Regulators have had their say; the agencies themselves have implemented changes to methodologies and processes; but how would investors fix the credit ratings business? Credit asked investors at some of the largest fixed income asset managers in the world their thoughts on the future of the rating agencies. Almost four years on from the start of the financial crisis, it is clear the agencies’ efforts to repair their reputations is still a work in progress. Luke Spájic, head of European credit portfolio management at Pimco “Rating agencies are meant to assess default risk and talk about impairment of asset quality – the risk to cashflows on any credit. The good news is they have a well-developed template and a long track record; the bad news is they tend to be behind the times. They tend to be quite slow when a credit event does happen – or is about to happen – and quite slow on upgrades. If investors use the agencies as a risk tool, they are in danger of being behind the curve; if they use it as a rough guide then it may work in their favour. You need your own view of credit risk, your own research team and your own assessment of default probability. The issuer-pays model is a bit like a football team hiring their own referee. You want an independent referee and someone has to pay for that. A framework needs to be developed where investors pay the rating agencies as opposed to the issuers. Under that model you get some degree of independence. If banks have gone through the whole process of having their incentives checked, having their proprietary risks removed and being told ‘you can’t do this, you can’t do that’, why can’t the rating agencies go through a reshaping process?” Duncan Sankey, senior portfolio director and head of credit research at Cheyne Capital “Corporate ratings were not subject to quite the same issues of credibility as those in structured finance because rating a corporate was, and I hope remains, a human, analytically based activity rather than a model-driven process. I fear the agencies found the model-based approach of structured finance rather seductive because it would appear cheaper to operate and more scalable. Couple that with a wealth of liquidity-fuelled structured issuance, and the agencies must have seen the scope for generating fat operating margins. But despite the problems they had in structured finance, it is going to be very hard for any newcomer to do a full-frontal assault on Moody’s and S&P, particularly in the corporate arena. There are still big barriers to entry in that industry and so the place where new rating agencies will possibly be able to get a foothold will be in niches, as you saw many years ago in the bank market.” Ashish Shah, senior vice-president, global credit at AllianceBernstein “Rating agencies have taken a lot of time trying to tighten up their processes, almost to a point where they may be sitting back and saying some things are less safe than they truly are. Just like banks tend to overly tighten credit standards at the bottom of the cycle and let them get too loose at the top of the cycle, you see similar dynamics when it comes to rating agencies. Our entire investment scheme and regulatory scheme within fixed income is based on ratings, however. It would be difficult to come up with something better. Shifting from an issuer-pays model will not make a huge amount of difference and would be hard to operate, because the people the agencies are working with to get information are the issuers and originators. It is much more important that regulation ensures the data the rating agencies base their analysis on is widely available to investors.” Martin Reeves, director of global fixed income and credit research at AllianceBernstein “Agencies are not evil; they are paid to provide an opinion. Those opinions can be fallible, and the problem arises if people underestimate the fallibility. The problem becomes even worse when people who have not paid the agencies for any opinion then rely on the rating, and worse still when regulators enshrine in law dependence on those opinions. There is a simple solution if people are worried about depending on the agencies: spend the money to come up with your own opinion. If people do not want to pay for hiring credit analysts, they need to do their own cost/benefit analysis of the risks they face.” Tamara Burnell, head of sovereign and financials credit analysis at M&G Investments “Rating agencies made mistakes, but so did plenty of investors and issuers. Anyone who relies on a third party to form their own investment opinion is asking for trouble. In general we support moves to remove external ratings from regulations and from standardised market contracts and infrastructure. We are particularly concerned about ratings being hard-wired into financial regulation, such as Basel III or Solvency II. This effectively forces investors to use ratings in a way in which they were never intended to be used, and potentially gives regulators a false sense of security about the safety of the financial system. Similarly, the authorities need to be wary of building ratings criteria into the sovereign debt restructuring process, via the European Financial Stability Facility and European Stability Mechanism. The goal should be fiscal sustainability and transparency, with investors able to undertake their own analysis of progress towards this goal.” Maurice Browne, credit portfolio manager at Aviva Investors “During my career we have heard the death-knell for rating agencies a few times but it has never really happened. They are ingrained within our investment management agreements and ingrained more fundamentally within the market in terms of bond documentation. The problem is that quite often the people working at rating agencies are trying to please a number of masters. For example, investment banks have a huge amount of resources, and can put a lot of weight on rating agencies to get the result they want, not necessarily the result that is best for investors. In the Eurozone crisis, the agencies are being much more proactive and trying to slip behind the market view of what has been priced in, but even there they are caught in this difficult position of trying to please lots of people. Governments involved will have a hand in their regulation. If you anger them by being aggressive in downgrading them, you are probably putting yourself in an even more difficult position.” Hans Stoter, head of global credit investments at ING Investment Managers “The agencies’ analysis is a useful input in our own fundamental credit analysis of a company, much like we use sell-side fundamental research. We do not rely on ratings, but perform our own analysis too. The criticism towards rating agencies for being slow to respond is mainly caused by their ratings of structured finance transactions. The agencies have been much more successful in their corporate debt rating activities. Over the long run, the percentage of rated companies that have defaulted on their debt has been close to what could be expected given the rating of these companies five or 10 years prior to default. A fair criticism is that they are paid by the borrower, and thus potentially could be subject to undue influence from the issuer or investment bank. But I do not see the buy-side picking up the bill as it would be hard to organise this in such a manner that we would still have publicly available ratings. The solution could be to require that bond issues larger than a certain size must have a rating from all three big rating agencies. This could put some limits on the commercial activities of the agencies, and would also remove the possibility for borrower and investment bank to shop around for the best rating.”...
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