A Multilateral Credit Rating Agency, anyone?

Back to a century-old question why rating agencies do not always provide warnings to the market in time. Rating agencies are also under fire for not being ahead of the curve. End of the day, the agencies are here to serve investors, aren't they? Well, we know credit ratings are all business and not non-profit operations. It is all about who is paying them in the first place.

First, rating agencies earn mostly from debt issuers/borrowers. That moral hazard relationship discourages agencies not to be too harsh on negative rating actions or risk losing relationship with issuers/borrowers.

Second, rating agencies are under strict regulations after the global financial crisis in 2008. Thus, whatever rating agencies come out with their reports, a long rating process needs to be in place. As a result, rating agencies are not fast to react to market news. Rating agencies are also fearful not to precipitate the market sell-offs which in a way can affect credit fundamentals of issuers of which rating agencies make good money year in and year out.

Third, rating agencies do not have many market practitioners and many analysts have never traded bonds/loans or tracked bond performance. On the flip side, rating analysts usually move on to research or trade bonds after a few years at an agency but it is not the other way around as money at investment banks or asset managers are usually much better. Thus, rating agencies focus more on ratios and figures which can be falsified by issuers/borrowers (even with the audit). They can lack instinct that the market is telling. The lack of market knowledge also results in rating agencies not being able to understand bond yield movement. There used to be a saying that the difference between a rating analyst and a bond analyst is that the former talks ratios and the latter talks spreads. That could not be further from the truth. 

Last but not least, rating agencies stay away from recommending bonds and pinpointing irregularities without a long rating process to back it up. One clear example is when Hong Kong’s SFC sued Moody’s for assigning warning flags to Chinese companies. The regulator won the case with controversies to say the least. I am of the opinion that SFC may have had the evidence and their own regulations to back them up but the fact that a rating agency cannot warn investors on corporate governance is simply a loss to the investment community.

Problem #1 and #2 clearly come from the relationship between rating agencies and issuers who pay them handsomely. There are rating agencies which get paid only from investors but it appears that investors do not want to pay a hefty fee to agencies and those agencies are not very successful commercially. Subscription fees are usually only a small portion of rating agency revenue.

Perhaps, one solution is for a group of countries (such as ASEAN or ASEAN+3) team up to contribute to establish a multilateral and non-profit rating agency which will get paid from issuers indirectly through a rating fee.

Yes, investors can still subscribe to the platform for rating reports but the majority of the revenue will come from a government-mandated rating fee in a bond/loan underwriting process. The rating fee will be paid by issuers (to the multi-lateral credit rating agency) in order to issue bonds or borrow more than certain levels. Issuers with strong ESG mandate can perhaps ask for an exemption where government will instead contribute the rating fee on their behalf.

The fee will surely be passed on to the investors but that is what it is all about. Credit ratings are here to protect investors so investors must pay for their protection. The rating fee arrangement also make sure there is no relationship between a rating agency's income from issuers and a rating agency's negative rating actions on issuers.

This arrangement will also make sure there will be a rating on any bond issued in the member countries and also enable local experts (instead of foreigners 10,000 miles away) to contribute to the local rating process. A not-for-profit organization will make the agency akin to Asian Development Bank where the purpose is to serve the public, not to maximize shareholders' wealth. A local multi-lateral rating agency will also make sure the cost of issuing ratings is reasonable and the money stays in the region to help develop local bond markets.

Problem #3 and #4 are beyond what rating agencies could do, in my view. I see a digital rating platform which uses the market information come in handy to assist investors. Problem #4 is about the regulators and I can only hope that market participants worldwide make sure their regulators understand what and how rating agencies can serve the investing public. Regulations are drafted to protect investors, not to hide material public information.