Reports 2012

Making the case for an international non-profit credit rating agency

4 June 2012

“Let’s decouple corporate ratings from sovereign ratings, and have a non-profit agency,” said Annette Heuser, executive director of the Bertelsmann Foundation North America.

Making the case for an alternative to the status quo, Heuser argued that having an international non-profit credit rating agency (INCRA) would help to address governance issues arising from the dominance of the traditional ‘big three’ rating agencies: Moody’s, Standard and Poor’s and Fitch.

“We believe an alternative proposal is particularly necessary for sovereign ratings. As the highest asset class, they’re the elephant in the room. They affect everyone, but they’re rated in an un-transparent manner – and the indicators can be improved,” she argued.

Heuser said indicators should be reformed to take into account qualitative, forward-looking and socio-economic factors as well as macroeconomic issues.

“We’re saying that sovereign ratings are public goods affecting all sectors of society. All key societal actors must be integrated into the process,” she said, suggesting that governments, corporates and foundations could provide financial support for the endowment, which she estimated would need to amount to $400m.

Dismissing concerns that governmental involvement in INCRA would constitute a conflict of interest, Heuser argued instead that their participation would be crucial. “We’d have a stakeholder buffer with civil society and consumer organisations to buffer perceived conflicts of interest between funders and operational interests,” she said.

“We must improve indicators to get a comprehensive picture of sovereign risk,” Heuser said.

“The process involved much discussion and it was decided that non-profit was the best way,” said Vincent Truglia, formerly managing director and head of the sovereign risk unit at Moody’s Investors Service.

Predicting that “private rating agencies will copy INCRA if it’s good,” Truglia explained that “it […] eliminates the perception of a conflict of interest and gives people faith that what’s being presented is being done in the best way possible with no hidden agenda affecting the outcome”.

“Ratings first became involved in the regulatory environment in 1933 after the Great Depression, to help regulate major banks,” said Edward Emmer, former executive managing director at Standard and Poor’s.

Governments were worried about the investment choices that banks were making, and expressed their desire for a third party to provide a rating service. The concept of investment grade and non-investment grade was born, Emmer explained.

“Ratings became more involved in regulatory standards and requirements,” said Emmer.

After the crash of 2008, 2009 was characterised by “the realisation that investors had outsourced risk assessment to credit rating agencies,” he said.

“Institutions must no longer solely rely on work done by credit rating agencies. Take it into account, but don’t rely on it,” Emmer advised.

“The [INCRA] idea has a lot of merit,” said Mario Nava, acting director for financial institutions in the European Commission’s internal market department.

“The Commission has issued a proposal for a new directive to reduce overreliance on credit rating agencies for investment decisions and boost competition – the market is extremely concentrated. We want an open market,” Nava said.

“We must avoid ratings without an explanation. Avoid situations where ratings fall overnight with no apparent trigger,” he said.

“The current situation is clearly a very oligopolistic market, so having one more idea is great. Two more ideas would be fantastic. In ten years’ time, we won’t have the same market structure for credit rating agencies. It must change. Anything that changes the oligopoly is good,” Nava claimed.