Credit ratings agencies are quick to pass judgement on the economic situation in countries across the globe. But how would the agencies fare if their own performance were assessed?
The controversy surrounding the US’s credit downgrading and additional warnings to the UK, as its economy falls into a double dip recession, about the potential future loss of its coveted AAA status has thrust the role of credit ratings agencies (CRAs) into the spotlight.
Many commentators would like to know whether the agencies are fit to rate countries and if they being supervised properly. A report published today by Infrangilis suggests not.
‘Rating Sovereign Raters’ is an international study comparing and contrasting the performance of CRAs to assess their rater worthiness. Each agency is rated according to its performance with regard to responsible leadership, good governance, public disclosure and ratings performance.
We conclude that none of the CRAs assessed was able to meet the AA- to AAA gold standard. On this evidence, there is a negative outlook for the industry as a whole, in terms of it being fit for purpose.
Whilst there are weak results across the board, poor performance is particularly acute in relation to the aspects of ‘responsible leadership’ and ‘ratings performance’. In terms of responsible leadership, this appears to be because agencies have a narrow understanding about the impact of their actions (for instance failing not only to appreciate their role in partly causing the financially unstable climate but also failing to understand other non-financial problems too – for example environmental resource constraints or poverty).
These findings are further supported by the damning verdicts on ratings performance that many of the agencies received in annual checks made by both the US Securities and Exchange Commission and the European Securities and Markets Authority (Esma).
This research also concludes that deployment of resources may not always match the bold talk on CRA supervision. Freedom of Information applications by Infrangilis to a number of national and international supervisory authorities revealed, for instance, at Esma just 13 staff (from a total of 75 people) are dedicated to dealing with the CRA industry across the whole of the eurozone, with only €150,000 allocated to onsite CRA investigations (which is less than the €161,000 allocated to postage and telecommunications, and a fraction of Esma’s €20.3m annual budget).
To put these numbers in further context, the European Commission employs 33,033 people and has a total budget of €147.2 billion. So the question becomes, is this an appropriate allocation of EC resources to CRA scrutiny given the eurozone bailout fund is €734bn? This is even more pertinent, given that it is alleged the financial meltdown was precipitated in part by a failure of the CRAs to identify and warn the markets about the Greek collapse and US sub prime mortgages.
A number of key policy changes are needed to remodel sovereign debt ratings to make the system resilient to future shocks and be more productive. These include:
- A return to the CRAs serving the public interest
- ‘Rewiring’ regulation to reduce the importance of the CRA industry
- The right kind of competition amongst CRAs
- Up-skilling the CRA workforce
- More effective co-operation between governments on CRA supervision
- Political leaders to provide better stewardship of CRA supervision and wider industry reform.
Philip Monaghan is chief executive of the think-tank Infrangilis. Rating Sovereign Raters: Credit Rating Agencies – Political Scapegoats or Misguided Messengers? is published by Infrangilis on 31st May 2012. It can be downloaded for free at http://www.infrangilis.org
