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Has anyone ever rated the credit rating agencies? The answer is simple: no. In 2011 the US Securities and Exchange Commission (SEC) published a long report with a generic downgrade of all the agencies, without naming them and asking for a further effort not to repeat the mistakes of the past. A second report published three weeks ago underlines that the rating agencies have not fixed many of the problems noted by the SEC one year ago: they have not been reformed since the days of the financial collapse and they are still paid by the issuer of the debt, which may put them under pressure to give it a high rating. Rating agencies are like a relationship with an attractive, evil woman: can’t live with her, can’t live without her.
An attempt to reform
In the 2,000 pages of the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), the American Congress tried to improve every aspect of the financial services industry, enhancing controls and regulations. A big part of the act is dedicated to rating agencies: it requires the SEC to write an annual report on them, to highlight possible conflicts of interest, to decide fines and penalties and to disclose their credit rating methodologies. Dodd-Frank also stiffened the rules to qualify as a Nationally Recognized Statistical Rating Organizations (NRSROs), the only way to operate as a recognized rating agency in the United States. The SEC however does not take part in regulating the process through which agencies decide on the creditworthiness of a bond or another financial product.
In the 2011 report the “Proposed Rule” issued by the SEC tried to replace requirements based only on credit ratings with an alternative method. Companies that have issued more than $1bn in nonconvertible debt securities over a three year period could file their offerings using a S-3 form to get greater access to the public securities market and meet some safety criteria. The proposal has been coldly received by investors: relying on past performances does not offer any additional security, as the financial crisis taught.
“Rating agencies” says Paolo Ferrari, banker at Citigroup and a bond market expert “can do for bond prices what the stock market does for share prices. Agencies have a huge power, but their ratings are not necessarily a perfect reflection of debt quality. When a bond is downgraded, a knowledgeable investor who knows the issuer well can profit from buying the security at a cheaper price, being aware that the underlying economics of the issuer are unchanged. Therefore the investor’s own judgment remains fundamental.”
Civic anger
It is difficult, if not impossible, to downgrade rating agencies. Nevertheless, around 60 cases have been filed against them around the world: the majority are in the US, regarding securities and CDOs, others in Italy and Germany on bonds and products connected to the bankruptcy of Lehman Brothers. Forty cases have been already dismissed, although appealed in higher courts. Others 20 are moving through the courts.
In the second week of November, prosecutors of Trani, a small city in Southern Italy, have asked five officials of Standard & Poor’s and two of Fitch to stand trial for market manipulation in last year’s downgrade of Italy. Prosecutors state that agencies’ reports were leaked during market hours, causing high losses on the Milan stock market. The case started in 2011 when prosecutors received a legal complaint from two consumer rights groups.
In Australia a court ordered Standard & Poor’s to pay AU$ 15m (plus interest and legal costs) to 13 municipalities, after securities they bought with a top rating collapsed during the financial crisis. The derivatives, purchased in 2006 with a AAA notch, lost 90 per cent of their value. Standard & Poor’s said it will appeal against the verdict.
New companies?
Rating agencies are supposed to judge the main characters operating in a free market. But there is no competition between them: they work in a regime of classical oligopoly. Since 2008 the “Big Three” control 95 per cent of the market, raising doubts not just about their independence, but also on the possibility of forming a cartel and acquiring yet greater influence over the global market. That is why China launched in October a new rating agency, The Universal Credit Rating Group, a joint venture that brings together China-based Dagong Global Credit Rating Company, Russia-based RusRating and US-based Egan-Jones Ratings Co. The aim is to break the dictatorship of the Big Three, to focus on Asia and to provide more balance to the entire system.
By now the Chinese Dagong is the agency that gained more international prominence. It downgraded US sovereign debt to a single A after FED’s quantitative easing policies, and gave a triple A to Norway, Denmark and China. Meanwhile, the whole EU debates on the possibility of a European agency to rate each country’s debt.
PART 2 WILL BE PUBLISHED SHORTLY
