Investors trusted credit ratings agencies too much, and the agencies themselves were too trusting of their clients, according to a white paper out this week from the International Organisation of Securities Commissions (Iosco).
Iosco said too many investors had "relied on credit ratings as their sole method of assessing risk", which meant that a sudden loss of confidence in the agencies left the investors adrift without any independent guidance; "this in turn caused the market for the securities to dislocate".
The agencies were also at fault, Iosco said, raising the concern that "in some cases some agencies relied on information that, on its face, appeared questionable..., uncertain or of dubious quality. Although agencies cannot be expected to uncover issuer fraud or conduct the level of confirmation expected of independent auditors, ratings based on information that fails to pass even a basic sniff test – or, more importantly, methodologies which fail to take into consideration market changes that may have an impact on the quality of the information upon which the ratings are based – fundamentally undermine investor confidence in the rating process".
Iosco called for agencies to publish historical records of rating changes, to allow investors to put current ratings in perspective. It also recommended agencies pay more attention to the quality of data they use, and that consulting businesses (which advise on the construction of structured products) should be kept isolated from the rating business. Furthermore, it suggested, downgrades could be handled by a different team from that responsible for initial ratings.
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