Credit Rating Agencies: The New Emperors and Their Clothes
RBC Capital Markets' Open Forum Notes - 30 April 2004
From humble origins as suppliers
of information and arm's-length opinions, the major credit rating
agencies have developed into powerful global institutions, whose
positions are virtually unassailable by would-be new players and
deeply entrenched in the workings of today's financial markets.
This note maps the rating agencies' remarkable evolution and points
to a number of critical and potentially problematic implications.
The transformation of the agencies'
role would not have been possible without the endorsement of regulators,
which in essence have awarded the agencies effective control over
the access to and the costs of funds in bond markets and beyond.
Over time, the agencies have become
increasingly commercially minded, with most of their revenues now
generated from issuers, which contrasts with the self-restraint
and investor-biased revenue mix they displayed until only a few
The protected position in their home
market has helped the agencies to fund their rapid global expansion
as well as the development of profitable 'bolt-on' services.
Unsolicited and unpaid ratings, once
the industry's mainstay in its early days, have turned into an effective
means - intentional or not - to drive reluctant issuers into paid
rating relationships and away from potential competitors.
The agencies' dominant position has
also been supported by the complicity of the markets, which have
largely outsourced responsibility for the analysis that they should
be undertaking themselves.
Despite recurring disquiet about
both their performance record and their dominant market position,
which has led to complaints from politicians, regulators, investors
and issuers alike, the agencies continue to remain largely unregulated
and unsupervised, as well as effectively unaccountable for negligence
or other professional wrongdoing.
In another note the author will evaluate
alternative proposals how the 'leviathan' can be tamed and how the
agencies' core service to financial markets can be revitalised.
John Thirlwell is an independent
consultant and former senior director at the British Bankers' Association
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