Global Reform of Credit Rating Agencies and Challengers From Emerging Markets

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Trudi Makhaya, Jan 28, 2014

Concerns about the South African economy raised by credit ratings agencies are “not about numbers but about sentiment.” This was how South Africa’s Finance Minister Pravin Gordhan characterized the actions of credit rating agencies in remarks made after delivering the country’s Medium Term Budget Policy Statement in October 2013.┬áIn various interviews, the Minister went on to provide a critique of the manner in which credit ratings agencies operate, touching on their perceived conflicts of interest and the quality of their analysis.

For emerging economies, the findings of credit rating agencies are crucial as they influence how the international investor community perceives a country’s risk profile and its attractiveness as an investment destination. Credit rating agencies are relied upon to provide investors with information and guidance that serves as input into the analysis of securities and decision-making processes. For example, sovereign ratings provide an indication of the general business environment within a country and usually provide a ratings ceiling for the private sector. In playing this role, the views published by rating agencies have an impact on the cost of credit and access to capital markets, especially where local markets are small and opaque. The quality of CRA pronouncements and the cost of ratings also have a great impact on private sector companies that require ratings.

The dominance of the big three firms; Moody’s, Fitch, and Standard and Poor’s, is well-documented. The entrenchment of this dominance through regulation and legislation, starting with the endorsement of these three agencies by the United States as nationally recognized statistical ratings organizations, persists.

As the global financial crisis led to scrutiny of the ability of rating agencies to guide investors in assessing risk, key elements of their operating models have come to the fore as problematic. The dominant issuer-pays model, where the institutions issuing securities pay to be rated, distorts agencies’ objectivity. The significance attached to the ratings issued by the big three is also being challenged, with governments across the G20, including South Africa, implementing measures to remove strict references to agency-issued ratings from legislation, regulations, and investment mandates. These measures also aim to encourage investors to form an independent assessment of credit risk beyond the assessments given by CRAs.