Bond markets are in their infancy in Asia. In Malaysia, for example, only M$25 billion ($10.9 billion) was raised through the local debt markets between 1991 and 1994, a tiny sum compared with the Kuala Lumpur Stock Exchange's market capitalization of M$518 billion and banking-sector assets that exceed M$300 billion.
All that is about to change. With growing affluence, a big pool of pension and insurance funds throughout Asia will become available for investment in debt. Japanese investors will also begin to seek attractive fixed-income assets in the region.
But if Asian issuers are to attract funds at attractive rates, they will need reputable credit ratings. These may not be easy to achieve. Standard & Poor's and Moody's Investors Service, which dominate ratings in Europe and the US, provide little comfort to investors in Asia, or indeed in any of the emerging markets.
"The big agencies have made tentative moves but have yet to make a significant push in the emerging markets," says Bruce Johnson, co-chairman of research at ING Barings in London. Failure to understand local accounting norms and business culture could lead to mistakes and the erosion of the agencies' credibility, which has been so painstakingly nurtured in developed markets. An editorial in an August 1995 issue of S&P's Creditweek put it bluntly: "While no-one should deny the potential of these many, diverse and volatile markets to provide excellent investment opportunities, the bottom line is that we do not know much about them."
S&P has sought to overcome the problem by forming alliances with local agencies. "Over time we want to penetrate domestic markets in developing countries as we have already done in France, Spain, Italy and Germany," says George Dallas, managing director for European ratings at S&P. In 1990, S&P bought a 50% stake in France's Adef. The agency, renamed S&P Adef, continued to be staffed by French analysts and to produce research literature in French. S&P has since bought out the remaining 50%.
This strategy has its pitfalls. S&P's link-up with the largest credit rating agency in India, Crisil, highlights the risk it runs of tainting its reputation by getting involved in less-developed markets. According to a February agreement, expertise and information will be exchanged between the agencies, and S&P retains the option to buy a minority stake in Crisil. The hope is that Indian companies tapping the Euromarkets will eventually be awarded joint ratings by S&P/Crisil.
There are, however, lingering doubts about Crisil's credibility, because its core shareholders are financial institutions. The principal criterion for assessing the independence and objectivity of an agency is whether or not it could benefit from one of its own ratings. "The idea of a bank owning an agency would run counter to principles of credit rating," says Dallas. "This explains why a link with publishing houses is so prevalent."
Once a government has given its blessing, a rating agency can be established fairly easily. The barriers to entry are low. Capital outlays are limited to an office, a couple of analysts and some computers. So a reputation for independence and impartiality is crucial.
The ownership structures of the large US agencies do not present any obvious conflicts of interest, as they are all either independent or owned by non-financial companies. Throughout Asia, though, agencies are owned by consortia of financial institutions, including ones for which credit ratings are issued. The question is especially salient in India. The two leading agencies, Crisil and Icra, are respectively sponsored by the Industrial Credit and Investment Corporation of India (ICICI) and the International Finance Corporation of India (IFCI), both of which channel business through their own agencies.
Since being set up in 1987, Crisil has rated 1,700 entities, amounting to $30 billion in total debt. It commands 70% of the market and employs 150 analysts, dwarfing rivals Icra and Care. ICICI, the Housing Finance Corporation of India and Unit Trust (India's largest mutual fund), hold 30% of the agency's equity. In a blatant conflict of interest, ICICI holds a seat on the agency's board and an AAA rating by its credit committee, as does the Housing Finance Corporation.
Despite the relative sophistication of the market for ratings in India, most foreign banks there holding portfolios of assets employ their own analysts, while corporate debt is largely of the plain vanilla variety. But Gunit Chadra, head of corporate finance at Citibank in Bombay, predicts the development of a yield curve for liquid and traded corporate debt, based on reputable local credit ratings. He sees little wrong with the ownership structure of India's three local agencies. "Cross-holding structures are the norm in India," he says.
Nevetheless Crisil needed a foreign partner if outsiders were to be convinced of this - which explains the enthusiasm with which it courted S&P. "I wrote a letter to S&P in 1991 inviting them to take a token equity stake but not a contingent interest," says Pradip Shah, former chief executive officer of Crisil. "They refused my offer. Around the same time the IFC pushed us into a relationship with Fitch [the US credit-rating agency], but as far as we were concerned they were an also-ran." S&P remained the favoured choice for a partner. "Our methodology is most akin to S&P's," says R Ravimohan, managing director of Crisil. "We don't do unsolicited ratings - nor does S&P."
On this point S&P draws a sharp distinction between itself and arch-rival Moody's, which last month faced an inquiry by the US Justice Department after allegations that it was issuing unsolicited ratings as a way of encouraging companies to pay for more thorough rating reviews. "Unlike Moody's we rate issues only on request," says Michael Petit, director for international ratings at S&P in New York. "So our market penetration depends on demand." But the agency's expansion has focused on agreements with other rating agencies, rather than directly courting custom from issuers. Although in India Crisil's owners have refused to relinquish control, in other countries S&P has been forming alliances with local agencies, taking equity positions with options to buy them outright. Such an arrangement led to the purchase of Mexico's Caval.
Thai Rating and Information Services (Tris) may be the next on S&P's shopping list. Tris has a "technical services agreement" with S&P, having linked up with the US agency when it was established. A source at Tris describes its agreement with S&P, under which the larger agency retains the option to buy it outright, as "a pact with the devil", because the desire to expand is tempered by a fear of being taken over by its larger partner. "Tris was naive and inexperienced and is justified in feeling short-changed," says a representative of another member of the Asean Forum of Credit Rating Agencies (Afcra). Crisil, on the other hand, had a large book of ratings before joining forces with S&P.
Moody's strategy in emerging markets has tended to be to establish its own agencies rather than take stakes or forge alliances. In Cyprus, for example, it initially approached local firm Capital Intelligence with an offer of outright purchase. When the Nicosia-based agency asked for too much money, Moody's outflanked it by poaching its three senior analysts and setting up its own office from scratch.
Moody's Cyprus office will spearhead its advance into the emerging markets of the Middle East, eastern Europe, south Asia and Africa. The agency's Hong Kong office covers southeast Asia and its New York office deals with Latin America. Moody's maintains credit ratings on about 600 banks, more than half of which are outside the US. "We want to raise our total coverage to at least 1,000, and we expect that most of these banks will be in non-OECD countries," says John Bohn, president of Moody's.
The agency expects to rate some 250 banks through its Cyprus office over the next five years. The ratings will consist of traditional bank-debt ratings, which measure the ability and willingness of banks to meet cross-border obligations, and bank-financial-strength ratings (BFSRs), which assess a bank's inherent strength, regardless of implicit or explicit support from the government.
The Cyprus office has already begun to flex its muscles in the region by sending letters to Turkish banks notifying them of pending unsolicited ratings. "Most of the banks went ballistic," says a foreign banker based in Istanbul. "Moody's uses unsolicited ratings as a means of getting its claws into clients in emerging markets," says another.
The banks are left with little option than to co-operate. "We got a letter from Moody's saying they would be in Istanbul in two weeks and would like to come and look at our accounts," says a source at a Turkish bank. Turkish bankers are particularly annoyed because they are being asked to pay for the unsolicited ratings.
"We don't discuss our business development strategy in public," says George Fasel, managing director of global communications at Moody's in New York. Rival agencies are not so circumspect. "We conduct ratings on the basis of demand," says Lionel Marsland Shaw, general manager of Capital Intelligence in Cyprus. "But we are all tarred with the same brush, as few issuers distinguish between the expansion strategies pursued by different agencies."
Warring with ratings
Issuers are also unhappy. "It's a form of moral blackmail," says an issuer on the receiving end of an unsolicited rating from Moody's, "as they tend to rate a notch below the opposition, which can increase the yield paid at issuance." It's a ploy Moody's has used over and over again to lever open a market. Much to the chagrin of issuers, there is no note attached to the rating indicating that it was unsolicited.
Moody's has also begun to issue unsolicited ratings for Indonesian banks. Bank Negara Indonesia (BNI) was given a D plus rating. BNI's executives were infuriated by the rating, given the significant improvement in the bank's performance in the last three years. Profits rose by 31.3% to Rp405.8 billion ($174.4 million) last year from Rp309.2 billion in 1994.
Other agencies have taken a less controversial approach to the emerging markets. Thomson Bankwatch has embarked on a joint venture in Argentina, signed an agreement in principle for a joint venture in Peru, and is holding discussions with agencies in Taiwan and India. Thomson rates more banks in the emerging markets than any of its rivals, maintaining over 1,000 ratings in over 50 countries.
Duff & Phelps (DCR) has formed alliances in Chile, Colombia, Mexico, Peru and Venezuela, taking minority stakes and giving the local agency the kudos of access to DCR's brand name. "In Mexico we are known as a Mexican agency because we have taken a minority interest alongside Mexican companies," says David Roberts, head of DCR's international department, and to this he attributes DCR Mexico's status as the largest agency in the country. By contrast, S&P bought outright Caval, the second-placed agency.
Econsult, another DCR partner, is the largest agency in Chile, where all issuers must have at least two ratings. These agencies provide ratings for local markets, ranking banks and companies within the confines of one country. The scale begins with an AAA rating and so is not constrained by a sovereign ceiling. DCR's presence on the ground in Asia is sparse by comparison, although expertise has been traded with Rating Agency Malaysia (Ram) and DCR offices are planned in India and Pakistan.
Latin America has experienced more competition for ratings among local agencies than Asia. The number of agencies in Chile peaked at eight but has now fallen back to three. "The Chilean government mandated ratings for issuers but allowed too many agencies to rate," says Robin Monro-Davies, managing director of rating agency Ibca. These agencies have nowhere to go outside their own markets. So it seems the future for most is to nurture a steady local business with little growth - assuming they're not swallowed by a larger agency or forced out of business altogether.
In Asia, governments have sought to maintain tighter control over local agencies. Indeed, the genesis of most local Asian agencies can be traced directly to governments. "The involvement of governments is a double-edged sword," says Capital Intelligence's Marsland Shaw. "Governments can get these agencies off the ground but often they seek to use them as a regulatory tool."
Malaysia and Indonesia are prime examples. In Malaysia, the law requires a company that wants to issue debt to have a rating. But Ram is the only agency, so it has a captive market. Pefindo in Indonesia enjoys a similar monopoly.
Pefindo president Farid Harianto dismisses the suspicions investors have of a rating agency controlled by state-owned companies and commanding a domestic monopoly. "Once the level of companies being rated reaches a certain level," he says, "there may be a need for a second agency, as is happening in Malaysia. But for now we control the market."
Pefindo was established in 1993 and has since rated about 50 Indonesian companies. Despite the fact that none of its 122 shareholding companies has more than a 10% stake, it must overcome a mountain of scepticism from investors. Reluctance to form an overseas alliance compounds the problem, since the agency is unlikely to cede much to a foreign partner. "It would not be politically acceptable for Pefindo to fall into the hands of a foreign agency," says Harianto.
Malaysia's Ram, which has completed 290 ratings since being set up in 1990, enjoys similar protection. The agency does not hold a licence from the central bank or Malaysia's SEC. But both regulators have decreed that issues must carry a rating. Because Ram is the only agency in the country, this amounts to de facto official recognition.
Local vs international agencies
The Asian Development Bank and Ibca each hold a 4.9% stake in Ram. "We do not want an international agency to take a larger stake in Ram," says Wong Fook Wah, the agency's general manager. "The government wants to see ratings carried out by agencies with majority domestic ownership. But we are looking at the possibility of establishing a joint venture in Singapore."
The government is planning to set up a second agency and is encouraging local companies to provide equity capital. Wong is not unduly worried by the prospect, as it seems likely issuers of commercial paper and short-term debt, previously required to have one rating, may in future require two.
Tris, Thailand's sole credit-rating agency, is the only member of the Asean Forum of Credit Rating Agencies to have struck a formal alliance with a leading international agency - S&P. Tris aims to have rated 100 companies by the end of this year and expects to break even with income of at least Bt50 million ($2 million), matching its accumulated net loss.
Local agencies which attempt to go it alone will face unyielding scepticism from international investors. Unlike banks, which can be regulated by stipulating minimum requirements for tier-one and tier-two capital, the reliability of a rating agency is more difficult to appraise.
Throughout the emerging economies there is a general requirement on the part of the local securities regulator that an agency satisfies standards of independence and sound methodology. However, as in the US, there are no arbiters of methodology. "Local SECs have not substituted their judgments for those of the rating agencies," says Roberts.
So international investors remain sceptical of local agencies. "The credibility of local agencies is, for the moment, restricted to local markets," says Gregory Root, until recently Thomson Bankwatch president. "Companies in emerging economies tapping the Euromarkets still need a rating from one of the larger agencies." Root believes that for local agencies to be truly credible, even among local investors, they must be affiliated with one of the large agencies.
"I would place a lot of credence in a rating from Moody's or S&P," says a banking analyst in London. "If the only rating was from DCR or Thomson Bankwatch, I would be reassured but still slightly sceptical. So if all I had to go by was a rating from a local agency, I would be very sceptical." Even if a bank is convinced, its clients may not be. "It would be easier for us to broaden our client base marketing stocks in companies carrying a rating from a larger agency," says Peter Geraghty, managing director of ING Barings in London. "And with a dollar-based instrument a rating will always be sought from a larger agency."
DCR wins plaudits for its presence in Latin America. "Duff & Phelps are very strong in Latin America, but they don't rate Asian bonds," says Helene Williamson, director of fixed-income investments at Foreign & Colonial. "The big two - Moody's and S&P - tend to be too conservative when rating emerging markets issuers."
These markets provide the best opportunities for smaller agencies, whether locally owned or in partnership with DCR or Thomson Bankwatch, seeking to challenge the S&P/Moody's duopoly. In western Europe it would not be financially viable to establish a new agency as it would face immediate competition from the established ones. "It would take several years before any revenues could be generated, let alone profits," says Ibca's Monro-Davies. "Revenues can only be generated on the strength of a reputation."
But even in the emerging markets, smaller agencies may merely provide stop-gap ratings until Moody's and S&P consolidate their presence. "Investors will seek an opinion from a local agency and from one with a global presence," says Crisil's Ravimohan. This may be the spin that the new agencies will put on it, but the market for ratings will quickly become saturated by the presence of Moody's and S&P in a country. Although there is a high marginal benefit to seeking a second opinion, the marginal benefit of a third or fourth rating is slight. The process is time-consuming for the issuer and investors gain little. Indeed, too many ratings makes for a confused and ultimately dysfunctional marketplace.
The ratings provided by Moody's and S&P set the international benchmark and are instantly recognized and understood by investors. So a patchwork of local agencies is of little use. Ten agencies, using 10 different methodologies and scales, will confuse and panic most investors.
If the investor is diversifying only into one country it's not such a problem. But most will want to trawl across countries without having to worry about whether or not their information is accurate. Even if agencies provide accurate rank-orderings of default risk within their own countries, these ratings may be useless to international investors. A rough correspondence will emerge between the scales used, but the meaning of each rating will vary over time and between agencies.
The involvement of banks in local bond markets further complicates matters. Local banks participate actively in the local bond market by offering guarantees for paper issued. However, this defeats the purpose of rating a bond issue or a company's credit standing, since investors are guaranteed against the default of the issuer anyway. In guaranteeing bonds, the risk is transferred from the borrower to the banker, rather than from the borrower to the buyer of the bonds. Also, the rating of the paper reflects that of the guarantor rather than the borrower, so the stand-alone credit rating of the company is of little real significance.
But the potential benefits to be reaped from local agencies are vast. Often they are proselytizers for more sophisticated financial markets and could help to kick-start the development of a market for private debt securities and, particularly, a liquid secondary-bond market. Ram is promoting the establishment of an asset-backed securities market and encouraging foreign investors to place funds in Malaysia. "Domestic bond markets should not be confined to domestic issuers," says Wong Fook Wah, the agency's general manager. "So international investors must be comfortable with our ratings."
Only time will tell if international investors will place any real credence in local agencies. The danger is that issuers will seek ratings from agencies charging the lowest fees and offering the highest ratings. But rating shopping is ultimately self-defeating: if investors lose confidence in an agency's ratings, issuers will no longer be able to lower their funding costs by paying for a rating. So it seems the stage may be set for Moody's and S&P to seize control of the market for ratings in the emerging markets as they have already done in Europe and the US.
| How the agencies rate in the emerging markets |
| Agency |
Number of ratings issued |
Rating (S&P scale) |
| Standard & Poor's |
129 (banks and corporates) |
AAA |
| Moody's |
92 (banks only) |
AA |
| Duff & Phelps |
131 (banks and corporates) |
A |
| Thomson Bankwatch |
over 600 (banks only) |
A |
| Ibca |
120 (banks only) |
BBB |
| Fitch |
None |
n/a |
| Asean Forum of Credit Rating Agencies |
| Rating Agency Malaysia |
290 (banks and corporates) |
BBB |
| Thai Rating and Information Services |
60 (banks and corporates) |
BBB |
| Pefindo (Indonesia) |
50 (banks and corporates) |
B |
| Credit Information Bureau (Philippines) |
42 (banks and corporates) |
BB |
| (The ratings are awarded on the basis of the agencies' reputation among investors in emerging markets and |
| Euromoney's assessment of their expertise in rating emerging market issuers.) | |