cover story
‘That potential conflict of interest
arises when CRAs sell a rating to a bank or insurance company whilst at
the same time selling other professional services to the same institution’
Some track record The fact that anyone at all – let alone financially liter- ate traders and bondholders – listens to CRAs in 2011 is amazing given their track record in the run up to the financial crisis in 2008. The ‘big 3’ were still giving AAA ratings to bonds in 2008 whose collateral comprised of ‘assets’ that were completely worthless. I saw with my own eyes boarded-up homes inWisconsin in 2007 where the mortgage-holder had long since stopped paying but where the ‘asset’ had been nonetheless bundled into a Triple-A rated bond worth millions of dollars and was still being traded around the world. In hindsight, those sort of bonds were junk from the
word go and should have been removed from the market after August 2007 – the first month of the financial crisis – when banks woke up to the fact that, like a gourmet restaurant, all the fillet steaks they thought they were gonna sell at premium prices were completely rotten. The ensuing near-collapse of the entireWestern bank-
ing system in the autumn of 2008 led to some of the con- sequences mentioned above and the austerity measures many nations’ taxpayers must now endure. Of course, the agencies did admit to “poor ratings per-
formance” in this area and point out that this is a small part of their overall business – the rest of which contin- ued to “perform well”.
Changing landscape But the landscape is changing for CRAs. The regulatory environment, which so spectacularly failed to spot any problems before 2007 on either side of the Atlantic, is finally getting much tougher. Cue hackneyed aphorisms featuring gates, horses and bolting. In the US, new regulations that came into force last
July, and called the Dodd-Frank Act (named after the proposing US legislators), mean that CRAs became far more responsible for their ratings and can be sued if deemed to be reckless and wildly inaccurate. The new laws also set out ways to minimise the perceived con- flicts of interests. That potential conflict of interest arises when CRAs
sell a rating to a bank or insurance company whilst at the same time selling other professional services to the
same institution. If the bank doesn’t like the rating it gets, it might cut back on the other advice it pays for. Unscrupulous CRAs might be tempted to improve rat- ings in order to keep business on the other side of the balance sheet. In Europe, the new CRA regulations are on the way,
which – if advice from some MEPs are followed – could require CRAs to comply with rigorous rules of conduct in order to prevent those conflicts of interest. It could also blow away some of the smoke and secrecy that sur- rounds why one bond gets Triple-A and another only Single-A ratings. The EU Commission has just finished trawling for opinions as part of its new European Securities and Markets Authorities (ESMA). Expect concrete regulations later this year. Separately there’s even talk now from Germany and France of an EU-specific ratings body which would give its own European (rather than American-owned) view on the health or otherwise of a company or country’s bond issue. That though may lack credibility. The last time Europe published supposedly objective opinions on its own banks were last May’s ‘Stress Tests’, when only seven banks on the whole continent failed - even the now 93pc nationalised AIB passed. That hiccup aside, there’s no doubt that the times,
they are a changin’ for how companies and countries are rated. The oligopoly enjoyed by Moody’s, S&P and Fitch is being slowly eroded through increased competition (from, amongst others, Bloomberg) and the pitch on which they play is being slowly tilted in a direction they won’t like but governments might prefer. And from within CRAs have been bruised by a media and political onslaught since 2008 – initiating wholesale changes to how their ratings work. But one gets a sense that until the current eurozone
crisis recedes fully and normal growth returns to Europe in general and the PIIGS in particular, the mar- kets, media and wider public will continue to hold their collective breath for a while yet when CRAs make a major announcement.
Joe Lynam has donated his fee in full to
www.CaraMalawi.com
Spring 2011 Irish Director 17
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