Last month, the International Organization of Securities Commissions’ task force reviewed its work on the implementation of a code of conduct for credit rating agencies.
The interminable wait for a proper solution to the rating agency problem risks becoming futile.
Even if no one else does, the task force itself believes it is good news that Fitch, Moody’s and Standard & Poor’s – and four other agencies – have largely implemented its code.
“This is an encouraging sign that all CRAs, regardless of size and methodologies, are more aware of the concerns surrounding the credit rating industry and are taking steps to address these concerns,” Iosco argues. It also thinks that its assessment of the extent of rating agencies’ adherence to the code will help investors take a better judgement of the worthiness of ratings.
Iosco ignores the possibility that the agencies have only adopted these new rules because they will do nothing to change the deeply flawed way the agencies do business.
Iosco’s code was revised in 2008, largely to reflect concern about inadequate ratings in structured finance. There were various worthy stipulations that address corporate governance issues. Yet these fail to address the more fundamental problems. They are a well-thought-out list of suggested rules and regulations that, had they been implemented five years ago, might have stopped the sub-prime lending bubble being distributed across the globe via securitization.
The sound of stable doors being closed too late reverberates.
Pitifully, there is no attempt to address the fundamental conflict of interest inherent to the business model of the largest agencies. Everyone knows the problem with the model – issuers pay agencies a fee to buy a rating. Without the rating, investors will not, or worse cannot, buy bond issues.
Is it really so difficult to devise a system that would align investors’ interests with those of the ratings agencies that supposedly serve them?
The authorities are willing to throw billions of dollars at this credit crunch but when it comes to actually doing something fundamental to address the misalignment of interests at the heart of the credit business they publish useless codes of conducts.
Instead, they should restore a mechanism for getting investors to pay directly for ratings. A few years ago this would have been unthinkable – but now is the time to be thinking in unconventional terms. Doing this without reinforcing the anti-competitive nature of the rating agency business will not be easy – but who said regulation should be easy?
Another answer might be to set up an independent rating entity run by the regulators themselves. There is plenty of potential staff available. This entity could be paid for via a levy on publicly syndicated new issues. It would act as an honest broker.
Codes of conduct won’t help. The current system simply results in borrowers, either standalone credits or structured finance vehicles, going to the easiest agency. Ratings arbitrage is an accepted feature of the ratings advisory services that banks provide their clients. Staffed with former rating agency professionals, the system is inherently flawed.
Government and regulatory authorities need to recognize the reality that rating agencies are part of the marketing process in new issues. Until that happens, the root of the problem will remain. As Samuel Beckett himself said in his most famous play: “There’s man all over for you, blaming on his boots the fault of his feet.”
