Credit Rating Agencies: Meeting the Needs of the Market?

146 Pages·2007·1.78 MB·English

Credit Rating Agencies:
Meeting the Needs of the Market?
C
r
e
d
The recent turmoil in the international financial markets following the subprime i
t

mortgage crisis in the US has raised questions about the role of credit rating R
a
agencies in this crisis. Whether credit rating agencies are meeting the needs of
t
i
the market and if there is a need for increased regulation have become ever more n
g
topical issues. This timely publication looks at the views of market participants
A
before the crisis and provides an insight into the rapid development and practices g
of the agencies. e
n
c
i
Thereportcommenceswithbackgroundinformationonthecreditratingindustry, e
s C
including information on: the structure of the market; the ratings process; the :

M redit Rating Agencies:
perceived global domination of the market by two main players - Standard
e
& Poor’s and Moody’s; the recent criticisms that the agencies have faced; and e
international calls for greater supervision and accountability of the agencies. ti Meeting the Needs of the Market?
n
Against this background commentators have questioned whether credit rating g

agencies are providing an adequate service. t
h
e Researchers: Angus Duff Sandra Einig

Thisresearchattemptstoresolvesomeoftheseissuesbygatheringviewsofmarket N
e
participantsintheUKoncreditratingagenciesandthecharacteristicsofa‘quality e
rating’. The authors found that users had confidence in the independence of the d
s
rating agencies and found no evidence of a need for more formal regulation. The
o
report concludes with policy implications for the industry and identifies areas for f

t
future research, including an assessment of how market participants’ views have h
e
changed as a result of the turmoil encountered in the credit markets in 2007.
M
a
r
k
ISBN 978-1-904574-20-0 e
t
?
EAN 9781904574200
CA HOUSE • 21 HAYMARKET YARDS • EDINBURGH • EH12 5BH
TEL: [phone] • FAX: [phone]
EMAIL: [email protected] • WEB: www.icas.org.uk/research

CREDIT RATING AGENCIES:

MEETING THE NEEDS OF THE MARKET?

by

Angus Duff

University of Paisley

Sandra Einig

Oxford Brookes University

Published by

The Institute of Chartered Accountants of Scotland

CA House, 21 Haymarket Yards

Edinburgh EH12 5BH
First Published 2007

The Institute of Chartered Accountants of Scotland

© 2007

ISBN 978-1-904574-20-0

EAN 9781904574200

This book is published for the Research Committee of

The Institute of Chartered Accountants of Scotland.

The views expressed in this report are those of the authors

and do not necessarily represent the views of

the Council of the Institute or the Research Committee.

No responsibility for loss occasioned to any person acting

or refraining from action as a result of any material

in this publication can be accepted by the author or publisher.

All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted, in

any form or by any means, electronic, mechanical, photocopy,

recording or otherwise, without prior permission of the publisher.

Printed and bound in Great Britain

by T. J. International Ltd.
C
ontents
Foreword ..................................................................................... i

Acknowledgements ....................................................................... iii

Executive Summary ..................................................................... v

Abbreviations .............................................................................. xi

1. Introduction ............................................................ 1

Background .................................................................. 1

Purpose of the study and the research approach ............ 6

2. Credit Rating Agencies ........................................... 13

A brief history of the ratings industry ............................ 13

Ratings processes ........................................................... 14

The demand for ratings services ..................................... 15

Financial performance of credit rating agencies .............. 16

Demands for self regulation of credit rating agencies ..... 18

Barriers to entry ............................................................. 29

Summary ....................................................................... 32

3. Literature Review .................................................... 33

Market participants’ attitudes to credit rating agencies ... 33

Audit theory and audit quality ....................................... 38

Summary ....................................................................... 47

4. Interviews with Key Market Participants and the

Development of the Ratings Quality Survey .......... 49

Interviews ...................................................................... 49

Questionnaire development ........................................... 51

Technical features ......................................................... 54

Service features ............................................................. 59

Summary ....................................................................... 63
Contents
5. Conduct of Survey ................................................... 65

Financial managers ........................................................ 65

Other interested parties ................................................. 69

Investors ........................................................................ 70

Summary ....................................................................... 73

6. Results of the Questionnaire Survey: All groups ...... 75

Characteristics ............................................................... 75

Individual items ............................................................. 78

Summary ....................................................................... 85

7. Comparison Between Groups .................................. 87

Characteristics ............................................................... 87

Items ............................................................................. 95

Summary ....................................................................... 101

8. Conclusions .............................................................. 103

Main findings and comments ........................................ 103

Policy implications ......................................................... 106

Further research ............................................................. 110

References ......................................................................... 113

Appendix ............................................................................. 119

About the Authors ........................................................... 127
F
oreword
The recent turmoil in the international financial markets following the
subprime mortgage crisis in the US has raised questions about the role
of credit rating agencies in this crisis and as to whether credit rating
agencies are meeting the needs of the market and if there is a need
for increased regulation. This timely publication looks at the views of
market participants before the crisis and provides an insight into the
rapid development and practices of the agencies.
The authors recognise the lack of research in this topical area
and identify five areas for future research: to consider the relationship
between the credit rating agency and the issuer; to identify whether an
expectations gap exists; to gather the views of market participants in other
countries, particularly in the US; to better understand the processes and
methodology used by the agencies; and to see how market participants’
views have changed as a result of the turmoil encountered in the credit
markets of 2007.
This report commences with background information on the
industry, including information on: the structure of the market; the
ratings process; the perceived global domination of the market by two
main players; the criticisms the agencies have faced since the late 1990s;
and international calls for greater supervision and accountability of
the agencies. Against this background commentators have questioned
whether credit rating agencies are providing an adequate service and
‘quality ratings’.
This research attempts to resolve some of these issues by gathering
views of participants and interested parties to identify the components of
‘ratings quality’ and then comparing the views of three separate groups
of market participants in the UK: corporate treasurers; investors; and
other interested parties. The “other interested parties” group was made
ii Foreword
up of finance academics, finance professionals, consultants, journalists
and bankers.
The report then analyses the findings from the interviews
and questionnaires. The interviews were used to help identify 14
characteristics of rating agencies – ranging from technical features to
service features which were used to design the survey questionnaire,
which featured 71 questionnaire items. In the survey reputation, trust
and values were ranked as the most important characteristic, with
transparency and timeliness also ranked highly. The highest ranking
items were focused on integrity, ethical standards and credibility as
well as more competency based items such as the accuracy of ratings
and qualification of staff. User groups did not place any importance
on other services offered by the agencies. Users were confident in the
independence of credit rating agencies they dealt with.
Finally, the report concludes on the findings of the study and policy
implications for the industry. The policy implications are that: there
is no evidence to suggest a need for formal regulation of the agencies,
as existing codes of conduct are considered to be adequate; the codes,
and compliance with them, should be monitored closely; the agencies
themselves need to maintain and improve their commitment to quality
and improve their communication; agencies’ ancillary services should be
formally separated from their ratings work; and any unsolicited ratings
should be clearly identified as such.
This project was funded by the Scottish Accountancy Trust for
Education and Research (SATER). The Research Committee of The
Institute of Chartered Accountants of Scotland (ICAS) has also been
happy to support this project. The Committee recognises that the views
expressed do not necessarily represent those of ICAS itself, but hopes that
the project will contribute to current debate on credit rating agencies
and their role in the financial markets.
David Spence

Convener of Research Committee

October 2007
A
cknowledgements
The monograph benefits from comments of two anonymous reviewers,
together with John Grout of the Association of Corporate Treasurers
and Christine Helliar of The Institute of Chartered Accountants of
Scotland. We would like to thank the 16 individuals who agreed to be
interviewed and shared their experience and perspectives of the ratings
industry. We are indebted to those individuals who agreed to pilot our
questionnaire and who made helpful suggestions and comments. Most
significantly, we are grateful to those respondents who found time to
complete our questionnaire.
Finally, the Research Committee and the researchers are grateful
for the financial support of the Trustees of the Scottish Accountancy
Trust for Education and Research without which the research would
not have been possible.