Leading Rating Agencies Research Articles

Investor Owned and Controlled Rating Agencies: A Summary Introduction

Rating agencies have been broadly criticized for their failure to anticipate a range of credit market conditions. The dominant critique, voiced by the President of the United States, the Chairman of the SEC, leading members of Congress, and foreign regulators, is that the leading rating agencies are subject to inherent conflicts of interest arising from the “issuer-pays” model that drives their business: Because these rating agencies are paid by the issuers of the securities they rate, the agencies have embedded incentives to please the sources of their essential cash flow and therefore are neither as objective nor as critical as they might be if driven by an alternative business model. Proposals for reform currently under consideration by Congress and the SEC, however, do nothing to alter these basic incentives. They fiddle at the edges of the marketplace and leave untouched the fundamental incentive conflict about which policymakers appear to agree. This article suggests an alternative regulatory strategy. Under existing statutory authority, the SEC could create a new category of rating agencies - Investor Owned and Controlled Rating Agencies (“IOCRAs”) - and require that every rating issued by an issuer-paid Nationally Recognized Statistical Rating Organization (“NRSRO”) that is not an IOCRA, such as Moody’s and Standard & Poor’s, be accompanied by at least one rating issued by an IOCRA. Because IOCRAs would be under the control of the sophisticated investor community, and because any one investor’s ownership interest in an IOCRA would be capped, the incentives of IOCRAs should be oriented to generating ratings that accurately reflect the risks of holding specific debt instruments, even though their fees would be also paid by issuers. This regulatory strategy introduces immediate competition into a market that is a strong duopoly and incentivizes innovation that has been lacking. Most significantly, however, IOCRAs would constitute rating agencies with an inherently investor-oriented perspective, and if IOCRAs were to fail in anticipating credit market issues, the investor community would, at the end of the day, have only itself to blame.

Are Competitive Rating Agencies Efficient?

Two very large companies, Moody's and Standard & Poor's, dominate the credit-rating industry. These two companies own around 80 per cent of the market. No other significant major competitors exist, though there are companies that rate local securities in places like China and India. In India, bulk of the ratings done by the two leading rating agencies—CRISIL (S&P majority stakeholder) and ICRA (Moody as the major stakeholder) have more than 80 per cent market share. Is this industry efficient? In this article, we present a simple theoretical model of competitive rating agencies. We establish that competition among rating agencies need not be efficient. We also show that despite price war, a more efficient rating agency will not necessarily drive out the inefficient one.

Comparative analysis of risk ratings for the East European region

Following the aftermath of the 11 September 2001 events, the risks associated with engaging in international dealings have increased substantially, and become more difficult to analyse and predict for decision makers in the economic, financial and political sectors. The importance of country risk analysis is underscored by the existence of several prominent country risk rating agencies, which combine a wide range of qualitative and quantitative information regarding alternative measures of economic, financial and political risk into associated composite risk ratings. However, the accuracy of any rating agency with regard to any or all of these measures is open to question. For this reason, the paper provides a qualitative comparison of country risk rating systems used by seven leading rating agencies. The paper also provides a novel analysis of four risk ratings using univariate and multivariate volatility models for nine East European countries. These ratings are compiled by the International Country Risk Guide, which is the only risk rating agency to provide consistent monthly data for a large number of countries since 1984. The empirical results enable a comparative assessment of the conditional means and volatilities associated with county risk returns, defined as the rate of change in country risk ratings, across the nine East European countries. Moreover, the estimated constant conditional correlation coefficients provide useful information as to whether the countries are similar in terms of shocks to the four risk returns.

Reforming the Malpractice System

LAWRENCE E. SMARR IS PRESIDENT OF PHYSICIAN INSURERS ASSOCIATION OF AMERICA IN ROCKVILLE, MARYLAND.

Analysing and Combining Multiple Credit Assessments of Financial Institutions

The last consultative papers of the Basel Committee on Banking Supervision set the path for a future where a wealth of credit assessment sources may be available. New external credit assessment institutions and internal ratings-based assessments will be added to ratings of major international rating agencies and to benchmark assessment methods used by supervisors or central banks. In its first part, this paper contributes to the development of a toolbox to analyse and compare credit assessments by examining the ratings of three leading rating agencies on a set of credit institutions. The analysis decomposes the historical default rate corresponding to a rating into two components drawing on a of published information and an contribution. In the second part of the paper, correlation and variance analysis of the analyst contributions lead to a combination of the available ratings, building on both the common core and the analyst part.

Local versus Foreign Currency Ratings

The authors examine the statistical determinants of transfer risk using probit estimation and an extensive data set of over 300 sovereign ratings given by the leading rating agencies between 1992 and 1997. Both macroeconomic and balance sheet variables are found to be important, and regional and rating agency biases are present. The models both within and out-of-sample perform well and produce a close relationship with the variables predicting currency crises.

Boom and Bust and Sovereign Ratings

The 1990s have witnessed pronounced boom–bust cycles in emerging‐markets lending, culminating in the Asian financial and currency crisis of 1997–8. By examining the links between sovereign credit ratings and dollar bond yield spreads over 1989–97, this paper aims at broad empirical content for judging whether the three leading rating agencies – Moody's, Standard & Poor's and Fitch IBCA – can intensify or attenuate boom‐bust cycles in emerging‐market lending. First, an event study exploring the market response for 30 trading days before and after rating announcements finds a significant impact of imminent upgrades and implemented downgrades for a combination of ratings by the three leading agencies, despite strong anticipation of rating events. Second, a Granger causality test, by correcting for joint determinants of ratings and yield spreads, finds that changes in sovereign ratings are mutually interdependent with changes in bond yields. These findings are based on many more observations than just the highly publicized crisis episodes in Mexico and Asia. They imply that sovereign ratings have the potential to moderate euphoria among investors on emerging‐market bonds, but that the rating agencies have failed to exploit that potential over the past decade.

RESEARCH OF FOREIGN EXPERIENCE IN BUILDING EFFECTIVE MODELS OF PENSION PROVISION OF THE POPULATION

In the article the comparative analysis of pension system ofRussiaand some European countries according to leading rating agencies, the most developed. In particular the pension system of theRussian Federationis compared with such countries asAustraliaandNew Zealand. For this comparison of pension systems of these countries by factors of the ratio of the average size of pension’s inhabitants of these countries with the average salary, age of retirement, other terms of pension savings. Focuses on the pension system of the countries in which it is practically absent, and the pension is paid only to certain categories of citizens (India,China,Thailand). The relevance of the topic is justified by the fact that the pension system of the state is an important indicator of the performance of its social functions. In particular, it placed first in the countries, the budget has a social orientation. In a number of countries including theRussian Federation, which proclaimed itself as a welfare state. However, inRussiathe pension system is in the process of formation and development, therefore, it is important to explore positive and negative experience with pension reform in other countries. The statistical, factorial and structural method of investigation was used in the work. The negative point inRussia's pension system, in our opinion, is the size of payroll payments, which is the highest among the countries analyzed. It should be noted, however, that inRussiathere is a predominance of the indicator in relation to the average size of pensions with a subsistence minimum. For the first time in the scientific literature it is determined that the majority of structural changes in the pension system take place in an inefficient socio-economic environment.