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 decades ago.

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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