Symposium Credit Rating Agencies: Public and Private Responsibility
Regulatory reliance on credit ratings
Laws and regulations require from banks, insurers, money market
funds, pension funds, state and local municipalities, and other
institutional parties, to invest only in products that
have a good credit rating from recognized credit rating
agencies ("CRAs"). CRAs are thrust into the center
of the bond information market by this kind of regulations.
However, the CRAs explicitly disclaim that investors
should rely on credit ratings in making investment decisions.
The regulatory reliance on ratings should be reduced and/or dropped
for certain investors. Professor White pointed out that the bond
market is first and foremost an institutional market, and not
a retail market. Institutions have memories and the resources to
draw on expertise. They ought to be able to figure out who is a
trusted advisor and who is not, and who has a good track record or
a business model that you should worry about. Institutions can be
trusted to make this kind of decisions. Institutions should not be
forced to use certain ratings.
The issuer-pay model
Another dilemma concerns the pay model of the big
three CRAs. All panelists agreed that the issuer pay model
should be dropped. Jan Maarten Slagter made clear that the whole
issuer-pay model is obviously rife with conflicts of interest, and
recommended: "if you use a rating as an issuer vis-à-vis
the public you should explicitly state that the credit rating was
obtained from a rating agency paid by the issuer." The
same should count for the rating agency, the sellers of investment
products and banks advertising these products, according to Jan
Maarten Slagter.
The role of CRAs in the credit crisis
Gerben Evers pointed out that CRAs are included among the parties
that are to be blamed for the recent crisis. Institutional
investors who were required by law only to hold securities with
good credit ratings in the U.S. but also in Europe, after the
sudden downgrades, massively dumped those securities in very thin
markets, which led to the collapse of prices, and which led to the
downward spiral we all were in. The liquidity risks were
underestimated by the regulators and the CRAs. All of this was
accelerated by the capital requirements, which required more
capital on the balance of regulated financial institutions. Gerben
Evers recommends that the investment restrictions, only
to invest in products with good credit ratings from certain
CRAs, should be dropped.
Alignment of interest
Panelists agreed that the interests of the CRAs
should be aligned with the interests of the investors, and that the
issuer-pay model should be dropped. Gerben Evers recommends that
CRAs should only rate companies and not products. All companies
should be obliged to put all things on their balance: "The
world has changed. Don't fall into the trap of historic
faults." Jan Maarten Slagter pointed to the role of CRAs
in the Asia crisis, the Russia crisis, Enron, Worldcom, and the
CDOs, and asked: "Why do we get there time and time
again?"
The quality of ratings
Jan Maarten Slagter indicated that more regulation
may build a higher barrier for entry, which would decrease the
quality of ratings. "We should have a more open
system, in which the quality of ratings decides whether
you will stay in business." According to Sean Egan, the
ratings of the big three CRAs did not reflect the true underlying
credit quality. Sean Egan pointed out that in the current credit
rating industry good ratings do not win out; they do not gain the
bulk of the market share. Pointing to Fitch, Sean Egan remarked
that they were smart enough to merge with other ratings companies.
Sean Egan indicated that much will change as a result of class
actions in the U.S.
Investor protection
Jan Maarten Slagter maintained that the consumer
should be protected amidst all of this, in particular through
transparency about the business model. The disclaimers of CRAs
clearly do not suffice, according to Jan Maarten Slagter. Rather,
the CRAs should adopt a statement comparable to those in smoking
adds: "Trusting this rating may very seriously damage your
financial health." Deniz Coskun concluded that CRAs can
be held liable under Dutch law for issuing misleading
statements.
Conclusion
The main conclusion of the symposium is that the interest of rating
agencies should be aligned better with that of the investors.
The investors, in particular the mid- and lower tier investors,
were badly burnt by the sudden downgrades. Meanwhile institutional
investors were forced by law to massively dump downgraded products
in very thin markets, which led to the fall of prices, and the
ensuing downward spiral. The alignment of interests can be
accomplished by abolishing the issuer-pay model for regulatory
purposes and by requiring CRAs to meet a market test with
their credit ratings. In addition, the forced regulatory reliance
on ratings of certain CRAs should be dropped. In case credit
ratings are permitted by regulators, these ratings should meet a
regulatory and a market test.