The conundrum facing credit ratings agencies can perhaps be best illustrated by the comments of a director of one of the industry's largest players.
Speaking at a briefing session during a meeting of the African Development Bank, he recalled how, at an investor meeting in 2008, the company was criticised for the AA rating it had awarded Greece at the time. “The criticism was it should be triple A as there was no risk in Greece – it’s part of the euro area and we know that member countries, if ever in need, will step in and help Greece,” he said.
Four years later, and with bitter hindsight, the outlook for Greece was dire.
“Wherever we are, we get criticism for being too high, too low, for acting too late, or too quickly. What we try to do to the best of our ability is to give direction to the market about how we see credit trends evolving.
“I think it’s fair to say that the severity and breadth of the European Union crisis is unprecedented and very few market participants would have anticipated where we are today,” he said.
While the eurozone crisis has continued, South African MPs have drafted the Credit Rating Services Bill in an attempt to regulate the agencies, dominated by large players such as Moody’s, Standard & Poor’s and Fitch, which rate the credit worthiness of companies and countries that issue financial instruments such as bonds.
Complex financial instruments
Ratings agencies have been widely criticised for their role in the 2008 financial crisis, including their failure to rate properly complex financial instruments, such as the mortgage-backed securities that disguised toxic assets and played a major role in sparking the subprime crisis that felled Wall Street investment banks such as Lehman Brothers.
The Bill is in line with international efforts to regulate the agencies. The United States and the European Union have both drafted laws and regulations relating to them.
“The industry lost a great deal of credibility after the subprime crisis,” Melanie Brown, managing director of Global Credit Ratings, said. “This will go towards rebuilding that credibility.”
The Bill aims to increase accountability and transparency, and would require the agencies to register with the Financial Services Board.
But opinion at public hearings last week was divided about the implications of the Bill, particularly for large multinational agencies that have local subsidiaries.
Range of issuers and obligations
Moody’s, in its written submission to Parliament, warned that the Bill, particularly an endorsement requirement, could place unnecessary legal and administrative burdens on the agencies and the Financial Services Board. Agencies based in South Africa would have to endorse ratings “produced partly or wholly outside South Africa by the registered credit ratings agency or another credit ratings agency belonging to the same group as the registered agency”.
Moody’s said it would make it significantly more difficult for financial market professionals in South Africa “to access credit ratings agencies’ opinions on a diverse range of issuers and obligations”.
It also said that the civil liabilities that the Bill would impose on agencies were too severe; as it was, ratings agencies could be sued by third parties for things such as misleading statements and practices, and they faced criminal charges for offences such as insider dealing. If passed, the Bill could create “new and potentially unmanageable private causes of action”, Moody’s said. This could mean that agencies, in an effort to protect themselves against litigation, could publish lower ratings or “follow volatile market indicators in lock-step”.
It could also limit participation or deter new entrants to the industry.
Brown said that, as the Bill stood, any person who broke the law could receive up to 10 years in prison. With such heavy penalties, it would be difficult to hire and retain analysts.
But other commentators said that the Bill should have done more to keep credit ratings agencies in line.
Futuregrowth Asset Management, in its submission, said the Bill should include individual accountability, which would hold key personnel such as chief executives and lead analysts responsible for breaches of the law.
The treasury has said it was willing to make amendments in light of the comments, including those relating to endorsement, so that local credit ratings agencies would have to endorse only ratings on South African securities, and to limit the extent of criminal liability.
But the treasury appears resolute on other matters. For example, it would not change the provision that prevents ratings agencies from reducing or limiting their liabilities through a contract or agreement.
The Democratic Alliance’s spokesperson on finance, Tim Harris, said that the proposed changes did not fix several problems and could compromise the number and quality of credit ratings agencies in the country.
The standing committee on finance has delayed the Bill to brief MPs on its legal ramifications, according to acting committee chairperson Des van Rooyen.