Credit Rating Agencies: Culprits or Scapegoats? On Competition in the Industry

Throughout history, no single professional financial-market participant has been blamed with such concentrated intensity and pervasiveness as credit rating agencies (CRAs) after 2007.

Banks follow in a distant second place; in any case, they are partly excused because they were reportedly confused by the CRAs’ action (or absence of action).

Stimulated by media and demanding public opinions, policy makers have willingly entered into the rules of the industry’s game. All policy makers from multilateral to national, governments, parliaments and authorities have had their say.

The result was, e.g. in the EU, three new sets of rules were created in four years, as well as a brand new authority fully responsible at the EU level (the first one in EU history). In the US, a full set of novel rules has been introduced in the same period after decades of status quo.

One would hope that this concentrated focus on ratings and their role in financial markets from so many institutions would produce fully comprehensive regulation, shielding market participants from unfounded or even rogue CRA action. The view a candid observer might have, however, could be different.

The regulatory effort is likely to entail more transparency in CRAs’ actions, hence a net informational benefit to market participants. The foundations of the CRAs’ role in the market, however, cannot be determined by regulation.

A rating industry can play an effective role in reducing asymmetries of information if and only if the investor industry is willing to support its development by sharing opinions. This has been the foundation of the successes and the mistakes by incumbent CRAs certainly after WWII, and probably since the first decade of 20th century.

After 2007, evidence shows that the paradigm shared by CRAs and US/UK investors is at best under investigation, and at worst refused by another investor community altogether. The latter is holding true considering that the largest net financial asset stocks are based in the People’s Republic of China (PRC).

The factual evidence after 2007 demonstrated that PRC investors acted and reacted without conforming to incumbent CRA paradigms and consequent rating actions.  Examples can be found in sovereign, corporate financial and non-financial asset classes.

Might it be safe to deduct that a different paradigm exists and is consistently applied? Although it is too early to release a fully positive answer to this question, my personal opinion is that a different paradigm has existed for a while in the PRC.

A voice in the credit rating industry connected to that investor community, endeavoring to develop the implications of its paradigm is necessary for the good of international financial markets.

In conclusion, CRAs were neither culprits nor scapegoats, just affected by myopia induced by dogmatism.