The Credit Rating Agencies Between Crisis and
Resurrection of International Finance
Problems and Perspectives
by Giovanni Ferri & Punziana Lacitignola
(University of Bari – Italy)
[Lezione 10 del corso di Economia delle scelte di portafoglio]
Presentation largely drawn on Ferri-Lacitignola Le agenzie di rating
tra crisi e rilancio della finanza globale, Bologna, Il Mulino, 2009.
Key Questions in Presentation:
 Why are Credit Rating Agencies (CRAs) key to capital markets?
 Set up (industry structure & regulation) of the Global CRAs
(Moody’s; S&P; Fitch;DBR)
 Main allegations of the literature on GCRAs: some are grounded in
the evidence
 Are GCRAs enough for capital market development or do we need
Regional CRAs? (Europe vs. Asia)
 How about GCRAs specializing in multinationals & Regional CRAs
in smaller-sized regional issuers?
 National CRAs & the development of national financial markets
 CRAs responsibility and regulation matter
2
Why are CRAs key to capital markets?
Ratings are an essential lubricant for financial markets as they
reduce information asymmetry that investors undergo vis-à-vis
issuers; they determine the cost of borrowing
Though perfectible (see below) ratings greatly enhance market
information on issuers: unexpected rating changes affect levelvolatility of bond-share price (Kliger & Sarig 2000) and credit
default swaps (Hull et al. 2004; Norden and Weber 2004); bond
downgrades cause negative abnormal stock returns (Dichev &
Piotroski 2001, Ferri & Lacitignola, 2007)
Boot et al. (2004): in multiple equilibria states the rating is a
coordinating mechanism, providing a “focal point” for firms and
investors, thanks to the implicit contract relationship (monitorrenegotiate) but Carlson & Hale (2004) reach opposite conclusions
3
Set up of the Global CRAs – 1





Origin of the GCRAs
Interaction with financial markets
Regulatory evolution
Industrial organization of GCRAs
Some description of GCRAs’ ratings
 Origin of the GCRAs (Sylla, 2001)
First rating in 1909 by John Moody: US financial markets needed
certification after 1907 crisis
4
Set up of the Global CRAs – 2
 Interaction with financial markets
To reduce information asymmetries in financial markets, CRAs issue
credit ratings on sovereigns, other public entities, banks,
corporates and structured finance (SF) products.
The rating is an estimate of the issuer’s ability to honor its future
interest and capital payments
For issuers, ratings affect interest rate spreads (Ederington et al,
1987; Sy, 2002; Gonzalez at al, 2004) & the extent of available
investment flows
To the latter extent, it is key whether the rating is investment grade
or not (speculative grade)
Are corporate & SF ratings different? (Violi, 2004)
5
Set up of the Global CRAs – 3
 Interaction with financial markets (cont’d): Rating Scale
Moody’s
S&P/Fitch
Numeric
Conversion
Aaa, Aa1, Aa2,
Aa3
AAA, AA+, AA,
AA-
100 – 85
Best quality
A1, A2, A3
A+, A, A-
80 – 70
High quality
Baa1,Baa2, Baa3
BBB+, BBB,
BBB-
65 - 55
Good quality
Ba1, Ba2, Ba3
BB+, BB, BB-
50 – 40
Speculative
B1, B2, B3
B+, B, B-
35 – 25
Highly speculative
20 – 0
High risk of default
6
Caa1, Caa2, Caa3,
CCC+, CC, C, D
Caa
Interpretation
Set up of the Global CRAs – 4
 Regulatory evolution
1931 US Treasury Department: bonds with a rating below investment
grade (i.e. below BBB) must be posted with a value below
purchasing cost
1936 Banking Act: no holding of below BBB bonds
1975 SEC Regulation 15c3-1 establishes:
(i) higher capital
requirements for financial firms holding bonds with a rating below
BBB; (ii) list of Nationally Recognized Statistical Rating
Organizations (NRSROs: Moody’s, S&P, Fitch and, from 2003,
Dominion Bond Rating - DBR)
2004 Basel Regulation of bank minimum capital: standard approach
hinges on ratings
Ongoing:
- SOX-mandated SEC assessment & partial opening of NRSRO list;
- Current discussion
7
Set up of the Global CRAs – 5
 The industrial organization of GCRAs
Moody’s: (founded 1909)
Gross income ($ billion): 1.2 in 2009; 1.19 in 2008; 1.63 in 2007; 0.6
in 2000
Net income ($ million): 402 in 2009; 457 in 2008; 701.5 in 2007; 289
in 2002: 66% from US, 23% from Europe
Over 30,000 rated entities (sovereigns, banks & corporates)
1,700 employees of which 1,000 analysts.
S&P: (founded 1917; in McGraw-Hill group 1966)
In 2008 alone, Standard & Poor's Ratings Services published more
than 1,150,000 ratings, including new and revised ratings; 8,500
employees; it covers 70% of global market capitalization.
8
Set up of the Global CRAs – 6
 The industrial organization of GCRAs (cont’d)
Fitch: (founded 1913, merged with IBCA in 1997)
Net income (€ million): 350;
3,000 ratings on Sovereigns, Banks & Corporates;
1,200 employees of which 700 analysts.
DBR: (Canada based, NRSRO since 2003)
Other NRSRO agencies: A.M. Best (2005), R&I (2007), JCR (2007),
Egan-Jones (2007), LACE (2008), Realpoint (2008)
 GCRAs are very profitable: pundits accuse NRSRO regulatory
franchise
9
Set up of the Global CRAs – 7
 Description GCRAs’ ratings (BCBS, 2000): Banks
DCR=Duff &
Phelps Credit
Rating
DCR
Fitch
US
120
170
Europe,
Middle East,
Africa
73
Asia
Latin America
Total
Moody’s
S&P
Total
668
320
1,278 (39.7%)
308
596
338
1,315 (40.8%)
3
35
248
60
346 (10.7%)
52
38
148
45
283 (8.8%)
248
(7.7%)
551
(17.1%)
1,660
(51.5%)
763
(23.7%)
3,222
10
Set up of the Global CRAs – 8
 Description GCRAs’ ratings: Corporates
DCR=Duff &
Phelps Credit
Rating
US
Europe,
Middle East,
Africa
Asia
Moody’s
S&P
Total
245
2,645
2,224
5,548 (76.3%)
138
92
362
370
962 (13.3%)
8
3
286
94
391 (5.4%)
85
11
109
164
369 (5.0%)
665
(9.2%)
351
(4.8%)
3,402
(46.8%)
2,852
(39.2%)
7,27011
DCR
Fitch
434
Latin America
Total
Set up of the Global CRAs – 9
 Description GCRAs’ ratings: Structured Finance
DCR=Duff &
Phelps Credit
Rating
S&P
Total
Moody’s
DCR
Fitch
458
922
1,149
1,524
4,053 (78.6%)
101
60
312
318
791 (15.3%)
2
15
91
150
258 (5.0%)
15
2
16
22
55 (1.1%)
576
(11.2%)
999
(19.4%)
1,568
(30.4%)
2,014
(39.1%)
5,157
US
Europe,
Middle East,
Africa
Asia
Latin America
Total
12
Set up of the Global CRAs – 10
 Some description of GCRAs’ ratings
- Highly concentrated industry with Moody’s and S&P playing as
leaders (US Dept of Justice labeled it “partner monopoly”), Fitch
and DCR as distanced followers [Norden & Weber (2004): reviews
for downgrade by S&P and Moody’s have largest impact on credit
default swaps and shares];
- Though bank ratings are also important, the bulk of GCRAs’
business is in corporates and structured finance
- GCRAs’ business is for almost ¾ US based with bank ratings more
geographically widespread
13
Set up of the Global CRAs – 11


-
M&A of GCRAs increased concentration
In 2000 Fitch buys DCR, Thomson BankWatch;
Looking at ratings in emerging economies
Differences across regions of the world: GCRAs’ penetration is
highest in Europe, smallest in Asia, intermediate in Latin America
and Africa
- The number of ratings is much larger in Asia (and Latin America),
where GCRAs’ penetration is lower, than in Europe
- GCRAs moving from branches to subsidiaries
14
Set up of the Global CRAs – 12
NUMBER OF RATINGS ACROSS REGIONS: EMERGING ECONOMIES
5530
6000
5720
5000
4000
3255
2644
3000
2000
1000
226
564
373
810
0
Africa
Asia & Oceania
Europe
1998
2004
Latin America
15
Set up of the Global CRAs – 13
GCRAs' BRANCHES & SUBSIDIARIES VS. INDEPENDENT AGENCIES: EMERGING WORLD
36,9
40,0
34,5
34,6
35,3
35,0
30,2
28,5
% MARKET SHARE
30,0
25,0
20,0
15,0
10,0
5,0
0,0
GCRAs - Total external branches
GCRAs - Total external subsidiaries
1998
2004
Total national-independent
16
Set up of the Global CRAs – 14
GCRAs' MARKET SHARE: EMERGING WORLD
30,0
27,3
25,0
19,5
% MARKET SHARE
20,0
15,0
19,0
17,1
14,0
12,5
8,0
10,0
7,3
4,2
5,0
0,9
0,0
0,0
3,9
0,6
0,4
0,4
0,0
Moodys'
S&Ps'
Fitch
Duff & Phelps
1998
Thomson
BankWatch
2004
Capital
Intelligence
R&I
JCRA
17
Set up of the Global CRAs – 15
GCRAs' BRANCHES & SUBSIDIARIES VS. INDEPENDENT AGENCIES: EMERGING EUROPE
97,7
100,0
90,0
80,0
80,0
% MARKET SHARE
70,0
60,0
50,0
40,0
30,0
17,0
20,0
2,3
0,0
10,0
3,0
0,0
GCRAs - Total external branches
GCRAs - Total external subsidiaries
1998
2004
Total national-independent
18
Set up of the Global CRAs – 16
GCRAs' MARKET SHARE: EMERGING EUROPE
40,0
36,0
35,0
% MARKET SHARE
30,0
25,0
26,9
21,5
23,2
21,9
20,6
17,9
20,0
15,0
9,0
10,0
2,1 1,9
2,3
5,0
0,0
8,8
0,0
1,1
1,6
0,0
Moodys'
S&Ps'
Fitch
Duff & Phelps
1998
Thomson
BankWatch
2004
Capital
Intelligence
R&I
JCRA
19
Set up of the Global CRAs – 17
GCRAs' BRANCHES & SUBSIDIARIES VS. INDEPENDENT AGENCIES: EMERGING ASIA
48,9
50,0
42,8
45,0
40,0
% MARKET SHARE
35,0
30,0
29,1
28,1
27,1
24,0
25,0
20,0
15,0
10,0
5,0
0,0
GCRAs - Total external branches
GCRAs - Total external subsidiaries
1998
2004
Total national-independent
20
Set up of the Global CRAs – 18
GCRAs' BRANCHES & SUBSIDIARIES VS. INDEPENDENT AGENCIES: EMERGING LATIN AMERICA
58,8
56,3
60,0
50,0
% MARKET SHARE
40,0
30,0
32,1
21,8
19,4
20,0
11,6
10,0
0,0
GCRAs - Total external branches
GCRAs - Total external subsidiaries
1998
2004
Total national-independent
21
Main allegations on GCRAs – 1
GCRAs’ track record:
US: best (some exceptions); other OECD: good; Emerging
Countries: not so good/evolving
Main complaints for ratings outside US:
Too late
Pro-cyclical
Private ratings too linked to sovereigns’
Lower info quality of private ratings
GCRAs under-invest in info processing
Anticompetitive practices & conflicts of interest
22
Main allegations on GCRAs – 2
Too late: GCRAs followed the market rather than forewarn it in
the Asian financial crisis (IMF, 1999; BIS, 1999; Bhatia, 2002) [&
Enron, Worldcom etc.]
On GCRAs’ failures, Bhatia (2002) notices that: (i) sovereign
ratings result from one-size-fits-all ranking process; (ii)
improvement in methodology/disclosure after the EA crisis may
wish well for the future
Bissoondoyal-Bheenick (2004): generally, private rating changes
have little/no market impact
Bongini et al (2002): stock prices & ratings did not outpace
backward looking balance sheet information to assess bank
fragility in the EA crisis
23
Main allegations on GCRAs – 3
Too late: GCRAs follow the market (cont’d)
Sovereign downgrades follow (rather than lead) currency crises but
do better at predicting defaults (Reinhart, 2002; Sy, 2004) →
currency instability raises default risk (Reinhart, 2002 but not Sy,
2004); downgrades of structured products done after markets
collapsed
24
Main allegations on GCRAs – 4
Pro-cyclical: Late recognition of problems may lead GCRAs to
downgrade emerging countries (both sovereigns & companies)
excessively vis-à-vis what deserved by their fundamentals  so
GCRAs may exacerbate cycles & downturns in emerging
countries
- Macro evidence: Monfort & Mulder (2000); Mulder & Perrelli
(2001); Ferri, Liu & Stiglitz (1999); Kaminsky & Schmukler
(2002); Kräussl (2003) [but: Mora (2004) questions some of this
evidence for the EA crisis pointing to rating stickiness (in line
with a conservative hypothesis, Löffler 2004); Hu et al. (2004):
sovereign ratings were insufficiently conservative before the Asian
and Russian crises]
25
Main allegations on GCRAs – 5
Pro-cyclical: (cont’d)
- Reisen & von Maltzan (1999) are among the first authors to argue
about the boom & bust cycle triggered by procyclical sovereign
ratings
- Zhang (2003): GCRAs had assigned over-generous ratings to
Argentina, & their downgrade lagged market
- Block & Vaaler (2004) find that GCRAs downgrade developing
countries more often in election years as viewing elections
negatively, raising developing democracies’ cost of capital
- Wei (2003) proposes a new multi-factor methodology to come up
with a-cyclical ratings; because of assumptions he is criticized by
Amato & Furfine (2004): for all US firms rated by S&P they find
that ratings do not generally exhibit excess sensitivity to the
business cycle.
26
Main allegations on GCRAs – 6
FLS99: Pro-cyclical sovereign ratings in Asia
27
Main allegations on GCRAs – 7
Private ratings too linked to sovereigns’
- Sovereign downgrades cause firm-level downgrades (that are
sticky to sovereign upgrades instead) only in emerging
economies  via a ‘domicile effect’ (Nickell et al. 2000),
possibly excessive sovereign downgrades exert a negative impact
on the cost of capital for emerging economies’ private sector and
the new Basel criteria will amplify this impact (Ferri-LiuMajnoni, 2001)
28
Main allegations on GCRAs – 8 FLM01:
Asymmetric impact of sovereign downgrades
IMPACT OF A 1% SOVEREIGN DOWNGRADE
0
0
-0,1
-0,2
-0,3
-0,4
-0,5
-0,56
-0,6
-0,69
-0,7
-0,8
-0,9
-0,96
-1
FIRMS
DEVELOPED COUNTRIES
BANKS
EMERGING ECONOMIES
29
Main allegations on GCRAs – 9
Lower info quality of private ratings
A lot of asymmetry in determinants of firm ratings in developed vs.
emerging countries: firm specific risk dominates/sovereign risk
negligible for developed countries’ firms while the opposite holds
for emerging countries  information content of firm ratings is
much smaller in emerging countries (Ferri & Liu, 2003)
30
Main allegations on GCRAs – 10
FL03: Asymmetry in firm ratings
1,25
1,5
1
0,35
0,5
0
0
-0,5
-1
-1,5
-2
-2
1% SOVEREIGN DOWNGRADE
DEVELOPED COUNTRIES' FIRMS
1% INCREASE IN PERFORMANCE-BASED FIRM RATING
EMERGING ECONOMIES' FIRMS
31
Main allegations on GCRAs – 11
GCRAs under-invest in emerging countries: Vis-à-vis developed
countries, fewer analysts for sovereigns ( absolute underinvestment) and firm ratings positively related to the number of
analysts while the opposite holds for developed countries’ firms
 relative under-investment in emerging countries (Ferri, 2004;
Ferri & Liu, 2004, using data from Moody’s)
32
Main allegations on GCRAs – 12 FL04:
Absolute under-investment for sovereigns
Units of analysts for firms and sovereigns (median)
0,071
FIRMS
0,033
0,087
SOVEREIGNS
0,094
0,000
0,010
0,020
0,030
OECD COUNTRIES
0,040
0,050
0,060
0,070
0,080
NON-OECD COUNTRIES
0,090
0,100
33
Main allegations on GCRAs – 13 FL04:
Relative under-investment for firms
IMPACT OF 1 EXTRA ANALYST ON FIRM RATINGS
10,4
% POINTS ON RATINGS SCALED 0-100
15
10
5
0
-5
-10
-15
-15,9
-20
DEVELOPED COUNTRIES
EMERGING ECONOMIES
34
Main allegations on GCRAs – 14
Anticompetitive practices & conflicts of interest
- Sometimes GCRAs promote their business via questionable
unsolicited ratings (revised up only if the company pays its fee).
Dumping practice to conquer foreign markets (home market is
protected by NRSRO regulation)? Poon (2003): unsolicited ratings
for Japanese issuers lower than solicited ratings even controlling for
differences in sovereign risk & key financial ratios of the rated entity.
Issuers looks for better rating among CRAs (rating shopping, Skerta
&Veldkamp, 2009)
- Issuers of securities pay for credit ratings a fee based on the size of
issue → potential conflict of interest (Burnie & Langsam 2004);
Covitz & Harrison (2003): no evidence of conflict of interest
35
Main allegations on GCRAs – 15
Anticompetitive & conflict of interest (cont’d)
- Sometimes private contracts contain “NRSRO rating triggers”
causing adverse consequences, such as the shortening of debt
repayment schedules → since the trigger is usually around the
investment grade threshold, this may induce the rating agency to be
reluctant to downgrade
Johnson (2003): compares downgrading actions by an NRSRO CRA
vs. a non-NRSRO CRA at the investment grade threshold, the data
suggest the former hesitates (vis-à-vis the latter) to downgrade
issuers to speculative grade
36
Main allegations on GCRAs – 16
Anticompetitive & conflict of interest (cont’d)
Failure at rating structured products is blatant: e.g. Jul 1st - Aug 31st
07 S&P downgraded 1,544 securities guaranteed by resid. mortgages
- How much of this was due to the fact that the history of these
products was too short to allow rating them?
- How much, instead, was due to conflicts of interests as the agencies
were involved in both consulting and rating structured finance?
37
Main allegations on GCRAs – 17
For extreme chastising views on GCRAs see:
Partnoy (1999): “the reputational capital view of credit rating
agencies is not supported by history or economic analysis. Credit
rating agencies have not survived for six decades because they
produce credible and accurate information. They have not maintained
good reputations based on the informational content of their credit
ratings. Instead, the credit rating agencies have thrived, profited,
and become exceedingly powerful because they have begun selling
regulatory licenses, i.e., the right to be in compliance with regulation.
Credit ratings therefore are an excellent example of how not to
privatize a regulatory function … Never has too little, too late, been
so powerful”
White (2001) demands full liberalization dropping NRSRO list
38
Main allegations on GCRAs – 18
For a more balanced view on GCRAs see Hill (2004):
Rating agencies certainly didn’t do a spectacular job with Enron, but there is
considerable evidence that in the normal course, they do a good, if not stellar, job.
… The main problems regulatory change could address are those resulting from
market concentration. The price of ratings may not be as low, and the quality of
ratings may not be as high, as would be the case if the industry were more
competitive. But the rating agencies are not completely unconstrained as to price or
quality. Potential competition serves as a constraint, as does the specter of
increased regulatory scrutiny.
The SEC should permit provisional, location-specific, and industry specific
NRSRO designations …
Notwithstanding any efforts the SEC makes … with size and age conferring
significant advantages, it’s not easy for a new rating agency to be established or
gain a significant presence in the market. Recognizing that the market may still
remain quite concentrated, regulatory reform should also encourage rating agencies
to be more responsive to the needs of market participants. … creation of a public
forum in which market participants would comment on rating agencies’
performance (accountability through voice).
Annual certification by rating agencies that they are operating in accordance with
39
procedures to guard against conflicts of interest.
Regional CRAs & capital market development 1
In light of the shortcomings of the GCRAs & of the fact that they are
even less accountable abroad than in the US market, one may ask
whether Regional CRAs are needed for capital market
development
Answers differ between Europe vs. Asia: while in Europe short-lived
national credit rating agencies were sooner or later acquired by the
GCRAs, many Asian countries still have their own national credit
rating agencies, even if no truly regional agency exists yet
Specifically, Japan has the 2 largest & long lived
40
Regional CRAs & capital market development 2
How do the Regional CRAs compare to GCRAs?
Japanese CRAs often accused of being too lenient to local issuers
with respect to GCRAs, but:
BCBS (2000): Outside of the US, Japanese rating agencies are
among the oldest and most active. Data availability has thus
attracted the attention of researchers. In this case, analysis has
uncovered some fairly large differences between Japanese
agencies and non-Japanese agencies, which seem to be tougher on
the local issuers. Nevertheless, there may be fewer differences
across agencies about relative riskiness, as there is evidence that
both Japanese and non-Japanese ratings are highly correlated with
market-determined credit spreads.
[This was already pointed out by Kawai (1997), Packer & Reynolds
(1997), Packer (2000)]
41
Regional CRAs & capital market development 3
In recent years, Japanese CRAs have been awarded prizes (over &
above GCRAs) by JP Morgan for their work on the Samurai bond
market
Shin & Moore (2003): find a systematic bias upward for the two
Japanese rating agencies (RAs) and show the bias cannot be
explained by keiretsu belonging; however, when they estimate a
rating determination equation the discriminating power of the
Japanese RAs as measured by the adj R2 is no lower than for
Moody's or S&P
Do national companies perceive a difference between GCRAs &
Regional CRAs? (JCIF survey, 2001)
42
Regional CRAs & capital market development 4
5 Factors Viewed As Most Important (in % ) In Selecting Rating Agency (average; data for 2001)
45,0
40,0
35,0
30,0
25,0
20,0
15,0
10,0
5,0
0,0
Influence & Recognition
Rating Fairness
Global Activity
Japanese Rating Agencies
Industrial Specialization
GCRAs
Designated Rating Company
43
Still shallow EU financial mkts: 1995 vs. 2005
• post EMU progress of Euroland private securities markets lower
than expected (Hartmann et al. 2003; Cappiello et al. 2006)
• The rest is drawn from Ferri & Lacitignola (2007)
University of Bari
RATIO (%) OF PRIVATE BONDS OUTSTANDING TO GDP
120,0
115,2
100,0
83,9
80,0
60,0
41,7
40,0
31,9
40,2
30,1
23,0
21,9
20,0
21,7
13,2
8,3
11,2
5,9
7,1
10,8
2,7
0,0
Total Bonds - 1995
USA
Total Bonds - 2005
Asia
Corporate Bonds - 1995
Asia excluding Japan
Corporate Bonds - 2005
Euro Area
44
Factors behind private bond market
development
Various factors may promote the development of private bond
markets:
• By removing exchange rate risks, EMU was a main
promoting factor ... but it’s not the only one ...
• Asset management seeking diversification and higher
return
• Better market infrastructure, such as corporate ratings
becoming more widespread
45
Main features of GRAs and NRAs
• GRAs (established since 1909):
- Apply a “standardized” rating methodology across countries
regardless the environment in which firms operate
• NRAs (established since 1985):
- Have a comparative advantage to access more appropriate
knowledge of local environment (Packer, 2000)
- Originated with the support of regulation (Kurosawa, 1999)
- Lower fees than those applied by GRAs (JCIF, 2001)
- Less independent, most of them are owned by financial
institutions (Kurosawa, 1999)
46
Market impact of GRAs and NRAs
Specifically for Japanese financial markets:
- combination of NRA and GRA ratings predicts spreads on
securities’ secondary market trading more accurately than
any of the two classes taken separately (Packer, 2000)
- NRA ratings are more related to rated companies’ financial
ratios than GRA ratings (Packer, 2000)
- In the opinion of Japanese corporations, NRAs do not differ
from GRAs in terms of market influence and recognition
(JCIF, 2001)
- Impact on abnormal returns larger for rating changes
enacted by NRAs vis-à-vis those enacted by GRAs
(Lacitignola, 2007)
47
Markets seem to take into account both NRA and
GRA ratings when pricing securities (JCIF,
2001)
By enlarging the number of rated companies, both GRAs
and NRAs may actively CONTRIBUTE to FINANCIAL
MARKET DEVELOPMENT
48
• Only Asia features a significant presence of
NRAs, elsewhere (e.g. EU) NRAs have been
acquired by GRAs
MARKET SHARE (% ) OF NATIONAL RAs
100,0
90,1
90,0
82,4
80,0
65,8
69,0
70,0
61,0
60,0
50,0
40,0
25,3
30,0
20,0
10,0
0,0
0,0
0,0
0,0
0,0
0,0
0,0
0,0
Figure 2 Source: Our calculations on Financial Times Interactive data for Winter 2004
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ak
is
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al
ay
sia
M
or
ea
K
Is
ra
el
In
do
ne
sia
In
di
a
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ng
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hi
na
H
on
g
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ai
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0,0
49
NRAs issue numerous ratings compared to
GRAs
Number of issued ratings from both NRAs and GRAs
100
90
80
70
60
NRAs
GRAs
50
40
30
20
10
0
INDIA
SOUTH KOREA
Figure 3 Source: Our calculations on Bloomberg data for 2004.
MALAYSIA
JAPAN
50
Who are the GRAs and the NRAs?
•GRAs:
Moody’s, S&P and Fitch
•NRAs (example in 4 Asian countries):
Japan: JCR, R&I, Mikuni
South Korea: KIS, KR, NICE
Malaysia: MARC and RAM
India: ICRA, CRISIL and CARE
In the rest of the world there are about 60 rating agencies
(tab. 2.1 page 33, Ferri & Lacitignola 2009)
51
Presence of National Rating Agencies and
Financial Market Development (some evidence)
We augment the approach by La Porta et al. (1997, 1998)
with some innovations:
• Two different measures of financial market development:
a) ratio of stock market capitalization to GNP in 1994 scaled
by a rough measure of the fraction of the stock market held
by outside investors (EXTKGNP) [same as in La Porta at al.
(1997)];
b) ratio of private bonds/GDP (PB/GDP) [new];
• Presence of NRAs, specifically the Significant & Old
Rating Agencies (SONRA) [new];
• We use both the OLS estimation and the Instrumental
variable estimation [new].
52
53
54
Results:
• In both specifications, using different dependent variables,
the presence of NRAs (with the rule of law variable) has
significant effects on financial markets. Effects are confirmed
also in the Instrumental Variable regressions;
• NRAs’ impact on financial markets is larger when dependent
variable PB/GDP, i.e. it seems that ratings contribute even
more to private bond markets development than to stock
market development (measure problems?)
• NRAs seem an important factor to promote financial
market development
55
The Business Specificity of National Rating
Agencies: Evidence From Asia
•
-
•
GRAs tend to specialize in companies which are
larger/more internationalized for two reasons:
Reputation
Larger/internationalized companies are typically the clients
with which they do business (fees are related to the amount
of issued debt)
NRAs focusing on local/smaller entities are more cost
effective and are able to capture the business specificity of
their clientele
GRAs and NRAs may be complementary
and specialize in different clientele.
56
The Business Specificity of NRAs: Evidence
From Asia (cont’d)
We investigate this hypothesis using:
• Rating data for India, Japan, Korea and Malaysia
• Listed non-financial corporations only
• All rating issuer which have a rating either from GRAs or
from NRAs or from both
• Issuer size measured by total asset in 2002
• A proxy for the degree of internationalization (e.g. if the
issuer is listed in a foreign country)
Results are depicted in fig. 5
57
NRAs: rating less internationalized companies
% Share of Companies Listed Also Internationally
100,0
100,0
100,0
94,6
90,0
77,4
80,0
70,0
69,1
69,3
65,2
60,0
48,3
50,0
40,0
30,0
20,0
10,0
0,0
India
Japan
With Global Rating (also)
Korea
Malaysia
With National Rating Only
Fig. 5 Source: Our calculations on Bloomberg data between 1990 and may 2005
58
NRAs: rating smaller-sized companies
Relative (Average) Size of Companies With National Ratings Only
0,300
0,259
0,250
0,200
0,150
0,128
0,097
0,100
0,055
0,050
0,000
India
Japan
Korea
Malaysia
Fig. 6 Source: Our calculations on Bloomberg data between 1990 and may 2005
59
Results:
• Among the companies obtaining a rating (also) from
GRAs the share of companies listed also internationally
is significantly larger than among companies receiving a
rating only from NRAs (only exception Korea 
distortive national regulation);
• The average size of the companies obtaining a rating only
from NRAs is much smaller than that of those companies
receiving a rating (also) from GRAs.
60
To conclude on this part
(a) in a La Porta et al. (1997) framework, the presence of NRAs
associates with more developed financial markets (in terms of
both stock market capitalization and extent of private bond
issuance)
(b) focusing on Asia, we identify a specialization pattern whereby
NRAs concentrate on rating smaller-sized/domestic-focused
companies while GRAs devote themselves to rating larger/more
internationalized companies
61
CRAs responsibility and regulation matter 1
• Rating agencies’ behavior has come (again) under scrutiny;
they failed to forewarn markets, downgrades were too late
and excessively (procyclical effect)
• CRAs rating business has grown at a high rate in the last
three years especially in the structured product sector; in
2009 Moody’s rated 96,000 structured finance obligations,
its profits tripled from 1996 to 2006 (Lowenstein, 2008)
(difficulties of evaluation and conflicts of interest)
62
CRAs responsibility and regulation matter 2
• The switch from Originate to hold (OTH) to
Originate to Distribute (OTD) model had perverse
effects on screening and monitoring incentive
(transferred-risk)
• Conflicts of interest are even stronger in
structured products: CRAs were both advisors
in the determination of capital enhancement and
structuring of products and raters (does it work?)
63
CRAs responsibility and regulation matter 3
• CRAs have underestimated the implicit risk of structured
product (fire sale and systemic liquidity issues)
• In rating structured products (complex and opaque) they
relaxed the “mark to market” model in favor of the “mark
to model” with over-optimistic assumptions
• Class-actions by investor against CRAs
CRAs claim that ratings are opinions
protected by the First Amendment of the
US Constitution
64
CRAs responsibility and regulation matter 4
• As far as ratings had important systemic effects, regulators
(SEC, IOSCO, Basel commission, CESR) got involved in
new regulation proposal (protection of market stability, and
the role of financial information provider of CRAs)
• In 2009 the court of South-district of New York declared
that CRAs cannot hide their responsibility under the First
Amendment of the US Constitution
65
CRAs responsibility and regulation matter 5
Responsibility &
transparency
Indipendence &
Accuracy
Ex-post evaluation
(default studies)
Effective solutions?
-Reduction of conflicts of interest
-Transparency and publicity (different methodologies for
different products, each issuer seeks all ratings, type of
rating model etc.)
- improving of competition
66
- awareness in using ratings by market participants
CRAs responsibility and regulation matter 5
• Where regulation should stand? (open issue)
Regulate the rating
sector determining
CRAs responsibility
Leaving the determination
of CRAs responsability
to Markets, improving
market competition and
removing regulation reliance
on ratings
Independence & accuracy???
67
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72