2012-07-03 – London
The pan-European markets regulator, the European Securities and Markets Authority (ESMA), has launched a probe into the way the big three credit rating agencies evaluate banks to determine if the process is sufficiently rigorous and transparent.
The mass downgrading of sovereign and financial institutions by the ratings agencies amid the Euro-zone crisis has raised eyebrows within ESMA, which is responsible for supervising the agencies. Steven Maijoor, the ESMA chairman, said that the mass downgrades raised “concerns about whether there are sufficient analytical resources” at the rating agencies. He was keen to stress, however, that ESMA was not attempting to influence the ratings themselves, but only asking whether the analyses make economic sense.
The role of the main credit rating agencies – S&P, Moody’s and Fitch – has been widely criticized over the last several years, first for their role in rating structured products and banks before the financial crisis; and more recently for their mass downgrading amid the Euro-zone crisis. However, no meaningful measures have yet been taken to address concerns over the suitability of their ratings, while their opinions still have a remarkable impact on capital markets.
In our opinion, two issues have to be considered in assessing the role of credit rating agencies.
First, credit rating agencies might be subject to a potential conflict of interest as their fees are paid by underwriters. Consequently, their opinions may be flawed, eroding capital market’s efficiency, reliability and trust. Regulatory bodies have to control this practice carefully, investors have to be aware of any potential conflict of interest and credit rating agencies have to disclose fully and avoid any such conflict. Best practice would forbid underwriters paying any fee to credit rating agencies. Investors should rather undertake their own analysis, either in-house or through independent research companies.
Second, credit rating agencies should be free to issue any research according to a predefined set of rules – in a similar fashion as sell-side equity brokers. Regulators should prevent the use of material non-public information, but should not attempt to control credit rating agencies’ analysis process.
All in all, credit rating agencies have attracted harsh criticism during the last several years, but they should not be blamed for the mistakes of investors: investors themselves must take responsibility for their investment decisions and play their part in avoiding conflict of interest.
