SCCL Conference
Competition and Credit Rating Agencies
Dr. Aline Darbellay
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June 14, 2012
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Introduction
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US Commercial Mortgage Market
 «In July last year Goldman Sachs and Citigroup cancelled a
$1.5bn securitisation of commercial mortgages after S&P found
potentially conflicting methods in the way the agency rated new
and existing deals. […] no issuer has since hired S&P to rate
[CMBS]» (Financial Times).
European Sovereign Debt Crisis
 «Moody’s warned […] that developments in Spain and Greece
could prompt “a fundamental reassessment of credit risk” across
the eurozone and include a review of all sovereign ratings,
including those of triple A-rated nations» (Financial Times).
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The Credit Rating Agency Oligopoly
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Highly Concentrated Industry
 The Big Three: Moody‘s, Standard & Poor‘s and Fitch
 98 % of all outstanding ratings
 90 % of the total rating revenues
 Approximately 150 other smaller CRAs
Challenges:
 Economies of scale
 Reputational barriers
 Barriers of entry
 Alternatives to credit ratings
 Concerns about the effects of competition
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Credit Ratings Outstanding
Source: 2011 Report of SEC Staff’s Examinations of each NRSRO
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Credit Ratings Outstanding
Source: 2011 Report of SEC Staff’s Examinations of each NRSRO
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Competition Concerns
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Lack of Competition Among Credit Rating Agencies
 Over-reliance on certified credit rating agencies
 The use of credit ratings for regulatory purposes distorts
competition
 Over-reliance on the Big Three
Lack of Competition Between Credit Rating Agencies and Other
Gatekeepers
 Over-reliance on the credit rating industry as opposed to other
financial information providers
 Diversity of opinions on credit
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The US Approach
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Credit Rating Agencies Reform Act of 2006
 Competition as a core objective
 Designation of more NRSROs
Subprime Mortgage Crisis
 Counterproductice effects
 Rating Shopping
 Race to the Bottom
 Inflated credit ratings
 Over-reliance on credit ratings
 Idea: it is not possible to enhance competition as long as CRAs
perform a regulatory function more than a private function
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Dodd-Frank Act of 2010
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No Mention of Competition as an Objective
Emphasis on Withdrawal of Regulatory References to Credit Ratings
 Removal of statutory references to credit ratings
 Every Federal agency has 1 year to remove regulatory references to
credit ratings
 Looking for alternatives to credit ratings (e.g. market-based
measures)
 Opening the door to new entrants
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Dodd-Frank Act of 2010
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Liability Regime in the Securities Regulations
 Idea: no longer immunity from lawsuits
 2 dispositions in the Securities Regulations
 State of Mind
 Expert Liability
Disclosure Requirements
 Annual reports to the SEC and the public
 Transparency of ratings performance and methodologies
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CMBS Market
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Source: Commercial Mortgage Alert
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AAA Subordination and Pool-Level Delinquencies
for Fixed-Rate Conduit/Fusion CMBS
Source: Commercial Mortgage Alert
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Source: Andrew Cohen, Rating Shopping in the CMBS (2011)
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Competition in the CMBS market
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July 2011: S&P discovered an error in its methodology, and withdrew a
rating of a $1.5 billion Goldman/Citigroup bond offer.
No issuer has since hired S&P to rate CMBS offerings.
«After losing market share, S&P tries CMBS ratings revamp» (Reuters)
 Under the proposed new criteria, 10% of the outstanding CMBS
ratings could be upgraded and 15% downgraded.
 «At first glance, it seems the magnitude of the changes will
disappoint most investors» (Harris Trifon, Deutsche Bank)
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Competition in the CMBS Market:
Promise and Perils
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Promising Aspects
 Reputational constraints seem to function
 New entrants: Morningstar and Kroll
 «We feel there’s a great deal of room to do better work than the Big
Three credit rating agencies» (Jules Kroll)
Dangers
 Rating Shopping
 Race to the Bottom
 Pressures from the big underwriters
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The EU Approach
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Sovereign Debt Crisis
 Blame on the Big Three for exacerbating the crisis
 Greece: Apr./May 2010: interest rates of Greek debt rose sharply
when Greek bonds were downgraded by S&P and Fitch
 Recent Spanish bailout
Emphasis on the Excessive Market Power of the Big Three
«There are not enough ratings agencies, not enough competition and not
enough diversity. […] Why should there not be an agency that is more
European that those that exist today?» (Michel Barnier)
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EU Regulations on Credit Rating Agencies
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EU Regulation on Credit Rating Agencies of 2009
May 2012: Publication of the First Regulatory Technical Standards on
Credit Rating Agencies by the ESMA
Competition as a Leading Objective
 Establishing a European rating agency
 Promoting smaller competitors
 Lowering barriers to entry
 Improving comparability of credit ratings
 Reinforcing the independence of the credit rating agencies
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EU Regulations on Credit Rating Agencies
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Oversight
 Supervision through a centralized authority: ESMA
 Registration and certification process
Availability of Information
 Transparency report
 Information on historical performance in a central repository
 Disclosure of methodologies
Objective to Reduce Over-Reliance on Credit Ratings
Considering Alternatives to Credit Ratings (e.g. internal models, market
data)
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Implied Ratings Based on CDS Prices (2011)
Sources: Wall Street Journal, Markit, credit rating agencies
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Recent Spanish Bailout
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June 5: «The men in black will not be coming to Spain» (Spanish
Treasury Minister Cristobal Montoro)
Pressures
 High borrowing costs in the sovereign bond market
 Greek elections on June 17
 IMF report on the Spanish banking sector
 June 7: Fitch downgrade by 3 notches, from A to BBB
 Moody’s report – «Moody’s tries to ruin our weekend, would have
succeeded were it not already ruined» (Financial Times)
Conference Call between Eurozone Finance Ministers on June 9:
 100 billion euros
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Conclusion
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US and EU:
Two Different Approaches to Competition in the Rating Industry
Common Grounds:
 Need to reduce over-reliance on credit ratings
 Regulatory over-reliance
 Behavioral over-reliance
 Transparency
 Disclosure requirements
 Comparability of credit ratings
In sum: enhancing competition is a crucial aspect of the reforms, but
only if associated with the withdrawal of the regulatory use of credit
ratings