New report shows sovereign credit raters are bad for development

A rating of raters by think-tank Infrangilis shows credit rating agencies (CRAs) are failing to make the grade.

‘Rating Sovereign Raters’ is an international study comparing and contrasting the performance of CRAs to assess their rater worthiness and fitness to rate countries. The study is intended to contribute to public debate and policy development on supervision of the ratings industry following the controversy surrounding the credit downgrading of the USA and additional warnings to the UK, at its economy falls into a double dip recession, about the potential future loss of its coveted AAA status. Each of the CRAs analysed is rated according to their performance with regard to responsible leadership, good governance, public disclosure, and ratings performance. The research looks at issues ranging from competition, transparency and conflicts of interest through to capital flows to developing countries and competencies.

Rating the raters concludes that none of the CRAs assessed were 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 (see the table below). 

Rater ratings

Although other CRAs are often overlooked, the ‘big 3’ (Moody’s, Standard and Poor’s and Fitch) do not necessarily perform the best either, with Standard and Poor’s and Fitch doing less well than one of the smaller rating agencies (Dagong). 

Whilst there are weak results across the board, poor performance is particularly acute in relate to the aspects of ‘responsible leadership’ and ‘ratings performance’. In terms of responsible leadership, this appears to be because the CRAs 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 6 of these 7 CRAs received in annual checks made by both the US (SEC) and European (ESMA) regulators.

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 the European regulator 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 €20.3 million 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). The study questions whether this is an appropriate allocation of EC resources to CRA scrutiny given the Eurozone bailout fund is €734 billion. Given, particularly, 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.

Infrangilis recommends a number of key policy changes to remodel the rating of sovereign debt which will make the system resilient to future shocks and more productive. The study calls for:

·         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.

Rating Sovereign Raters: Credit Rating Agencies – Political Scapegoats or Misguided Messengers?is published by Infrangilis on 31^st May 2012. It can be downloaded for free at http://www.infrangilis.org