Capital Markets

Is This an Upgrade?

Will self-regulation backed by market discipline be sufficient to keep credit-rating agencies in line?
Janet KersnarDecember 16, 2004

Ask corporate treasurers what they think about credit-rating agencies, and you should expect to get an earful. A number of them lament that the process used by the raters isn’t transparent enough; others charge that the raters’ analysts lack knowledge of the companies and industries they’re grading. Still others fire salvos at the agencies’ failure to downgrade Enron and the like more promptly.

But could that hostility be on the wane in 2005? In October, standard-setters at the Madrid-based International Organization of Securities Commissions (IOSCO) published a proposal for a new global code of conduct for raters at Moody’s Investors Service, Standard & Poor’s, Fitch, and Dominion Bond Rating Service. Among their recommendations are that the agencies publish their ratings methodologies, document how they are addressing potential conflicts of interest, and reveal their nondisclosure policies about confidential data.

While IOSCO’s members will debate many of the proposal’s finer points at a technical committee meeting in South Africa in January, it has put a stake in the ground on an important issue: IOSCO doesn’t believe that the raters should be regulated as, for example, the German treasury association was once demanding. Rather it reckons that self-regulation backed by market discipline — not to mention the fear of bad publicity if the code is breached — are sufficient to keep raters in line.

Overoptimistic perhaps, but there have already been signs that self-regulation might work. Moody’s, for one, published a report in July explaining for the first time how it assesses off-balance-sheet exposures. (Its president, Raymond MacDaniel, welcomed the hands-off approach in a letter to IOSCO in November: “Market mechanisms have repeatedly imposed changes in the behavior of our industry and our company.”)

But what do the companies that are the subject of the ratings think? Nick Guest, group treasurer at Stagecoach, a £1.3 billion ($2.5 billion) Scotland-based transportation company, says a code of conduct is badly needed but adds that there are still some contentious areas to be addressed. First, many corporate treasurers say they’d like to participate in the “behind closed doors” rating process of their firms. “This would ensure we are being fairly represented by rating analysts and that committee members fully understand a company’s dynamics,” explains Guest. Second, “we’d clearly want some commitment to the code of conduct embedded in our contractual relationship.” That’s unlikely to happen soon, he grants, not least given a fear of litigation among the raters.

And while Guest also cautions against overregulation, he adds that time will tell “whether the rating agencies are simply improving the perception of the process or are actually improving the process.”

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