One of the European Union’s (EU) proposals to increase competition among rating agencies by requiring corporations to rotate rating agencies at least once every three years appears to have been largely abandoned.
Instead, agencies will only need to be switched once every five years and then only for very specific types of credit.
Reuters reports that the change was made because of intense pressure by corporations and banks who feared they would be forced to use rating agencies who lacked credibility among American and Asian investors.
There appears to be broad parliamentary support for this diluted rotation; however, the industry is still objecting. Reuters writes, “The Association for Financial Markets in Europe, a lobby group for the big banks, says mandatory rotation is excessive and could harm a revival of the securitization market, which is needed to help banks fund themselves.”
Other EU regulations on rating agencies that appear to be going forward include: reversing the burden of proof for those suing rating agencies – the agency would be required to disprove any claim; limiting the issuing of sovereign debt ratings for 27 EU countries to two or three fixed dates every year; and a ban on rating agencies from using non-public information to compile ratings.
In an interview with the Sunday Telegraph, the head of Fitch’s global sovereign ratings David Riley said, “The impression might be that if we downgrade Spain, or whoever, we’re cutting them off and making their situation more difficult. Yet, at the same time, we hear a lot of people saying ‘you’re late to the party, the market’s already there, it’s irrelevant what you’ve done.’ We can’t be both. We can’t be all-powerful and irrelevant.”
He continued to explain the idea that rating agencies, “create the crisis that you’re predicting” was impossible and he denied that any decision could create “a self-fulfilling crisis.” He said, “If you owe 1 trillion and your cost of funding increases permanently by 10 basis points, it adds up. But there’s no evidence that the impact is so great as to push what was a solvent liquid entity into insolvency.”
Frederic Drevon, Moody’s head of Europe, Middle East and Africa, echoed Mr. Riley’s thoughts. He said, “If there is a negative environment and we downgrade, we will be told you are contributing to the events as they are happening. But the reality is we have to make the calls as we see it.” He added, “You will have many people who agree and disagree…That’s the way we operate. We are open to criticism.”
The long list of countries lashing out at rating agencies for lowering sovereign debt ratings has gotten longer. Now India has joined most of the EU and many others in criticizing Standard & Poor’s (S&P). India’s complaint centers around an S&P report saying that their country could be the first BRIC (Brazil, Russia India and China) country to loose its investment grade rating.
The Business Standard quotes Union Home Minister P. Chidambaram as dismissing the report by saying, “I think we tend to overreact to rating, as you see in reports. In fact, some of these rating agencies have very poor records in the past. I think we need not see reports of rating agencies as the final word on the country’s economy.”
Mr. Chidambaram supported his position by pointing out how India survived the challenge they faced in 1991 and again during the Asian domestic crises in 1997. Today’s challenges, he believes, pale in comparison.
He agreed that inflation was too high, but blamed the problem on high fuel prices. The Business Standard has him explaining, “High crude oil prices are fuelling the price rise compounded by the fiscal deficit and the current account deficit. We have controlled inflation. We believe crude oil prices will moderate in coming months and gradually, inflation will come down.”
Writing for CBS Money Watch, columnist Constantine von Hoffman wonders, “Why are ratings agencies still in business?”
He cites two examples. The first is Standard & Poor’s upgrade of Greece’s sovereign debt “from really, really, really bad to merely very, very bad.” He doesn’t believe that Greece deserves a better rating, particularly in light of the then pending Greek elections.
He writes, “On Saturday, Greece will hold national elections in which anyone favoring budget cuts will be lucky not to finish at the bottom of the Aegean Sea.” He also points that markets reacted to the upgrade by driving the yield on Greek Bonds up even higher.
The second example is how the recent downgrade of Spain’s sovereign debt was “shrugged” off by the markets. He explains, “investors have known for some time that the economy there is a train wreck.”
He concludes by pointing out, “the agencies didn’t just miss the boat on mortgage securities, they missed the whole ocean.”
Credit Business Management reports that a paper written by Dr. Mungo Wilson, Saïd Business School, University of Oxford, and Jens Hilscher, Brandeis University, asserts that credit rating agencies’ ability to predict default is overrated.
Dr. Wilson said, “Our research proves what many critics of credit rating agencies have been arguing for years — that the accuracy and informational value of corporate credit ratings is dishearteningly low. Ratings are not an optimal predictor of default probability. They explain little of the variation in default probability across firms and they fail to capture the considerable variation in default probabilities and empirical failure rate over the business cycle.”
The two researchers conclude that it would be more accurate and useful to separate default prediction from the measurement of systematic risk.
Default prediction data could be updated frequently and rapidly to respond to firm-specific news, while measures of systemic risk could be a combination of current credit ratings and aggregate credit conditions.
The full paper is available at: http://people.brandeis.edu/~hilscher/CreditRatings_HilscherWilson_Jan2012.pdf
The former chairman and CEO of the Royal Bank of Scotland (RBS), Sir George Mathewson, is now the director of a small rating agency. He has called for a fundamental change in the way rating agencies do business.
In an interview with the BBC, he said that ratings must be “as accurate, fair and balanced as possible.” He also said that, “I don’t understand why there is so much emphasis on protecting a status quo which has been clearly see to have failed.”
Sir George came out in support of rotating rating agencies, an idea that has been largely abandoned by European regulators. He believes that using a series of agencies in rotation would lead to a “healthier industry and financial a sector with less risk.”
In a speech addressing the lessons learned from the recent Financial Crisis, Federal Reserve Chairman Ben Bernanke assigned blame for the collapse to a variety of industry players, including the rating agencies.
In his speech, he complained of “securities that proved complex, opaque, and unwieldy.” And he pointed a finger at the rating agencies that were asked to evaluate these hydra-like asset-backed securities and issued ratings that “were revealed to be subject to conflicts of interest and faulty models.”
Investors were unable to distinguish between AAA-rated securities. Mr. Bernanke said that even those who were able (or inclined) to do their own credit analysis found “the information needed to do so was often difficult or impossible to obtain.”
“It is clear that the statutory framework of financial regulation in place before the crisis contained serious gaps,” Mr. Bernanke said in summary. “Market discipline, imposed by creditors and counterparties, helped on some dimensions but did not effectively limit the systemic risks these entities posed.”
He left “to another time” any discussion of changes to the regulatory framework.
ANOTHER ATTACK ON THE RATING AGENCIES.
If you don’t like the opinion, BAN IT.
This fits the storyline that the problems in markets are the rating agencies’ fault.
Let’s recognize that governments enshrined ratings by the NRSRO designation.
Central planners need to answer this question. Ratings are an opinion, or they aren’t.
My guess is establishment of an official, “GSE-like” rating agency…
That will solve everything…
Europe Seeks to Reduce Debt Ratings’ Influence - New York Times, February 29, 2012
Filed under: European Union, Financial Reform, The Rating Agencies
ORWELL WOULD BE PROUD.
We don’t want your opinion unless we ask for it.
More of the same. The problem is the rating agencies, not the profligate spending of the politicians.
Credit-ratings companies should be banned from rating sovereign debt unless they have been contracted to do so by the country concerned, a European Union lawmaker said in a draft report on proposed EU rules. Leonardo Domenici, who is responsible for steering rules on credit-rating companies through the European Parliament, called for the measure to be added to last year’s proposals from the European Commission. Domenici also said either “an independent public European credit rating agency” or “an existing independent Union institution shall be entrusted, with the task of assessing the creditworthiness of Member States’ sovereign debt.” Domenici’s report will be voted on by other members of the parliament. The assembly, together with EU ministers, must agree on the final wording of the proposed law before it can be implemented.
-From Bloomberg News, “EU Parliament Report Targets Curbs on Sovereign-Debt Ratings” by Jim Brunsden, Feb. 17, 2012
I know this fits the “rating agencies are the Devil” narrative in D.C., but a little balance is called for. If there was a failing in MF Global, it was in management and regulatory oversight. Management took the risk, and the blame lies with them.
Regulators are empowered to oversee the safety and soundness of regulated entities and are charged with intervening if there is a problem. Rating agencies observe this process as a third party.
Let’s have hearings and ask all three parties what they know and when they knew it.
Rating agencies publish ratings opinions.
Regulators monitor safety and soundness.
There is responsibility and blame to be assigned in this collapse. Let’s make sure it’s assigned to ALL responsible.
Congress Presses Rating Firms – The Wall Street Journal, January 5, 2012