Moody’s Investors Service, Standard & Poor’s and Fitch Ratings are the troika of U.S.-based global credit rating agencies. The roots of these credit rating agencies date back to the middle of the 1800s in the U.S. The origin of Standard & Poor’s was when Henry Varnum Poor published History of Railroads and Canals of the United States in 1860, which compiled information on railroads companies, the most capital intensive industry at the time. Their scope of information coverage expanded gradually and took a quantum leap going through the Great Depression by providing credit rating information.
The lingering global financial crisis has made people aware of the increasing global influence exerted by the credit rating agencies. Even sovereign states bite their nails when their new rating adjustment is due, because a rating change would entail a lot of things including, most notably, an increase or decrease of the national cost of financing.
Not surprisingly, downgrades spark immediate outcries from countries involved. When Standard & Poor’s lowered the U.S. sovereign rating in August last year, the U.S. lashed out at the decision, claiming that the New York-based credit rating agency got it all wrong. President Barack Obama accused the agency of failing to take into account an accurate picture and declared that regardless of the downgrade “the United States will always be a “AAA” country.” This time the outcry comes from Europe. On Jan. 13, Standard & Poor’s downgraded the sovereign ratings of nine countries in the 16-country eurozone. Most noteworthy is the one-notch downgrade of France from the previous “AAA” to “AA+.” Disagreeing European Commission officials in Brussels even raise the issue of transparency of the internal review process of these agencies, coupled with a possibility of setting up its own credit rating agency.
Europe’s lackluster response to the financial emergency situation would hardly get any sympathy from anyone. But, at the same time, the tit-for-tat between the credit rating agencies and sovereign governments makes us pause. Critics argue that these agencies are not always privy to all the ins and outs of governmental policy formulation which is mostly done on a confidential basis. The statement of Standard & Poor’s upon its Jan. 13 downgrade announcement reads: “Today’s ... actions are primarily driven by our assessment that the policy initiatives ... taken by European policymakers ... may be insufficient to fully address ongoing systemic stresses in the eurozone.” It shows that the gist of the action is the private entity’s overall assessment of the financial policies of 16 Eurozone governments. This is quite a task to be performed by a private entity.
The governments are held liable to their domestic constituents. But to whom are the credit rating agencies held liable? Perhaps their shareholders? In fact, the sensitivity of the roles of the credit rating agencies has prompted the U.S. governments to take regulatory steps, such as Credit Rating Agency Reform Act of 2006, to insulate these entities from ulterior motives or conflict of interest. A suggestion that an international credit rating agency should be established reflects the realization that probably too much is at stake to leave the credit rating in all private hands, considering the enormous impact flowing from any credit rating decision.
Controversies aside, the increasingly important role the credit rating agencies play is undeniable. The authority wielded by these agencies offers an interesting instance where we could observe a reversal of roles: for a long time, it has been the states telling private entities what to do, but somehow private entities are essentially telling the sovereign governments what to do, when it comes to financial or economic policies.
Interestingly, despite all the perils, the reliance of lenders, investors and companies on the credit rating service in making business decisions has been increasing. Indeed, standardized presentation of risk relating to a particular entity, as offered by credit rating service, is hard to come by somewhere else. If credit rating constitutes an indispensable ingredient of the global economy and international business transactions, it may be more prudent for an international agency to take up the role. Evaluating governmental policies of all major countries in the world goes beyond the reasonable purview of a private entity. Recent exchanges of barbed words between credit rating agencies and sovereign governments seem to support the proposition.
By Lee Jae-min
Lee Jae-min is a professor of law at the School of Law, Hanyang University, in Seoul. Formerly he practiced law as an associate attorney with Willkie Farr & Gallagher LLP. ― Ed.
