De-institutionalizing credit ratings?
EC proposals might reduce the influence of credit rating agencies. But are market participants likely to ignore the agencies’ assessments?
Hidden away in the European Commission’s proposals to reform Europe’s trillion euro money-market fund industry is a bold and perhaps revolutionary idea that might have implications for the entire financial system.
Apart from the main thrust of the EC’s plans – altering the way these funds are valued and stepping up their capital buffers – an equally important part relates to credit rating agencies, and breaking money-market funds’ mechanistic reliance on them.
These funds, together with the rest of the world’s institutional investment industry, have long relied on credit ratings as a gauge of sovereign and corporate creditworthiness. This is not out of choice; rather it has been thrust upon them by the world’s financial regulators.
For decades, credit ratings have been enshrined in regulation, institutionalizing the opinions of the biggest agencies – Fitch Ratings, Moody’s Investors Service and Standard & Poor’s.
It is this, combined with the agencies being so deeply embedded into a vast array of financial contracts and market practices – everything from bond indices and performance benchmarks to secured funding, repo and over-the-counter derivatives markets – that has given the credit raters so much power.
Under the EC’s reform proposals however, this might change.
In an unprecedented move, the EC is proposing banning money-market fund managers from using credit ratings: "In line with the general policy to curtail ‘overreliance’ on third-party credit ratings, any MMF manager is obliged to conduct its own credit assessment according to a set of harmonized rules."
This is a bold move by the EC. Should these proposals become law and be replicated elsewhere, it might mean the de-institutionalization of credit ratings. By extension, this might help cut the power the big rating agencies have held for so long.
Unsurprisingly they are angered by this.
In a statement, S&P said: "Banning independent ratings would be unprecedented internationally, wholly unjustified, and do nothing to improve market confidence globally in the stability of European money-market funds."
It added: "We don’t support mechanistic reliance on ratings, but money-market fund managers and their investors should be free to use the investment tools they deem appropriate. The future of European money-market funds requires more, not less transparency, and more rather than fewer independent views of risk."
However, whether ratings are de-institutionalized or not, the reality is that they will continue to be widely used by market participants, and blindly relied on by some. It is a problem that possibly cannot be solved.