The Role Of Rating Agencies Case Study Sample
Over the past few years in the news and regular editions appear headlines with the words "rating agencies" and "credit ratings". These publications have reported increased or decreased credit ratings, as entire countries and individual companies. Last hype about the actions of rating agencies took place in the midst of the 2008 crisis. By themselves, the rating agencies are commercial organizations that are engaged in the study of the quality of asset management, assessment of the issuer's solvency, risk analysis for potential investors, and many others. At the moment, there are more than 100 credit rating agencies, the most famous of which are Moody's, Fitch Ratings and Standard & Poor's. In fact, all these agencies are publishing and media organizations that formulate and create credit ratings. It is considered that they are completely independent because they do not participate in transactions on markets.
The most famous area of rating agencies is to assess the solvency or offering credit rating that reflects the risks of defaults on debt obligations and has a direct impact on the profitability and value of the debt, as well as on the interest rate. The lower the risk of non-payment, the higher the credit rating of the issuer. Exhibiting credit ratings may be short-term and long-term. Short-term ratings predict the estimated solvency of the issuer during the year, and long-term for a longer period. In drawing up the long-term rating agencies give predictions that can be stable, negative, positive, or developing. These forecasts indicate a possible change in the credit rating in the next six months or a year.
Long-term rating may be at a value from D, which is the default, to AAA, which speaks of the extremely high capabilities of the issuer to repay loans. Between the lower and the higher value rating, provides the following categories: - serious difficulties, the beginning of the issuer's bankruptcy proceedings more than likely SS - great difficulty with any payments SSS - serious difficulties with payments on debt B - solvency is satisfactory, but the poor economic situation may adversely affect the payments BB - similarly rated B, but the probability of the impact of unfavorable economic conditions slightly below BBB - satisfactory solvency a - high capacity for payment of credit obligations, but depending on the economic situation AA - high possibility of the issuer to repay the loan obligations are portrayed in an interim assessment a "plus" or "minus" after the lettering credit rating. In addition to these ratings there are such values as: SD - refusal to pay for some credit obligations NR - no credit rating.
Short-term ratings are indicated much easier than the long-term and include the following categories: D - by the obligation defaulted C - limited chances for the payment of debts, which are completely dependent on the economic situation B - speculative debt obligation with a chance to pay off greatly depending on the market situation A 1, A-2, A-3 - similar to the first three measures of long-term ratings.
Ratings are used to restrictions on investment, as well for the admission to the list of eligible investments. For example, central banks require ratings for inclusion in the Lombard list - the lower the rating, the higher the discount; such requirements impose pension funds to invest. It should be understood that the ratings evaluate only the issuer's ability to pay debts. Therefore, countries or organizations that spend all their spare cash to service debt will be rated much higher than refinances and fast-growing issuers. Especially popular are the ratings during the crisis, when investors start looking for safe investment opportunities for their funds.
During determining the creditworthiness of the issuer is conducting a comprehensive examination of its willingness and ability to fulfill its financial obligations in accordance with the terms of their performance. When this is taken into account the competitiveness of the company, particularly its corporate governance and management, economic and geopolitical factors, performance, features activities, specific risk factors and other financial and economic characteristics that may somehow affect the performance of the debt. In determining sovereign credit rating of the issuer, which acts in the role of the national government, the focus falls on the political risks, the overall level of debt and the stability of the national currency. In assessing the credit quality of a particular debt, as that can be acted municipal bonds or comparative, and the probability of default on them most often used information that provides the issuer itself. When setting ratings of municipal and corporate bonds by rating agencies primarily assessed the creditworthiness of the issuer, and only after that the credit quality of the bonds as debt obligations. This evaluation mechanism serves as a kind of airbags, which limits the credit risks that may be linked to this commitment. Rating agencies can assess the level of the likely recovery of debt after default, or the possibility that if the borrower defaults investors will be able to return the unpaid portion of the principal amount. The probability of return can act as a single rating or be used as a factor when placing credit rating.
The main source of funding for the rating agencies are the issuers themselves, who pay for the very fact of their inclusion in the ratings. They pay a yearly fee for that receive assessment of their own capabilities with respect to payments on debt, as well as get advice on improving the currently existing credit rating. It turns out that in the interest of rating agencies, issuers and investors. The first group is committed to a high position in the rankings, to obtain more favorable financing terms. The second group is interested in honesty agencies when placing credit ratings. Since paying issuers, it is quite possible that between them and the rating agencies may exist informal contracts. Such a business model of vocal critics, but currently there is no real alternative. Therefore, the rating agencies continue to play a significant role in the global economy due to the fact that proves their mistakes are almost impossible, and to replace them at the moment no one.
Over the past five years, there are quite a few disgruntled governments have experienced the effects of credit rating downgrade, leading to a substantial increase in the cost of the external debt service. Despite such criticism, investors continue to listen to the rating agencies, because they need information about the financial affairs of a country. Reaction to a similar discontent manifested itself in Europe, the adoption, last month, a package of documents restricting the activities of rating agencies with respect to sovereign ratings. From that moment they can articulate only three times a year, which will reduce the number of investor interest in them because of the lack of efficiency of data.
Amid accusations of subjectivity, adequacy forecasts of rating agencies are easy to check. It is necessary to compare the number of defaults that occurred upon the Securities. The main factor for investors' confidence "ratings to" is that the credit ratings reaffirmed their predictive power. Statistics was very convincing, even in times of crisis: the bond market the number of defaults was in direct proportion to the rating level. The higher the rating - the less the bond defaults. There is quite a common misconception that the higher default rating is not possible, and if it happened, it was a mistake. Default can happen at any ranking, even the highest possible. The main question - is the number of defaults. Any investor should be aware that acquiring a portfolio of bonds with very high ratings, the entire portfolio will not be exposed to serious risks, even if some security is bankrupt. After all, the credit rating is not a panacea against default.
Currently, the most authoritative and well-known rating agencies are considered agency Fitch IBCA, Moody's and Standard & Poor's. These agencies are counting a large number of ratings, the most important of which are international credit ratings and investment ratings, describing the situation in the field of corporate and public finance.
Mortgage-backed securities in the midst of the crisis could not be sold on the market without their approval. Investors believe and rely on them, often blindly, and in some cases they are required to use their data. On the one hand, they help the market grow, but on the other hand, lowering the credit ratings cause excitement in all markets.
Define the role of rating agencies in the development of the world economy and assess their impact on the global crisis was the aim of our study
Back in the early 19th century, there are three main future ratings, which captured 90% of the market - first in the US and then the world. The intentions of the "Big Three" (so often referred to as the three rating agencies Fitch, Moody's and Standard & Poor's) were originally very best: assessing the risks (from a minimum of AAA to the maximum D), the agency signaled the degree of reliability of the borrower or the company, serving as a reliable guide in world capital.
Corporate and municipal borrowers past credit rating agencies recognized procedures have continued to raise funds through the stock exchange, while their competitors are bankrupt. The reason for this was another innovation in the financial market: the largest insurance companies and pension funds, which controlled the amount of about $ 1 trillion., It was forbidden to make transactions with securities, who did not have an investment grade rating, approved by recognized national rating agencies.
The new strategy brought the rating agencies to the beginning of the 1990s, billions of dollars in turnover and almost unlimited power, is not accompanied by responsibility.
However, the more influential became the top three agencies, the more costly their mistakes. For example, in 1997-1998, it became clear that for the developed countries compiled method of calculation rating (classified from the general public and even narrow) completely inappropriate for developing countries. The Agency concluded and corrected technique, but by the time customers have already lost their millions and billions of dollars.
Analysts Moody's, S & P and Fitch made a mistake in the case of Enron, which lost its investment-grade rating of only a few days before its bankruptcy. The same situation occurred with Lehman Brothers, which has become a reference point in the first wave of a new global financial crisis of 2008. And again - lost and hundreds of billions of deceived in their expectations of investors focused on the ratings of the "Big Three."
Rating agencies lowered the credit ratings on $ 1.9 trillion of mortgage securities in the period from Q3 2007 to Q2 2008, ie when the crisis was already in full swing. In other words, the agency failed to fulfill its primary mission and while not foreseen the collapse in the mortgage market. This is another indication that their initial estimates were not accurate.
But even after these events, no one refused the services of the Big Three: Agencies silently acknowledged the mistakes of the government and the press have expressed their criticisms, but the alternative they have not been found.
The US government is still interested in the role of rating agencies in the crisis of the mortgage category subprime, which began the collapse of the system. The main culprits were the banks that created complex financial products with subprime securities available for sale, but it was Moody's, S & P and Fitch assigns them the highest investment grade rating. But until now, the investigation came to nothing lead.
But if in the case of the 2008 crisis the actions of three agencies called only one reason for the problems with the onset of the second wave, they can become quite a originators or at least full-fledged actors in the crisis. For example, the New York Times wrote that the post-Cold War world there is only two known powers - the United States and Moody's. The first state can crush their military power, and the second - to bleed his finances and let the world, simply lower the ratings. And indeed it is.
For the first time in the history of the agency S & P downgraded the highest rating of the United States in August 2011, which triggered a collapse in all kinds of exchanges, which lasted three weeks long and resulted in the loss of trillions of investors. It was then at full length the question arose about the impact that got in a fragile recovery after the crisis, the rating agencies.
And then, "Big Three" have decided to start re-evaluation ratings of European countries that are going through hard times. Starting with a small (ratings of Greece, then Ireland and Portugal), Moody's, S & P and Fitch as sprawl crisis decided to revise credit ratings of Spain, Italy, Romania.
It should be noted that it is unclear who has provoked the crisis. Typically, the ratings just stating a fact deteriorating situation by lowering the rating. But now the situation is somewhat different, the agency rather ahead of events, and provoke further deterioration.
Everything happens as follows: in a crisis of European government debt as investors lose confidence in the borrowing countries, the agency reduces the country's sovereign rating. Government bond yields began to rise, loans become more expensive and become less available. The situation is getting worse with money every day, and the agency again lowers rating. It is a vicious circle.
Markets reacted very nervously to most of these actions, and representatives of the European Commission have directly accused the rating agencies in a coordinated attack on the EU and the "rocking the boat". However, attempts to limit the influence of agencies to anything in general do not lead.
Of course, it is worth mentioning that there is another point of view, which is that the rating agencies were neither the only, nor even the main originators of the mortgage crisis. US mortgage industry was unsustainable from top to bottom, from the buyers, who lie about their income to qualify for loans, and brokers taking buyers with bad credit history, to investors who bought bonds in the secondary market without sufficient research.
Why such a system does still exists? It is necessary to go back to history. In 1970, when the SEC began to look for ways to regulate capital adequacy brokers. And then the SEC adopted a list of "recognized as a national rating agency", which includes Moody's, Standard & Poor's, and created with the support of SEC agency Fitch IBCA. The Commission was much easier to simply accept the views of several agencies than to explore the entire system itself, and it will save money for the brokers.
The result is that almost the entire world was held hostage by the three rating agencies, which account for 95% of the relevant market. Their power is so great that the three of them can significantly weaken the economy of the entire EU, not to mention the opportunities that give them their powers to participate, for example, on the market. And it can not but worry the authorities of different countries, which make changes in regulation, trying a little to reduce the impact of these monopolists rating market.
Perhaps the best way out of this situation would be to make the rules of big business less dependent on ratings. In addition, it is advisable to introduce legal and financial responsibility for the rating agencies. The court may do so on their own. But the potential damage claims to create the rating should be so large that the agency may be forced out of business or they will have to do overly cautious conclusions threatened with legal action.
Thus, the credit agency is an interesting object of study. On the one hand, they have a great impact on the market and even more on market capitalization. On the other hand, numerous studies and the current situation in the world economy show that credit agencies have limited information value. Prosperity credit rating agencies in the face of declining significance of their information - and there is the paradox of their existence.
In summarizing, we can say that the rating agencies were initially market researchers, selling corporate debt evaluation clients, intended to buy this debt. However, over time they have become a company hired by the sellers of debt to get approval in the form of higher estimates AAA. When investing cash only rely on the ratings are not only unreasonable but also dangerous, they cannot fully meet their basic task of identifying risk securities. The results of their activities may be subject to manipulation and distortion. Moreover, a serious underestimation of the "big three" risk asset liquidity, market risk securities served as a catalyst for the further deepening of the last global crisis. But you cannot ignore the activities of the major credit rating agencies, as now they are one of the main elements of the global economy.
European politicians are not happy with the fact that the whole world is dependent on three, but in fact even two companies (Moody's and Standard & Poor's), which occupy about 80% of the world market in the field of rating services. In this situation, many are trying to find a piece of geopolitical conspiracy, since the roots "rating troika" of the United States. The first thing that comes to mind - to increase the number of rating agencies. Perhaps their estimates will differ from forecasts, the "troika" and investors will form an opinion about the companies comparing ratings. Europe starts to move along this path trying to increase the role of rating agencies. Unfortunately, these agencies will be respected within certain countries, and will mean nothing when assigning ratings on a global scale. From the idea of a European rating agency refused because of the conflict of interest. Worthy competitor "rating troika" will appear in the form of an international rating agency Universal Credit Rating Group (UCRG), which is created by companies from Russia, the US and China, to be a part of this project was offered to agency UCRA. The idea of creating UCRG based on a business combination with a local expert, a good understanding of the domestic market, able to efficiently and impartially assign ratings according to the national scale. These companies do not have to work for a global investor. The main objective of UCRG is the possibility of combining local players for the purpose of credit ratings on the international scale. The project has a good prospect, which confirms the existence of such initiatives. UCRG be able to press "rating three" only after 7-10 years, so it is impossible to instantly create a trust.
It is likely that the negative role of the largest agencies in the development of the financial crisis of 2008 is already leading to a decrease in the share of the big three agencies on the rating market, to the expansion of small and medium-sized agencies, especially those whose reputation was damaged by the crisis. Another important aspect of the crisis was the realization by governments and regulators of the importance of regulating the activities of agency and control over them, since the actions of agencies have an enormous impact on the level of interest rates and the prices of debt instruments. In addition, there is a decline in the authority of agencies in general - lower ratings (for example, the sovereign rating of the United States) do not lead to such negative consequences in the debt markets, as it was before the crisis.
Some positive moments of the crisis is the realization and institutional investors and market participants need to create their own system of risk assessment and management while reducing the level of trust placed in external ratings. Rating agencies have never called investors blindly believe in the ratings and promised that their judgments will be error-free, but until a practical test these words were not taken seriously by anyone. Only large and sometimes fatal losses, followed unnecessarily blind faith in ratings, helped investors realize the importance of their own analysis.
However, no one disputes the fact that the reliance on ratings continue to help improve the quality of the analysis. After all, the agency, based on the powerful techniques and professionals are able to disclose risks and information that may be missed with self-assessment. The role of the ratings for assessing debt remains high, alternative estimates of rating agencies in the market is not available, so there is no doubt that the agency as subjects of the information field will continue to operate, making a positive contribution to the overall development of the market. In this case, the efforts made to eliminate shortcomings in their activities, which are partly caused the financial crisis, can also be assessed positively.
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