THE Big Three rating agencies hardly seem to be out of the news with their ability to move markets. Following Standard & Poor’s (S&P) decision to reduce its assessment of the health of France’s sovereign debt by one notch to AA+ from AAA status, top German politicians like Michael Fuchs and others have jumped on the agency-bashing bandwagon – berating them for “inconsistent” ratings.
The big agencies were heavily criticised in the wake of the credit crisis for giving vehicles like collateralised debt obligations (CDO) triple A ratings, largely based on the strength of the underlying financial institution issuing the debt. Olli Rehn, an EU commissioner, slammed S&P’s recent move to downgrade the EFSF bailout fund by one notch, branding the agencies as being the tools of “American financial capitalism”. Strong stuff.
How big a deal was the downgrade? AA+ and AAA-rated securities differ very little in their yields, usually by only 10 basis points (0.1 per cent) on average. But it’s all about perception.
According to Moody’s, another of the Big Three, the average cumulative issuer-weighted global default rates from 1920-2009 (excluding Asset-Backed Securities and muni/local government bonds) indicated that over a one year period AAA rated debt exhibited a 0.00 per cent rate of default, versus a 0.07 per cent rate of default for AA rated debt. Over five and 10-year periods the historical default rate increases to 0.72 per cent and 2.22 per cent, respectively.
More concerning is whether the market, investors and subscribers can rely on the agencies’ ratings. Various examples over recent years illustrate just how far behind the curve S&P, Moody’s and Fitch were.
Collectively, the three agencies control 97-98 per cent of the entire ratings market and 90 per cent of all revenues. Other agencies do exist: nine firms are now registered with the US SEC as nationally-recognised statistical rating organisations (NRSRO).
Unsurprisingly, the dominant players resist changes to their business model, based on an issuer-pays model. By contrast, some rivals such as Rapid Ratings, an agency headquartered in New York, espouse a subscriber-pays model. They are also not remunerated by the issuer of the debt/entity they are rating.
Rapid was the first agency to signal problems with MF Global, the now defunct US broker, as far back as May 2009. This was some 30 months before the broker filed for bankruptcy late and years before the big boys noticed. It appears not to be a fluke. Rapid made early calls on US housebuilders, an early signal of the sub-prime crisis, and provided forward-looking alerts on Bear Stearns, Enron, Parmalat, Ford and US Steel.
Silly proposals made recently by the EU’s financial market watchdog Esma to ban ratings on a state or nation – at certain critical times – would restrict the analysis available and would merely fuel any crisis of confidence. The real issue is that the market needs insightful and actionable ratings – and that means a level playing field for all agencies to encourage real, genuine competition.
Roger Aitken is an associate analyst with benchmarking firm BISS Research and a former RNS editor at the London Stock Exchange. www.bissresearch.com