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Regulators fail and new ratings agencies needed
By Sean Maguire |
May 26, 2010, Wednesday
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THE European Commission has sent out a warning to the major credit ratings agencies as member states grow impatient with what is seen as their disproportionate and unregulated influence within the world economy.
The euro has fallen to its lowest level in over a year as a result of the decision by Standard & Poor - one of the big three ratings agencies - to cut the rating of Spain's sovereign bonds.
This decision came after the agency downgraded Portugal's rating and threw Greek bonds onto the world financial scrap heap.
The principal purpose of ratings agencies is to assign credit ratings for issuers of debt obligations or bonds which will eventually be traded in an open market setting. Each ratings agency has its own model by which it calculate the credit worthiness of an issuer, which directly affects the rate the issuer will offer to purchasers of the bonds.
Their record is hardly pristine. At the beginning of the noughties, the agencies were slow in spotting the tide of corporate debt defaults, including Enron, and were arguably complicit in the sub-prime meltdown, for example, in giving a triple A rating to Abacus, Goldman Sachs' now-notorious synthetic collateralized debt obligation.
Part of the reason for the continuing influence of ratings agencies is that they are built into the way that the markets do business, and old methodologies die hard. Some investors, banks and insurance companies, for example, are only permitted to buy investment-grade securities. That means that they are obliged to off-load junk-grade securities. Similarly, ratings are used in determining the soundness of a bank's balance sheet.
Ratings also play a part in determining how big a "haircut" - a managed default under which investors get less than full payment - is required when banks and investors pledge collateral. One doesn't have to look far to see peculiarities in current ratings. Looking at sovereign debt ratings compared with the cost of insuring these debts, there are several discrepancies between what the credit ratings agencies say and what the credit default swaps market suggest.
Ratings agencies are free to operate in a legal never-never land to the extent that, technically speaking, all they do is offer an opinion, which is protected by the right to free speech. Moreover, they are typically paid by the issuers that they rate, which is hardly conducive to a ratings ascription based upon objective analysis.
Much better would an independent ratings system with small ratings companies that are paid by investors, so that the ratings may actually serve those who are making the investment decisions on them.
It is about time that an answer is provided to the old question: Quis custodiet ipsos custodies? (Who watches the watchmen?)
(The author is a lawyer at Allbright Law Firm. The views are his own. His email: sbjmaguire39@yahoo.co.uk)
The euro has fallen to its lowest level in over a year as a result of the decision by Standard & Poor - one of the big three ratings agencies - to cut the rating of Spain's sovereign bonds.
This decision came after the agency downgraded Portugal's rating and threw Greek bonds onto the world financial scrap heap.
The principal purpose of ratings agencies is to assign credit ratings for issuers of debt obligations or bonds which will eventually be traded in an open market setting. Each ratings agency has its own model by which it calculate the credit worthiness of an issuer, which directly affects the rate the issuer will offer to purchasers of the bonds.
Their record is hardly pristine. At the beginning of the noughties, the agencies were slow in spotting the tide of corporate debt defaults, including Enron, and were arguably complicit in the sub-prime meltdown, for example, in giving a triple A rating to Abacus, Goldman Sachs' now-notorious synthetic collateralized debt obligation.
Part of the reason for the continuing influence of ratings agencies is that they are built into the way that the markets do business, and old methodologies die hard. Some investors, banks and insurance companies, for example, are only permitted to buy investment-grade securities. That means that they are obliged to off-load junk-grade securities. Similarly, ratings are used in determining the soundness of a bank's balance sheet.
Ratings also play a part in determining how big a "haircut" - a managed default under which investors get less than full payment - is required when banks and investors pledge collateral. One doesn't have to look far to see peculiarities in current ratings. Looking at sovereign debt ratings compared with the cost of insuring these debts, there are several discrepancies between what the credit ratings agencies say and what the credit default swaps market suggest.
Ratings agencies are free to operate in a legal never-never land to the extent that, technically speaking, all they do is offer an opinion, which is protected by the right to free speech. Moreover, they are typically paid by the issuers that they rate, which is hardly conducive to a ratings ascription based upon objective analysis.
Much better would an independent ratings system with small ratings companies that are paid by investors, so that the ratings may actually serve those who are making the investment decisions on them.
It is about time that an answer is provided to the old question: Quis custodiet ipsos custodies? (Who watches the watchmen?)
(The author is a lawyer at Allbright Law Firm. The views are his own. His email: sbjmaguire39@yahoo.co.uk)
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