Credit Rating Agencies: Change by Competition Law or Regulation?

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Paolo Palmigiano, Simone Pieri, Jan 28, 2014

Credit Rating Agencies have become increasingly important in the last few years due to the increasing changes in the financial sector. The industry for ratings started in 1909 with the creation of Moody’s and was followed soon after by Fitch and by Standard & Poor’s. The role of these companies is essentially to try to measure, in an objective manner, the credit risk of an issuer so that investors, who otherwise would not have the appropriate information, can make informed decisions.

CRAs do so by assigning credit ratings, that is ratings assessing the ability of an entity to meet financial commitments, such as repayment of principal and payment of interest. Such ratings have now become a common standard of credit risk that allows investors to make comparisons across all issuers. Letters are used to express the rating (AAA being the highest) and rated issuers can be companies, special purpose entities, states, and local governments. A credit rating may affect the interest rate an issuer pays—the better the rating the lower the interest rate (and vice versa).

CRAs were recently in the spotlight when certain securities, which were given high rating by CRAs, were downgraded to junk after the crisis, and when they downgraded Member States in Europe during the sovereign debt crisis. This has led several authorities to look more closely at CRAs and to introduce new regulations. The spotlight has also highlighted how concentrated the industry is, with two CRAs (Moody’s and Standard & Poor’s) controlling over 80 percent of the market, rising to over 94 percent if Fitch is included.

As a consequence of such concentration, the question has arisen as to whether, in addition to regulation, competition law should have a role. This article will describe the market and its issues, consider the possible application of competition law, and then conclude with the European regulatory changes that have or are being introduced to address some of those problems.