Two of life’s certainties, goes the cliché, are death and taxes. To those I guess you could add dumb-ass soap operas and inane TV talent shows. And potentially credit ratings.
Capital markets cynics will tell you the hugely dominant trio of Moody’s, S&P and Fitch is already three agencies too many … but now that the dust is starting to settle on the hefty EU rules that came into force in January, I see that there are no fewer than 18 agencies registered or certified with the European Securities and Markets Authority, apart from the big three.
That list of 18 (six German, eight in the eurozone periphery and Eastern Europe, and the remainder well established non-Europe-based players) is a motley crew ranging from small single-product firms to multinational business services organisations that among other things are already involved in corporate, public-finance, insurance, structured finance, trade-related, credit insurance, asset-based finance or fund ratings.
While most of the European firms are domestically focused, some are starting to flex their muscle cross-border and are moving into new areas. How do I rate their ability in the short to medium-term to break the stranglehold of the incumbent oligopoly – to the extent that’s even on their radar screen? Well, for those that have international capital markets ambitions I rate the chances B with a negative outlook on the proprietary Mullin scale.
Difficulties will arise from the fact that the big three oligopoly (or perhaps better put the Moody’s/S&P duopoly plus Fitch) is so heavily entrenched in capital markets that even with the best efforts of regulators both to encourage end-users to reduce their over-reliance on external ratings by conducting their own research (nice idea in principle but indolence, inertia and ass-covering will put paid to that); and to try and force issuers to mandate one of the smaller agencies, it’s potentially going to be a long hard slog to make progress.
The EC is doing what it can to offer free marketing to the smaller agencies, saying issuers “should consider the possibility to mandate at least one credit rating agency which does not have more than 10% total market share …” In addition, small agencies are exempt from the mandatory four-year structured finance rotation.
Rating agencies certainly needed heavier oversight in the wake of the subprime debacle
BUT MORE BROADLY, I wonder what impact the new EU rules – which mirror the relevant piece of Dodd-Frank in the US – will have. The rules cemented in a host of tough governance and supervisory metrics as well as some pretty robust and restrictive rules around sovereign and structured finance ratings in particular. I don’t think I’m overstating the case to say that the EU rules constitute such a serious restriction of trade that if similarly over-bearing rules were in place in another part of the world, Brussels would be screaming foul and demanding they be torn down.
The rating agencies certainly needed heavier oversight in the wake of the subprime debacle and the serious conflicts of interest that came out of the issuer-pay model. But where we’ve ended up is so narrow and prescriptive a rule-set that I wonder why some of the new ESMA pretenders would even want to be in the business at all, even with the following wind of the EU’s positive discrimination. One of the intended outcomes is greater competition; another, however is lower rating fees.
In the longer-term, how the fortunes of the ratings industry play out will ultimately depend on demand for additional ratings from investors; the extent to which issuers can be bothered to seek multiple ratings; or the extent to which the new entrants can bring something new to the table in a world we’re assured needs alternative opinions.
But you never know. Notwithstanding my scepticism, there are some initiatives in play that will be interesting to watch. Scope Ratings’ new bank rating initiative is one. The Berlin-based agency’s break-out from its existing funds, asset-based and corporate ratings business is a brave move, since it’s taking on the big boys head on. Scope has turned to ratings veteran-turned regulator-returned ratings veteran Sam Theodore to head it up. By the end of the year, he wants to have a team of half a dozen analysts in London to rate (eventually) 60–80 major banks, initially European then global.
THEIR PITCH HITS every marketing tick-box you could ever wish for – “crisp, more transparent and forward-looking methodologies more suitable to the post-crisis banking realities free of the legacies of the past”; no repeated methodology adjustments; a mix of qualitative and quantitative factors, delving into the regulatory environment, assessing business models, risk governance etc etc. Scope even invoked the dreaded “C” word: culture, so will be picking up on hippy issues such as reputational risk and business conduct. Whether the end-result will offer a viable alternative will be something to watch out for.
The other area that’s of huge interest to me is the ability of the smaller agencies to capitalise on the coming mid-market debt revolution. European SME ratings could become all the rage as this phenomenon takes hold. The fact that NYSE Euronext’s Alternext SME bond platform has made ratings mandatory in France for public offerings by companies with a market cap of below €100m is an encouraging sign.
When French property developer Capelli launched its €11.7m “initial bond offering” last November – by the way I love Euronext’s creation of the IBO, which equates debut bond issuers to companies undergoing IPOs on the equities side of the fence – the agencies authorised to rate the offering were Creditreform, Euler Hermes, GBB and Scope (the latter ultimately providing the rating). Not a ratings oligarch among them.