Exportaciones de productos agrícolas ecuatorianos a EEUU

Closely related to the compliance of CRAs to the regulation is the subject of what actions are taken to correct their misconduct.

In January 2015 SEC announced charges held against S&P which was the first endorsement action ever conducted on the big three CRAs. The press release mentions three orders against S&P which are already being settled (violation of rating methodology, false and misleading publication and RMBS surveillance issues).111 _{The CRA is settling the order by paying out $77}

mln fine of civil charges. There is also an ongoing order in which SEC investigates whether the head (Barbara Duka) of S&P CMBS Group concealed the less stringent methodology of

110. The CRA also informs about the solicitation status of the issuer.

111. The first case relates to misrepresentation of the methodology used when rating CMBS transactions. As a result of not disclosing the methodology which was being used, as opposed to the one S&P claimed to be in place, S&P agreed to withdraw from rating conduit fusion CMBS. After the enforcement, and as a way of getting back to the CMBS market and convincing market participants about its conservatism (stemming from the new rating criteria), S&P issued the “false and misleading article” (SEC, 2015). The research was found to be using the erroneous data and to be built on incorrect assumptions. The final order relates to deficiency in the surveillance of RMBS ratings. S&P altered one of its basic assumptions when rating these debt obligations which effectively made the ratings less conservative. According to the SEC, the outlined orders are violations of sections such as fraud, internal control, books and records violations and lastly no documentation explaining discrepancy between output of the numerical model and ratings.

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the CMBS ratings. Public hearings are scheduled by the SEC Enforcement Division to determine if the allegations hold and if countermeasures are required (SEC, 2015).

Interestingly, the other two of the big tree CRAs did not undergo examinations by SEC or DOJ in the recent times. Neither did they receive penalties for their ‘contribution’ in deteriorating economic conditions leading towards financial crisis as widely expressed by market participants and academics (Hill and Faff, 2010; Financial Times, 2013; Alsakka et al., 2014). In September 2010 SEC dropped fraud charges, aimed at Moody’s, which originated in 2007 due to a computer defect when rating CDO products (FT, 2010). As of February 2015 DOJ was at the preliminary stage of inspecting the CRA and its allegedly inflated MBS ratings from the pre-crisis period (Reuters, 2015b). It is not certain whether there will be a lawsuit. To this point Fitch was not subject of legal scrutiny by the US Justice Department.

The timing of the empirical investigation of this chapter gives a mixed picture of S&P in comparison to other CRAs. At the same time, focus of the regulatory attention and significant fines imposed on solely S&P raises the question whether the CRAs are subject to the same treatment by the regulator.

The first enforcement action on the CRAs in Europe was handed down by ESMA on the 29th June 2015 to DBRS for insufficient internal controls in place (ESMA, 2015a). However, the fine of €30,000 seems inconceivably small and not worth the effort of the legalities to conduct assessments and carry out inspections. In this respect the monetary value of the penalties and the interventions taken by the regulators should be commensurate with the amount of time spent and other costs involved when inquiring and inspecting the CRAs. Otherwise it might leave the market participants and CRAs in belief that the regulator is lenient and the consequences of not complying with regulation are not severe enough to avoid them.

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4.2.2.5 Business model of CRAs

The predominant business model of the CRAs has raised number of criticisms over the recent years. The issuer-pays112 _{remuneration approach offers rating information to the wider market}

(academics and market participants) and not only investors who purchase ratings as it is the case in the investor-pays113 model. It also eliminates the free-rider problem which might result in better quality of ratings (see section 2.5 and 2.5.1). Although both remuneration models are prone to the conflict of interest the issuer-pays model is questioned more frequently.

Some of the problems mentioned by policymakers include independence of CRAs as well as high market concentration where often shareholdings between CRAs and rated institutions overlap (SEC, 2009) (also see section 2.6.4). For instance, such conflict of interest might lead to shopping in ratings and put pressure on the level (thus quality) of ratings assigned by CRAs (e.g. Becker and Milbourn, 2011; Hau et al., 2013; for more information see section 3.4). Some commentators claim that the issuer-pays model leads to the failure of CRAs. The chief economist for the Financial Times Wolf (2009) believes “It is a scandal that the model of

payment for the credit rating agencies has not been changed. They should be paid by agents for the buyers not by the sellers.” The theoretical literature also calls for implementing the

investor-pays model (Mathis et al., 2009; Skreta and Veldkamp, 2009; Sy, 2009; Pagano and Volpin, 2010; Bolton et al., 2012).

On that note the World Bank (2009) published a revision document where the introduction of the subscriber-pays model is encouraged. Nevertheless, the report sheds light on the possible side effects of implementing such system. For example, the investors are unlikely to replace the income stream to the CRAs with their individual subscriptions. Additionally, the smaller issuers or less frequently traded issues could receive less interest in being rated. Others including CRAs believe that the conflict of interest rather being minimised could shift from the issuers to investors. The supranational organisation suggests hybrid solution, where the issuer pays for the rating the conventional way and searches for the second rating released by subscriber-pays based CRA,114 as a viable resolution to the problem.

112. The issuer employs the CRA to issue the rating.

113. In the investor-pays model the CRA attracts investors who purchase the right to view (single or) pool of credit ratings issued by them. These buy-side credit ratings are self-motivated and an effect of private needs of investors (Duan and Laere, 2012).

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In the same vein, Calomiris (2009a) criticised changing the model and stressed that the

investor-pays model would result in inflated ratings. Namely, the investors would compensate CRAs for underestimating risk since the high ratings relax the regulatory constraints as to in which products they can finance. Additionally, Richardson and White (2009) allude to the free rider problem which might not be resolved even with increased competition.

SEC (2003) claims that although the conventional model gives rise to conflicts of interest and often inflated ratings, market participants consider CRAs to be successful at mitigating these problems. Additionally, it is argued that CRAs do not allow themselves to engage in short- sighted monetary aims by releasing low quality ratings due to reputational concerns (Schwarcz, 2002; Covitz and Harrison, 2003; SEC, 2003; for more see section 6.3.2 and 6.3.3). However, the subsequent experience of the US sub-prime crisis has starkly identified that practices in different rating segments (e.g. structured finance versus corporate ratings) can be vastly different. Publicly available ratings increase discipline in the field and prove to be a low-cost coordination mechanism (Boot et al., 2006).

To date, there is limited empirical evidence on which CRA business model is more appropriate (Jiang et al., 2012). A body of literature suggests that subscriber-paid ratings tend to be more timely and informative than the issuer-paid ratings (Beaver et al., 2006; Cornaggia and Cornaggia, 2013; Xia, 2014; Bruno et al., 2015).115 Bruno et al. (2015) suggest they the former are more timely because it is the paying investor who demands the rating therefore incentivising a CRA to update them more often.116

Further, Xia (2014) adds to the literature which finds a negative connection between the new entrant CRA and the incumbent CRA’s information quality.117 _{Unlike other papers it considers}

the investor-paid CRA (EJR) which enters the market and compares the performance of the

issuer-paid CRA(S&P) as an effect of that. The presence of the former appears to improve the discipline and the quality of ratings by the latter CRA in line with the reputation cost

115. Although the paper finds that ratings based on the investor-pays model are more timely and symmetric they do not advise against the converse model as a solution to the rating inflation. Firstly, because if all ratings are buy-side type some CRAs might provide ratings to those investors who prefer when they are inflated to be able to be compensated for their risk. Secondly, the conventional model “facilitates public dissemination of ratings which serve as a disciplinary tool and a low-cost coordination mechanism” (Bruno et al., 2015; p.27).

116. In their study, the CRA operating under this model (EJR) updates its ratings three times more often than the one of the largest CRAs operating under the issuer-pays model (Moody’s). Moreover, the former ratings are more symmetric with respect to positive and negative rating events.

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hypothesis/channel (Mathis et al., 2009; Skreta and Veldkamp, 2009; Bolton et al., 2012; Bar- Isaac and Shapiro, 2013; Fulghieri et al., 2014; Opp et al., 2013).

What has to be considered is that the little literature which focuses on the subscriber-pays based model118 _{does not inquire about (the proportion of the) number of analysts involved in the}

rating process (to the amount of outstanding ratings). This chapter is unique in this sense as it presents long reaching comparison of the CRA market with regards of staffing against the rating output (see section 4.4.2 and 4.4.2.2).

Furthermore, the credibility of the investor-pays model has been undermined when EJR and its president Sean Egan (the only CRA fully operating under this model) were banned by SEC in January 2013 from issuing ratings to sovereigns and asset-backed securities (SEC, 2013). Paradoxically the allegations concern the violations of the conflict of interest and misreporting information. Prior to that, the CRA was openly expressing its critique over the issuer-paid

CRAs and the flaws of the industry operating under this theme. Active participation in the CRAs’ and SEC hearings resulted in numerous regulatory proposals and triggered uncertainty of market participants involving the credibility of the current paradigm and the big three CRAs in particular (Lindorff, 2001; Greenberg, 2002; Morgenson, 2002; Egan, 2003, 2009).