Posts Tagged ‘CRA’s’

Who should pay for Credit Rating?

Monday, June 21st, 2010

Who should pay for Credit Rating?

This is a Guest post by Mr. Sacha Singh. He consults on change management, process evaluation and valuation of firms and he also enjoys ghazals and thumris and at times bhajans.

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Who should pay for rating – investors or issuers? In the aftermath of the GFC this has become a point of serious debate. Credit Rating Agencies (CRAs) maintain that their internal systems and procedures are adequate to take care of any conflict of interest between their marketing (get more business) and rating functions. Others are not so sure. Many seem to be thinking that an investor-pays-model will be better. CRAs are quick to point out that an investor-pays-model too will give rise to pressures for favourable (better) ratings as any down-gradation will force the investors to take a hit on their profits. I think we need to be more imaginative about the model and we also need to be clear about the role and functions of a rating agency.

Credit ratings started as investment recommendations, paid for by the investors. Only after the Second War the issuer-pays-model really took off. This model permitted CRAs to recruit an array of professionally qualified analysts, streamlined the rating process & methodology and to some extent it took the mystique away from the business of rating. In practice an issuer asks beforehand what the likely rating of their next issue is. CRAs play demure but hint at what could be done to improve rating. (Often they have made special teams that work closely with their marketing wings to educate the issuers on structuring (read rating) of unusual instruments.) GFC, many insinuate, came from the failure of CRAs. I make no such insinuation. I assert it. They had / have a fiduciary role and they failed. I have posted about it earlier too, see here.