Beyond these implications of my study, the European sovereign debt crisis has led to further criticism of CRAs for their political judgments (see chapter 1). How have rating agencies and regulators responded to these criticisms since 2011?
7.3.1
Rating Agencies’ Response
As shown in this study, political factors are indispensable rating drivers and CRAs have good reason for incorporating them in their ratings as indicators for a government’s willingness to repay. For CRAs, this finding implies that they should not simply disregard their political analysis in response to criticism of their political assessments. Neglecting political factors would decrease the reliability of sovereign ratings. In response to criticism in the debt crisis, CRAs have instead opted to become first more transparent and second to rely more on quantitative political indicators compiled by other institutions.
CRAs have become more transparent in recent years by publishing longer and more precise rating methodologies, by discussing changes to their methodologies with investors, and by providing additional reports to explain their decisions. All of these actions were attempts to fend off criticism of their “secrecy and vagueness” (Biglaiser & Staats 2012: 518) and their “opaque” work (Beaulieu et al. 2012: 731).
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First, as analyzed in section 3.3, CRAs have published more extensive methodologies in recent years. Until the crisis in 2009/2010, rating methodologies by all three CRAs were about 7000 words or less (S&P 2002, 2004, 2005, 2006b, 2008, 2010b, 2011a, 2013a, Moody’s 2006, 2008, 2012b, Fitch IBCA undated, Fitch 2009, 2011a, 2011b, 2012a). In their most recent methodologies, CRAs now provide more than double that amount of text (ibid.). But these methodologies are not only longer, but also more specific on the indicators that CRAs use in their risk assessments. In its 2011 methodology, Fitch has published a quantitative sovereign rating model for the first time (Fitch 2011b). Moody’s also revealed the weighting of sub-factors and details of specific indicators in its proposal for a new methodology in 2012 (Moody’s 2012b). Second, Moody’s proposal for a new methodology was also a new way for CRAs to engage investors. Moody’s specifically asked for “market feedback on a range of refinements” (2012b: 1). In a similar way, S&P had already requested comments on its new methodology in 2010 (S&P 2010c). These calls for comments are attempts by the CRAs to ensure that their sovereign ratings remain relevant to and accepted by investors.
Third, in response to public criticism, CRAs have also published additional reports to explain their decisions in the European debt crisis. For instance, S&P published a research update on 22 June 2012 titled, “In the Debt Debate, Our Sovereign Ratings Have No Austerity Bias” (S&P 2012b) to convince the public that they do not demand harsh austerity measures. S&P also directly responded to criticism of its sovereign ratings issued in an academic working paper by Gärtner and Griesbach (2012) (S&P 2012c). Moreover, S&P’s then Managing Director for European sovereign ratings, Moritz Kraemer, explained S&P’s decisions in many interviews, in talk shows, and as guest at political events (see, e.g., Grüne Bundestagsfraktion 2012).
In addition to increasing transparency, in recent years, CRAs have also begun to rely more on quantitative political indicators compiled by other institutions. By using these external quantitative political indicators, CRAs can shy away from making their own assessments and claim to use objective indicators that are not based on their subjective political analysis. The introduction of new external quantitative indicators is evident for all three political factors analyzed in this book.
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All three CRAs have started using some external quantitative indicator for the quality of a country’s economic liberalization policies. Fitch provides the World Bank’s stability and ease of doing business indicators in its sovereign risk database (Fitch 2012b, see also section 3.3). As shown in my text analysis, Fitch has used these indicators for the first time in 2007. S&P also mentions the World Bank’s Doing Business reports in its 2010 and 2011 methodologies (S&P 2010b: 15, S&P 2011a: 12) although they suggest they still rely mostly on their qualitative analyses and have dropped references to these reports in their most recent methodology updates (S&P 2013a). Moody’s mentions the World Economic Forum Competitiveness Report for the first time in its 2008 methodology and also takes this measure into account as one specific sub-indicator in its 2012 proposal for a new methodology.
For their assessments of a country’s political institutions, all three CRAs have begun to refer to the World Bank Governance Indicators in recent years. As shown in the text analysis in chapter 5, Fitch mentioned this indicator for the first time in 2008 in a rating action for Israel and regularly only since 2010.135 Moody’s started to use the World
Bank Governance Indicators in 2010.136 As for the liberalization policies, S&P only
refers to this indicator in its 2010 and 2011 methodologies, but not anymore in its most recent methodology (S&P 2010b: 15, S&P 2011a: 12, S&P 2013a). S&P still sees a strong need for qualitative judgments in its assessments of political stability and elections (ibid.).
In its most recent 2013 methodology update, S&P also introduced some external quantitative assessments for evaluating the compliance with international agreements. In contrast to the period up to 2010 that is investigated in this book (see chapter 6), S&P now started to refer to the IMF’s Special Data Dissemination Standard as part of its balance of payments analysis (S&P 2013a: 21) and to compliance with Article VIII obligations as part of its monetary policy analysis (S&P 2013a: 31).
It remains to be seen whether these recent methodological changes actually increase the acceptance of sovereign ratings by investors, policy-makers, and the general public without decreasing the quality of sovereign ratings. For now, these changes are one
135 Fitch: 2008_02_11 for Israel, 2010_02_16_Jamaica, 2010_08_24_Rwanda,
2010_11_26_HongKong, 2011_02_03_Seychelles
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way for CRAs to limit criticism of their qualitative political judgments without neglecting political factors completely.
7.3.2
Regulators’ Response
As I have argued in chapter 2, sovereign ratings derive at least some of their impact from regulatory endorsements. Public regulation forces financial institutions to use the sovereign ratings of the three main CRAs. In response to the debt crisis, policymakers have tried to reduce their regulatory reliance on credit rating agencies’ assessment of political factors. However, all attempts to reduce reliance on sovereign ratings on the international level, in the US, and in the EU have been unsuccessful.
On the international level, policymakers and regulators have discussed reducing their reliance on the three main CRAs at several meetings without taking any clear decisions. The new Basel III framework did not remove the central role of rating agencies (BCBS 2011: 51ff.) although the Basel Committee on Banking Supervision continues its discussions on this issue (see FSB 2013a: 1). In 2010, the Financial Stability Board passed a list of principles for reducing over-reliance on ratings (FSB 2010). The FSB published its most recent report and an interim peer review report on 29 August 2013 for the St Petersburg G20 Summit (FSB 2013a: 1). Except for the US and the EU, the FSB sees a lack of progress in most jurisdictions (ibid.).
In the United States, the Dodd-Frank financial reforms force the US regulatory agencies to find alternative indicators to the assessments of the three leading CRAs. For sovereigns, the US regulatory agencies wanted to use official sovereign ratings produced by the OECD (Federal Deposit Insurance Corporation 2012: 21, BCBS 2012: 23). As discussed in chapter 2, the OECD strongly objects to the US’ use of its country risk ratings and has simply stopped publishing any ratings for high income OECD and Euro area countries (OECD 2013c). This leaves US regulators without any alternatives to the sovereign ratings provided by the main CRAs.
In the European Union, the European Parliament called for the creation of a European credit rating foundation in a resolution in 2011 (European Parliament 2011). But the European Commission has not followed up on this proposal. The European Union also shied away from promoting banks’ own internal sovereign risk assessments in the EU’s revision of the capital requirements directive (EC 2013a: 31). According to the EC, “sometimes external ratings – however imperfect – remain the best solution available”
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(EC 2013a: 31). Moreover, they had learned from the US experience that it would not be appropriate “to remove references to ratings without having alternatives in place” (EC 2013b: 11). Instead, the European Union has passed three regulations since 2010 with two main attempts to reduce reliance on the three main CRAs (see EC 2013b). First, the EU tried to promote rating competition. For this purpose, the EU has introduced a common registration procedure and publishes all ratings on a common platform (ibid.). The EC also discussed the introduction of a rotation model, which would have forced issuers to change CRAs and hire new ones (EC 2013b: 10). But in the end, the EC proposed this model for all ratings except for sovereigns and the European Parliament limited the rotation model only to the ratings of re-securitizations. It is thus unlikely that the new regulations will promote competition in the sovereign rating market.
In particular, it is unclear how new competitors can finance their sovereign rating business as more and more states do not pay for their sovereign ratings. New competitors have therefore better chances in other niches, such as in the rating of insurance companies or specific financial products. Despite the wide attention to sovereign ratings during the European debt crisis, new competitors were mainly unsuccessful in entering the sovereign rating market due to a lack of financing. Only four of the 17 newly EU-recognized CRAs until the end of 2012 provide sovereign ratings and one of these CRAs, Capital Intelligence (Cyprus), has already withdrawn most of its sovereign ratings (ESMA 2013a).
The German consultancy Roland Berger tried to establish a new independent European rating agency financed by a foundation backed by financial companies (Roland Berger 2012). But their proposal failed due to a lack of investors (EU Observer 2013). The Bertelsmann Foundation also proposed a new sovereign rating agency financed by an international non-profit foundation (Bertelsmann Foundation 2013). Thus far, their proposal has not led to the creation of a new rating organization. It is also unclear why their new sovereign model should perform better than the sovereign risk assessments by the three main CRAs. The Bertelsmann Foundation suggests that the new competitor could produce better sovereign ratings if it paid attention to “qualitative indicators in addition to traditional macroeconomic data” and political indicators “such as governance” (ibid.). However, as argued in this book, the three main CRAs already take political factors into account in their rating assessments.
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Second, the EU chose to regulate and supervise CRAs more closely. In an attempt to reduce the market impact of sovereign ratings, CRAs are only allowed to publish rating changes on Fridays after close of business (EC 2013b). Moreover, CRAs have to announce changes to their methodologies, ask for comments, and give explanations for their changes to the European Securities and Market Authority. ESMA can also investigate CRAs. In December 2013, the regulatory agency published its first results of a sovereign rating investigation. All of these measures increase regulators’ influence on CRAs’ choice of criteria (ESMA 2013b).
However, conflicts of interest are apparent if governments attempt to meddle with their own sovereign ratings produced by private companies. Moreover, stricter state regulation could limit CRAs’ leeway to update their criteria and to base their decisions on important qualitative political factors, which could reduce the accuracy of sovereign ratings. The new common registration procedure and the regulation and supervision of rating methodologies also give the impression that ratings have an official seal of approval. Without regulatory endorsements, CRAs’ risk assessments would be one opinion on sovereign risk among many others. If the attempts to promote rating competition fail, the new regulations might thus even embed ratings more strongly into the regulatory system and force investors to use them.