overview
evolution
industry
criteria
issues
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Profiles:
credit rating
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overview
This
note considers the corporate rating service industry.
It covers -
The
note supplements discussion in the separate guides on
the Digital Economy and
Capital. There is a complementary
note on consumer credit
reporting and reference services.
introduction
Corporate ratings services are non-government bodies that
provide investors with information about the credit worthiness
of businesses (particularly large corporations) and governments.
That information is typically comparative, with an historical
basis, and is significant because it influences the cost
of borrowing or even whether borrowing takes place. An
agency thus evaluates a debtor or a debt instrument (eg
a bond) and assigns a grade - often expressed as a range
from AAA to D - according to its relative creditworthiness.
A low rating (eg a C or D, often characterised as "junk"
or "high yield") is considered speculative.
Higher ratings are given to those corporations and sovereign
debtors (ie governments) who are assessed as having the
greatest commitment and ability to repay borrowings. Fees
are typically paid by the debtor or debt issuer and can
be negotiated.
The services emerged from the 1850s, when investors sought
independent advice about early joint stock enterprises
such as railroads. As the following page notes, they have
gone on to rate lending to governments and have accompanied
the growth of personal credit
reference services.
As a result they have been glibly described as unelected
and self-regulated 'masters of the universe'. Thomas Friedman
for example 1996 commented that
there
are two superpowers in the world today in my opinion.
There's the United States and there's Moody's Bond Rating
Service. The United States can destroy you by dropping
bombs, and Moody's can destroy you by downgrading your
bonds. And believe me, it's not clear sometimes who's
more powerful.
The Bank of International Settlements indicates that there
are around 130 to 150 corporate rating agencies worldwide.
Most of those agencies are small and typically focus on
particular jurisdiction or economic sector. Only a few
are formally recognised by governments for regulatory
purposes, signalled by status as a Nationally Recognised
Statistical Rating Organisation (NRSRO). The US and global
markets are dominated by three agencies that rate corporations
and nations: Standard & Poor's, Moody's and Fitch
Ratings.
The 10 member countries of the Basel Committee for Banking
Supervision (BCBS) recognise six agencies, while in the
US the
Securities & Exchange Commission (SEC) recognises
only four (the big three agencies plus Canada-based Dominion
Bond Ratings).
During the past decade questions about the effectiveness
of the major agencies in rating enterprises (particularly
new enterprises), addressing concerns about corporate
governance ratings and assessing the sovereign risk of
nations (eg the likelihood that governments in emerging
economies will default on international loans) have led
to the emergence of new services whose evaluation encompasses
non-traditional value indicators that may not easily be
captured in a corporate balance sheet but have significant
implications for the particular enterprise's competitiveness,
long-term share value and viability.
Critic Frank Partnoy has persuasively argued that the
dominant rating agencies have enjoyed an oligopoly based
on their ability to accumulate and retain reputational
capital, strongly reinforced through public/private sector
regulatory standards. Increased competition would decrease
the value of such property rights, allowing debtors and
debt issuers to acquire credit ratings at a lower cost.
studies
For accounts of the contemporary ratings industry
see Credit Reporting Systems & the International
Economy (Cambridge: MIT Press 2003) edited by Margaret
Miller, Ratings, Rating Agencies & the Global
Financial System (London: Kluwer Academic 2002) by
Richard Levich, Giovanni Majnoni, Carmen Reinhart &
Giocanni Majnoni, the US Securities & Exchange Commission
2003 Report on the Role & Function of Credit Rating
Agencies in the operation of the Securities Markets
(PDF)
and Credit Ratings: Methodologies, Rationale &
Default Risk (London: Risk Books 2002) edited by
Michael Ong.
Transborder and regulatory issues are explored in papers
in Credit Reporting Systems & the International
Economy (Cambridge: MIT Press 2003) edited by Margaret
Miller, the 2005 Regulating the Rating Agencies
(PDF)
paper by Claire Hill, The Basel Handbook: A Guide
for Financial Practitioners (London: Risk Books 2003)
edited by Michael Ong, Globalisation: News media, images
of nations and the flow of international capital with
special reference to the role of ratings agencies
(PDF)
by Michael Kunczik and Global Governance of Financial
Systems: The International Regulation of Systemic Risk
(Oxford: Oxford Uni Press 2005) by Kern Alexander, Rahul
Dhumale & John Eatwell. A perspective on Australia
is provided by Emawtee Bissoondoyal-Bheenick's 2004 Determinants
and Impact of Credit Ratings: Australian Evidence
(PDF).
For industry economics and performance see Richard Cantor
& Frank Packer's 1994 The Credit Rating Industry
(PDF)
and their 1996 'Determinants and Impact of Sovereign Credit
Ratings' (PDF),
Jewell & Livingston's 1999 'A comparison of Bond Ratings
from Moody's, S&P, and Fitch' in Financial Markets,
Institutions & Instruments, Frank Partnoy's 1999
influential paper
'The Siskel and Ebert of Financial Markets: Two Thumbs
Down for the Credit Rating Agencies' in Washington
University Law Quarterly, Yingjin Gan's Why Do
Firms Pay for Bond Ratings When They Can Get Them for
Free? (PDF)
and Lynnette Purda's 2003 Consistency of Global Credit
Ratings: An Analysis of Firm versus Country-Specific Factors
(PDF).
The emergence of alternative regimes is considered in
James Salo's The Emergence of Non-Financial Rating
Agencies for the Promotion of Global Standards: An Assessment
and Empirical Analysis of Two Proprietary Databases
(PDF)
An historical perspective is provided by Richard Sylla's
crisp 2001 A Historical Primer on the Business of Credit
Ratings (PDF),
Born Losers: A History of Failure in America
(Cambridge: Harvard Uni Press 2005) by Scott Sandage and
Money of the Mind: Borrowing & Lending in America
from the Civil War to Michael Milken (New York: Farrar
Straus Giroux 1992) by James Grant.
Practitioner guides include Standard & Poor's
Fundamentals of Corporate Credit Analysis (New York:
McGraw-Hill 2004) by Blaise Ganguin & John Bilardello
and The Standard & Poor's Guide to Measuring and
Managing Credit Risk (New York: McGraw-Hill 2004)
by Arnaud de Servigny & Olivier Renault.
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