion of losses in the wake of the subprime slump.

``This doesn't address the core issue, which is ratings being paid for by issuers,'' said Christian Stracke, a strategist at CreditSights Inc. in London. ``It's a good first step but it leaves a lot of wiggle room.''

Borrowers pay for credit ratings rather than investors. Potential conflicts of interest between rating companies and the banks that pay their fees were flagged last year by European Central Bank President Jean-Claude Trichet and U.S. Senate Banking Committee Chairman Christopher Dodd. The Securities and Exchange Commission said in August it was examining the way the companies assign ratings.

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Moody's earned $884 million in 2006, or 43 percent of total revenue, from rating so-called structured notes, securities that package asset- and mortgage-backed debt, according to Neil Godsey, an equity analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia. That's more than triple the $274 million generated in 2001.

Clearly there is more to do before this issue is fully resolved.