17 November 2011

Paul N Goldschmidt: Rating agencies - misguided Commission proposals

The inexcusable error of Standard and Poor's in releasing an announcement concerning the loss of France's triple A rating has considerably reinforced the "emotional" appeal of further poorly thought-out reforms of the rating industry.

First it should be quite obvious that the market has decided - rightly or wrongly - that France does no longer deserve the AAA as the spread over Bunds reaches - as I write - 170bp. This fact can no longer be attributed to the S&P mistake. This assessment by the market is based on two main factors: France's poor economic outlook which will cause further austerity measures to meet the French commitments on the budget deficit, but more importantly, the lack of political consensus between Government and opposition which translates itself by the obligation of the opposition to criticise every Government measure as part of their "electoral" strategy. This typically French characteristic will pollute the eurozone debate on further economic and fiscal integration until the elections next May and weigh heavily on the market's assessment of French creditworthiness. It may also be to late by next May to save the euro!

Turning to the proposals themselves, their intrusiveness in several key aspects is likely to harm very seriously the unquestioned usefulness of ratings and lead to greater market volatility. Ratings are, and should remain, private "opinions" expressed by respected professionals. It is right to frame rules that cover areas such as "conflicts of interest" as well as transparency of the methodology used by agencies. It is wrong to interfere with the freedom of issuers and investors to rely on the ratings they choose to trust by imposing a mandatory "rotation" in a poorly thought-out copycat measure inspired by the regulations applied to auditors. The idea of even a restricted form of "suspension" of ratings is also bound to be counterproductive as the measure - should it ever be used - will in itself create a negative market feedback loop.

The most important initiative that the Authorities could take in the area of ratings is to remove all instances where ratings are used as “legal” criteria of eligibility for assessing risk parameters, mainly in the field of the use of securities as collateral (ECB) or the determination of risk in investment portfolios of insurance or legal pension funds. Rating agencies are requesting such a move. This would not prevent private institutions from using ratings as a "tool" and under their own responsibility in assuming their credit assessment responsibilities or as a reference in private contractual agreements.

The Commission should realise that this is not the right moment to overhaul fundamentally the rating industry in the middle of the crisis. It will unavoidably give rise to criticisms that it is itself at the heart of "conflicts of interest" it wishes to "regulate".

Original Commentary

© Paul Goldschmidt