loic sarton

1. The role of external ratings in regulation?
Are rating agencies independent and transparent?
Do they have an oligopolistic position?
BRIDOUX Jonathan
DAKE Mensah Augustin
PERCY Cédric
LSMS2020- Risk Management of Financial Institutions (Part 2)
Professors : HENRARD L. - OLIESLAGERS R.
25 avril 2012

2. Introduction
▫ Credit Rating Agencies (CRAs)
▫ Structure
1) Role of external ratings in regulation
2) Transparency and independence of CRAs
3) Oligopolistic situation : The “Big three”

3. Since BASEL II (first pillar)
a) Important role of CRAs in banks’ capital requirements
IF
the standardized approach is chosen
NOT IF
the internal ratings based approach is chosen
Role of external ratings in regulation

4. « Regulatory role » in determining the capital requirement :
 Boost for CRAs
Nevertheless,
1) “External Credit Assessment Institutions” (ECAIs) validated by national
supervisors
2) Banks can choose among the different ECAIs for the Standardized approach
3) As banks have the choice… Is it objective ?
New role of CRAs…

5. • Some official institutions (IOSCO, SEC….) asked for more transparence from CRAs in
their methodologies
• First, the United states Securities and Exchange Commission (SEC)
• In 2005 , SEC released several recent regulatory initiatives
• Second, the International Organization of Securities Commissions (IOSCO)
• In 2004 , IOSCO implemented the code Fundamentals
• IOSCO set up three aspects of CRAs:
-quality of rating
-integrity of rating
-CRA responsibilities to the investing public and issuers
The transparency and independence of CRAs

6. • No real evolution regarding the transparence has been shown
• CRAs give some factors that are used to compute ratings
• But don’t publish the relative weights that are assigned to factors exposed in their
publications
• An effort must be made by both the CRAs to improve transparency and by the
authorities that can be stricter and bring more discipline.

7. • The rating agencies have conflict of interest
• The Agency becomes judge and part
• CRAs could be influenced to give a better rating than the deserved one in order
to gain or keep their clients
• This conflict of interest is due to the fact that issuers can choose their own CRAs
• In the European Union , the European Securities and Market Authorities
(ESMA) goes against the problematic of independence
• The big three would like to increase their political power
• Another example of conflict of interest is between Moody’s and Verkshire
Hathaway
Independency of CRAs

8.  Drivers of the oligopoly in the rating industry
High barriers to entry
a) New entrants have a fewer capacity (resources and skills)
 lower quality of ratings and lower number of issuers analyzed
b) Price competition is not a solution for new entrants because
quality of their ratings may decrease
c) Difficult to obtain a strong reputation and a great credibility
 difficult to attract issuers
The oligopolistic position : The « Big Three »

9.  Regulatory protection
• In 1975, th SEC designated the « Big Three » under the NRSRO
denomination
• During the next 25 years, only 4 additional agencies received this
status
• In 2000, return to the previous situation
• The NRSRO denomination reinforces confidence
• Lack of transparence about the selection criteria used by the SEC

10.  To cut a long story short:
Regulatory protection + high barriers to entry
=
Dominant position of the « Big Three »

11. Conclusion
CRAs have gained in importance thanks to Basel II
(first pillar)
Lack of transparence from CRAs in their
methodologies and processes
 CRAs are not perfectly independent (conflict of
interest,…)
Ratings industry is an oligopolistic market due to
high barriers to entry and regulatory protection

12. • Do you think that because of Basel II, banks and
investment firms rely too much on CRAs ?
• Is the oligopolistic situation of CRAs
sustainable?
• Should we implement an indepedent CRA in
Europe? If yes, why ?
Some questions