Controversies Credit Rating Agencies Face: Parte 2

Controversies Credit Rating Agencies Face Parte 2 Controversias con las agencias crediticias Parte 2 PR1ME Capital México

The payment model and the claims of favoritism that placed the credit rating agencies under the radar. 

In the last chapter we talked about how the credit rating agencies’ reputation has been affected by events like the misinterpreted ratings during the 2008 crisis, monopoly claims and spontaneous reduction of the rating to various countries. Nonetheless, there are other two additional factors that have also been subjected too much criticism…

Claims of favoritism with the United States

The Big Three have also been constantly accused of giving preference to the United States in their ratings, as the American country has mostly kept its impeccable high AAA rating despite its deficit increasing public debts. The first agency to downgrade the United States for the first time in history was S&P in 2011.

Payment model

Most of the criticism is centered on the payment model that The Big Three (Moody’s, S&P, Fitch Ratings), with which the issuer of a bond pays rating agencies for the initial rating of a security, as well as for ongoing ratings.

Experts have expressed their fear that the payment method will generate conflicts of interest in certain cases where a higher rating than deserved may be produced in exchange for a bigger sum of money; or even give a better rating to companies or securities when someone has an acquaintance in the company.

Earlier this year, the European Securities and Markets Authority fined the Fitch Ratings group of companies in France, Spain and the United Kingdom a total of 5,132,000 euros for failing to maintain independence and avoiding conflicts of interest.

Controversies-Credit-Rating-Agencies-Face-Parte-2-Controversias-con-las-agencias-crediticias-Parte-2-PR1ME-Capital-Mexico
Fitch headquarters in London, Reuters | Reinhard Krause

Fitch UK, Fitch France and Fitch Spain issued ratings on Casino Guichard-Perrachon, Fondation Nationale des Sciences Politiques and Renault. This was despite the knowledge that one of their shareholders, who indirectly owned 20% of the shares in each of the Fitch group companies, was also a member of the board of directors of the rated companies.

Another possible risk would be that investors could pressure rating agencies to view the securities as risky because lower-rated securities pay higher returns. In this way, companies can also benefit financially from negative ratings.

In addition, the possibility of issuers approaching various rating agencies and “buying” the best possible rating is also discussed, implying that the market only sees the most optimistic ratings that the issuer has bought. 

However, Mishek Mutize, a professor at Capetown University’s college of finance, argues that abandoning this business model is not a solution and would only cause the bankruptcy of  the smallest credit rating agencies. 

The agencies have spoken about these issues and their solution is always the same: complete transparency. There is nothing else that can be done to verify the objectivity and sustainability of each rating they issue.

Keep learning with PR1ME Capital

Previously we discovered the origin, evaluation procedures and competitive differences  of the Risk Rating Agencies  and we understood that for companies, having a good rating is vital in order to find new investors who want to give a part of their capital to the development of the organization. 

With the necessary information, the agencies carry out an exhaustive analysis of the  key factors for the rating , such as financial reports, information from the private and public sector and the company’s performance over long periods. 

Now we know that there are  more than a hundred other rating agencies at the international level  , 118 of which are currently active; of these, only nine are approved and recognized by the US Securities and Exchange Commission.

Just as we addressed in the first chapter the controversies with the credit bureaus and we saw how their reputation is affected by various factors.

What will we talk about next week? Follow us on our social networks to continue learning with  PR1ME Capital  and don’t miss our next content.

Source:  Foreign Affairs,  The Conversation,
VOXInvestopedia

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