Rating Agencies Attempt To Calm Fears About Japan’s Sovereign Debt

The Financial News reports that Moody’s Investors Services senior vice president Thomas Byrne wrote, “the shock from Friday’s earthquake does not make a fiscal crisis in Japan imminent. The country’s deep and liquid government debt market will likely continue to fund government deficits, even a larger deficit as a result of the earthquake, at an exceptionally low cost.”

Mr. Byrne also mentioned that The Bank of Japan had provided Y55bn ($670m) of emergency liquidity to 13 banks.

Similarly Standard and Poor’s assured that although the country had suffered “significant” fiscal and economic shock, Japan’s AA- sovereign rating was not at risk. However the Financial News quoted Standard and Poor’s as cautioning that the problems with the nuclear reactors were troubling, “Whether the macroeconomic damage is short-term or more prolonged depends on the outcome of the situation with the nuclear reactors, an event that is still unfolding, and time needed to recover the output of electricity sufficient to cover demand.

The global head of sovereign ratings at Fitch Rating Fitch, David Riley, was reported to have emailed that, “It’s too early to estimate the economic impact of these tragic events.”

Bahrain Reacts to Downgrade

The recent political unrest in Bahrain led Moody’s Investors Service to downgrade their sovereign debt on fears about the country’s domestic problems.

Bahrain central bank governor Rasheed Mohammed Al Maraj told CNBC, “I think the credit rating agencies took a hasty decision in terms of basing their decision on the political situation.” Al Maraj explained, “The economic fundamentals of Bahrain have not changed, as a matter of fact the public finance of Bahrain has slightly improved as a result of higher oil prices…Investors need to distinguish between the countries in the Middle East, as their dynamics are different.” He added that Bahrain had not experienced any negative impact from the region’s situation.

Unlike its neighbors, Bahrain does not have significant oil wealth and is not a member of OPEC. However, Bahrain has emerged as a Middle East banking capitol. This also causes Moody’s concern. Total bank assets are about 11 times Bahrain’s national income. Moody’s notes that, “potential liabilities stemming from the banking sector in a systemic crisis could…present a significant challenge to the authorities.”

Credit Rating Agencies Form New Trade Group

The Credit Rating Agency Constituency Group (CRA-CG) is a new constituency group for credit rating agencies that currently includes Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s. The group has been formed within the Financial Information Services Division (FISD) of the Software & Information Industry Association (SIIA), and the CRA-CG is open to having other Nationally Recognized Statistical Rating Organizations join.

According to their press release, the CRA-CG’s mission is to “develop best practices regarding compliance with regulatory requirements and facilitate communications within the credit rating industry with its various stakeholders.”

FISD Managing Director Tom Davin welcomed the new group and said that this is the ideal forum for the credit rating agencies to discuss the challenges facing their industry. “Those challenges have been the subject of significant legislative, regulatory and media attention over the past two years. We are delighted to be able to provide a home for these companies as they confront a new and more challenging business environment.”

Moody’s Walt Winrow, Group Managing Director Global Project & Infrastructure Finance added, “the credit rating agencies really need a setting to discuss critical issues among our peers, and FISD/SIIA can provide a productive home for us.”

Market Knows Best

EU Looks to Launch Rating Agency In Mid-2011

Michel Barnier, the European Union’s (EU) financial services commissioner announced at a press conference that they will create “a new [rating] agency, particularly with a European dimension” and “new ways of dealing with sovereign debt ratings by the middle of 2011.”

The European Council presented their plan at a recent meeting of EU finance ministers and central bank heads in Brussels. In a copy of the proposal secured by Bloomberg News, the council rationalized the initiative by saying that the “economic and political implications” of sovereign-debt ratings mean “it is particularly important that ratings of this asset class be accurate, timely and transparent.”

At the same meeting, ministers discussed rules to force rating companies to disclose reasons for changing a sovereign-debt rating. Following the meeting, Swedish Finance Minister Anders Borg also made clear that ministers were “ready to discuss” fines for ratings companies who mislead investors with poor quality ratings.

Academics Caution About Increased Rating Agency Competition

In the wake of the mortgage-backed securities debacle and other questionable business practices, regulators in the U.S. and particularly Europe are urging that the “big three” rating agencies face increased competition to drive better quality ratings. However, Bo Becker of Harvard Business School and Todd Milbourn from Washington University, warn that increased competition may not be a solution.

Analyzing Moody’s and Standard & Poor’s reaction to the rapid growth of the then-upstart Fitch in the early 1990s, the authors explain in Financial Times that, “The evidence we uncover appears unequivocally consistent with lower ratings quality as competition increased.” Specifically, as Fitch’s market share grew, the accuracy (measured as the correlation between ratings and bond yields) of a rating fell about one-third and the predictive power of default fell by two thirds.

The authors hypothesize that “…competition most likely weakens reputational incentives for providing quality in the rating industry, and thereby undermines quality. The reputational mechanism appears to work best at modest levels of competition.”

TÜSİAD Scrutinizes Rating Agencies

Ümit Boyner, the chairwoman of the Turkish Industrialists’ and Businessmen’s Association (TÜSİAD) announced at a meeting in Istanbul that the association is conducing research to determine whether large, multinational rating agencies are under inappropriate political influence.

At the Chief Executive Officers Forum sponsored by TÜSİAD Boyner said, “During the crisis, concerns about the decisions of international rating agencies appeared.” The association’s findings will be made public at the November meeting of G-20 countries.

Off the record, Turkish business people are skeptical about the integrity of the international credit rating agencies. Officially TÜSİAD claims that international rating agencies simply have “doubts about Turkey’s economic growth” and that the agencies “need to be convinced” that Turkey’s growth and economic performance is sustainable.

Chinese Look To Develop Investor-Paid Rating Agency

The National Association of Financial Market Institutional Investors (NAFMII) is a Chinese self-regulatory organization set up by China’s central bank in 2007. It is now spending 50 million yuan ($7.5 million) to develop a new rating agency to help protect investors as private companies sell more debt.

Central to the establishment of the new rating agency is an investor-paid business model. China’s bond market regulator said that investors must fund the agency instead of issuers to avoid conflicts of interest.

Bloomberg News quotes Shi Wenchao, secretary-general of the NAFMII, as saying, “The credibility of China’s credit-ratings agencies and their authority is not high…The inadequate set-up of the industry in China has imposed no effective external constraints, and has caused some misbehavior in the market.”

China currently has five credit-rating firms all using an issuer-paid business model.

Efforts Made To Delay Ban on Ratings in Rules

Until a better alternative can be developed, banks and regulators are pushing Congress to rethink the ban on using ratings agencies’ assessments in regulations used to oversee banks.

They say the ban is too much too soon and forces regulators to rely on untested tools when assessing banks’ viability. Specifically, the worry is that banks may avoid holding public and private debt because of the work involved in demonstrating to regulators that those investments are at a low risk.

Barbara Roper, director of investor protection at the Consumer Federation of America and a leading advocate for tough financial reforms, is quoted by Reuters as saying, “This one, I just think in the heat of the moment, they didn’t think it through.”

It may be difficult for regulators to moderate the ban or to convince lawmakers that it needs to be narrowed. The ban was one of the few aspects of the Dodd- Frank reform law that enjoyed bipartisan support.

Regulators have until July 2011 to identify credit rating agencies references in their rules and to develop alternatives.

EU Addresses Foreign Rating Agency Regulation

The European Union (EU) regulators envision two ways to handle ratings from agencies that come from non-member states. The first is to accept ratings of countries that they believe are “equivalent,” such as Japan.

The second way to is to accept ratings from other countries so long as their process is as “stringent” as in the EU and an EU agency has endorsed the assessments.

If the latter is imposed in a strict sense, it could affect both borrowers and lenders from other countries looking to engage Europeans institutions. Banks in particular could have a hard time holding non-EU assets as regulated capital under the new law.

The Financial Times quotes a worried diplomat as saying, “European banks could be shut out of certain capital markets…it’s not a small issue.” The United Kingdom and the Netherlands among other Nordic states are urging a loose interpretation of the regulation whereas France and Italy are pushing for a strict application.

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