Should we trust the “three witches” of the financial markets?

In recent years, the three main global rating agencies (Moody’s, Standard & Poor’s, and Fitch Ratings) have established themselves in the international economic landscape. Indeed, by assigning ratings to companies, states and communities, the “Big Three” ( three witches) directly influence the ability of these actors to borrow money outside the banking system. They are thus making the rain and the sun shine on the financial markets….

 three witches

However, it would seem that the hegemony of these three firms, which alone account for around 95% of the market, is partly called into question… In addition to the opacity of the rating methods, the three witches have made numerous errors of assessment in recent decades!

None of them had anticipated the Savings and Loan crisis in 1987, the Robert Maxwell scandal in 1991, the Asian crisis, Argentina’s descent into hell in 2001, the Enron affair or the subprime shock. More recently, the inability of the “Big Three” to predict the bankruptcy of the multinational investment bank Lehman Brothers has definitively shaken (the three witches) their legitimacy…

Indeed, a few days before its bankruptcy, on 15 September 2008, the fifth largest US investment bank (whose collapse was described as a detonator at the beginning of the global financial crisis) was still rated in the “investment” category by the three major agencies.

Moreover, it is now clear that the markets are no longer reacting as strongly to any downgrades by rating agencies. This is the case for Belgium, which, since the downgrade of its rating, has seen its borrowing rates fall by 2.5 points to its lowest level in 15 years, to 2.2%.

But this is not an isolated case: among the governments that have borrowed at lower rates since their deterioration, we can mention the United States, Japan, Italy and more recently France. There are two reasons for this paradox: on the one hand, markets anticipate downgrades before they are announced by agencies, and on the other hand, there is an emerging distrust of the ratings assigned by the “three witches“.

As a result, large institutional investors are increasingly focusing on other factors such as bond yields and underlying performance.

In addition, many voices denounce conflicts of interest that have arisen within agencies because of the way they are remunerated. Indeed, most of their income comes from the debt issuers to whom they assign their ratings… It is therefore difficult to be impartial! In this sense, the countries of the European Union agreed last November to introduce tighter controls on credit rating agencies.

Thus, an agency may not rate an entity (or its products) when the latter holds more than 10% of its capital. A way, undoubtedly, to establish more probity and objectivity on the part of the agencies… which can no longer be judge and jury!

Finally, on November 5, Standard & Poor’s was sentenced by an Australian judge on the basis of analyses published on two financial products from ABN Amro Bank. The Australian Federal Court described the triple-A ratings of the two credit derivatives, which were downgraded a few months later to just above the rank of “rotten” assets, as “misleading”.

Shortly after their acquisition by the municipalities of New South Wales, these so-called Rembrandt securities defaulted, resulting in a net loss of A$16 million, or more than 90% of the capital invested. The court therefore ordered S&P, the bank and the intermediary to pay jointly and severally the damages claimed by the 13 Australian local authorities that had invested in these two securities “blinded by the agency’s excellent rating”.

Are we witnessing a shift in the responsibility of rating agencies? For Norbert Gaillard, an economist, independent consultant to the World Bank and author of the book Les Agences de notation, there is no doubt about it: “On the one hand, they are accused of not having done all they can to properly judge the quality of a credit. But, on the other hand, they are also held responsible for giving ratings that do not reflect reality.”

Until now, the agencies’ argument has been that their ratings represent only an opinion and not investment advice. “Rating is an art, not a science”, Standard & Poor’s defended itself in this way. But it would seem today that the situation is changing… Indeed, by condemning S&P, Judge Jayne Jagot has put back on the agenda the question of the introduction of civil liability for rating agencies.

Thus, on Tuesday 28 November, Brussels announced its intention to tighten the supervision of rating agencies. Michel Barnier, European Commissioner for the Internal Market and Services, said he wanted to impose new limits on rating agencies, in particular by establishing a new liability regime:

“Agencies may be held civilly liable if they have harmed an investor by violating the regulation, whether negligently or intentionally”, companies and rated states may thus claim damages from the agencies.

In addition, “Rating agencies will need to be more transparent about which ones rate sovereign states, respect timing rules on sovereign ratings and justify when unsolicited sovereign debt ratings are published. ».

Michel Barnier, in a press release, welcomed an “important agreement” that should make it possible to ensure “more financial stability”. Moreover, the Commission has also stated that it will present a report by 2016 on the possible desirability of creating a European rating agency.

What is there to question about the value of the ratings of these agencies? In the long run, could investors lose complete confidence in them? Are the “three witches” do they have to burn at the stake?

Some specialists in the sector fear a kind of “big bang” in the rating market. Indeed, the discredit thrown at agencies could, in the long run, make them lose their profitability in favour of new rating alternatives such as CDS (Credit Default Swap), interest rates, or bank and insurance ratings. On the other hand, if the multiple complaints were to turn into convictions (like S&P’s in Australia), the industry could simply go bankrupt.

While criticisms of rating agencies are increasingly numerous and virulent (Christian Noyer, the Governor of the Banque de France, thus denounced agencies that have “become frankly incomprehensible and irrational”), many actors persist in defending these agencies and asserting their legitimacy.

Marc Ladreit de Lacharrière, founder of Fimalac, wrote a book entitled “Le Droit De Noter – Les agences face à la crise”. In this work, the author invites his readers to ask themselves about the precise role of these women? Are they the real culprits of these successive crises or the scapegoats that our leaders willingly accuse? Is the thermometer responsible for the fever?

“Market detractors”, “excessive power”, “incompetence” or “guarantees of the stability of the financial system”… Opinions on rating agencies differ between politicians, regulators, economists and investors… But what then is the real future of these three “witches”?

Despite the “decline in the omnipotence of the triumvirate” revealed by Axa’s former boss, Claude Bébéar, and the various criticisms made of it, it would seem that the rating industry still has a long way to go… for lack of “strong enough” competitors to compete against these Big Three (the three witches) who now enjoy world supremacy.

Caroline BONNET


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