From The Archives: Integrity of rating agencies called into question
AS THE ECONOMIES of more nations go into recession, one investment analyst has criticised the role of credit rating agencies, particularly in the sub-prime mortgage crisis that triggered the global financial meltdown.
Eric-Vincent Guichard, chief investment officer of Gravitas Capital Investors, a Washington, DC-based investment advisory firm, called into question in a presentation to the 35th Annual General Meeting And Conference of Caribbean Association of Indigenous Banks the impartiality of the ratings given by rating agencies based on how they operated.
“If you keep in mind that people behave according to the systems that they are subjected to, then you have to look at the ratings agencies’ business model,” Guichard said.
Currently there are three dominant international credit ratings agencies – Standard & Poor’s, Moody’s and Fitch – assessing the creditworthiness of companies and countries. Each of the three operate on an “issuer pays” model, which means that the entity issuing the security seeks a rating and pays a fee to be rated by the agency.
Asking for trouble
But, said Guichard, that was asking for trouble.
Since rating agencies have an interest in being paid by the companies they work for, that could compromise the integrity of the ratings they issue.
“There is an inherent conflict of interest in that business model. The key issue here is: who should be paying for the rating? Should it be the entity that’s trying to sell its bond to the marketplace? The answer is no,” he said.
Instead, suggested the investment analyst, investors should be the ones to pay the ratings agency since they are the ones, ostensibly, who would benefit the most from an accurate and unbiased assessment.
“And how do you get a million, two million people to pay fees when you don’t even know where they are? The exchanges that list companies should be responsible for collecting the funds in order to retain the rating agencies to make those independent assessments. In that case, the rating agencies are not beholden to their clients, they are beholden to the exchange,” Guichard said. (OC)