1 1 Credit Rating Agencies and developing economies I. Introduction The 21st century has been characterized by a relative scarcity of sovereign defaults and major restructurings, with notable exceptions like Greece and Argentina. Wave after wave of monetary loosening may have helped to keep financing conditions easy and global investors on an increasingly desperate lookout for yield. All too often they found that yield in emerging and developing countries (EMDEs), several of them tapping international capital markets for the first time, especially across the African continent. The pandemic induced global economic crisis has put that period of EMDE funding into question. Private capital flows into the poorest countries dropped sharply. In Sub-Saharan Africa, only the most credit worthy countries can currently access the market. Long-term US-Treasury rates have now begun to inch up, making the mostly USD-denominated debt of frontier markets relatively less attractive. In Africa, 2021 is characterized by relatively few principal repayments. But that will change significantly in 2022 and beyond. The risk of sovereign debt restructurings seems likely to rise. The re-emergence of default risk has directed attention to the institutions that are tasked with predicting and declaring defaults: the international credit rating agencies (CRAs), especially the “Big 3” (S&P Global, Moody’s and Fitch). As far as developing economies are concerned, the rating agencies have gained importance compared to previous cycles of sovereign debt crises, such as the one sweeping across Latin America in the 1980s. Back then only a small number of sovereigns even had a sovereign rating at all. In Sub-Saharan Africa, for example, only South Africa had a rating at the beginning of the century. The CRAs role has expanded significantly since. Rating agencies derive their ratings applying published methodologies. While the methodologies, as well as the ratings differ between the three agencies the main building blocks are the same. They consist of an analysis of (i) institutional and governance quality; (ii) economic growth and resilience; (iii) public finances; (iv) external accounts; and (v) monetary flexibility. The agencies typically create indicative “anchor scores” for each of the five rating factors and then apply a “qualitative” overlay. The credit committee can adjust the indicative scores up or down. The rating, which is always determined by a group of analysts in a credit committee is therefore a mix of objective quantitative and subjective qualitative factors. 1 This Policy Note draws on a forthcoming paper written by Stephany Griffith-Jones and Moritz Kraemer, titled “Credit Rating Agencies and Developing Countries; analysis of the issues and policy suggestions”, written for UNDESA.
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1Credit Rating Agencies and developing economies
I. Introduction The21stcenturyhasbeencharacterizedbyarelativescarcityofsovereigndefaultsandmajorrestructurings,withnotableexceptionslikeGreeceandArgentina.Waveafterwaveofmonetarylooseningmayhavehelpedtokeepfinancingconditionseasyandglobalinvestorsonanincreasinglydesperatelookoutforyield.Alltoooftentheyfoundthatyieldinemerginganddevelopingcountries(EMDEs),severalofthemtappinginternationalcapitalmarketsforthefirsttime,especiallyacrosstheAfricancontinent.ThepandemicinducedglobaleconomiccrisishasputthatperiodofEMDEfundingintoquestion.Privatecapitalflowsintothepoorestcountriesdroppedsharply.InSub-SaharanAfrica,onlythemostcreditworthycountriescancurrentlyaccessthemarket.Long-termUS-Treasuryrateshavenowbeguntoinchup,makingthemostlyUSD-denominateddebtoffrontiermarketsrelativelylessattractive.InAfrica,2021ischaracterizedbyrelativelyfewprincipalrepayments.Butthatwillchangesignificantlyin2022andbeyond.Theriskofsovereigndebtrestructuringsseemslikelytorise.There-emergenceofdefaultriskhasdirectedattentiontotheinstitutionsthataretaskedwithpredictinganddeclaringdefaults:theinternationalcreditratingagencies(CRAs),especiallythe“Big3”(S&PGlobal,Moody’sandFitch).Asfarasdevelopingeconomiesareconcerned,theratingagencieshavegainedimportancecomparedtopreviouscyclesofsovereigndebtcrises,suchastheonesweepingacrossLatinAmericainthe1980s.Backthenonlyasmallnumberofsovereignsevenhadasovereignratingatall.InSub-SaharanAfrica,forexample,onlySouthAfricahadaratingatthebeginningofthecentury.TheCRAsrolehasexpandedsignificantlysince.Ratingagenciesderivetheirratingsapplyingpublishedmethodologies.Whilethemethodologies,aswellastheratingsdifferbetweenthethreeagenciesthemainbuildingblocksarethesame.Theyconsistofananalysisof(i)institutionalandgovernancequality;(ii)economicgrowthandresilience;(iii)publicfinances;(iv)externalaccounts;and(v)monetaryflexibility.Theagenciestypicallycreateindicative“anchorscores”foreachofthefiveratingfactorsandthenapplya“qualitative”overlay.Thecreditcommitteecanadjusttheindicativescoresupordown.Therating,whichisalwaysdeterminedbyagroupofanalystsinacreditcommitteeisthereforeamixofobjectivequantitativeandsubjectivequalitativefactors.
1ThisPolicyNotedrawsonaforthcomingpaperwrittenbyStephanyGriffith-JonesandMoritzKraemer,titled“CreditRatingAgenciesandDevelopingCountries;analysisoftheissuesandpolicysuggestions”,writtenforUNDESA.
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Ratingagenciesusecomparableratingscaleswith20rungsfromthehighest(AAA)tothelowest(D),withtheuppertenratings(AAAtoBBB-)beingreferredtoasinvestmentgrade,andthelowerhalf(startingfromBB+)asnon-investmentgrade,orspeculativegrade.Thesimilarityoftheratingsmethodologiesappliedhasledtoacomparabilityofoutcomes,especiallyforemergingmarkets.Therewillalwaysberatingsdifferencesfromonecountrytoanother,butonaveragetheagenciesagree.Theaverageratingofthe70EMDEsratedbyeachoftheBig3onJanuary31,2020,beforethepandemicspreadacrosstheglobewasalmostidenticalforthethreefirms,justbelowBBinthenon-investmentgraderange.Oneyearintothepandemic,theaverageEMratinghasfallenbyalittlelessthanone-halfofanotch,againuniformlyacrosstheagencies.ThehistoricallyobservedpatternofS&Pdowngradingfirstandtheothertwoagenciesfollowing,seemstohavebeenbroken.2Theagenciesnowappeartomoveinlockstep.InsectionII,whichfollows,wewillanalyzethemainchallengesposedbycreditratingagencies,especiallyfromadevelopingandemergingeconomiesperspective.SectionIIIwillexplorepossiblepolicysolutionstothosechallenges.
II. Challenges 1.) Potential bias against EEDEs
Mostofthetimes,ratingsmovegentlyupordownataglacialpace,attimesbrieflyinterruptedbydebtcrisis,eitherinoneorafewcountries,orinmoregeneralizeddebtandfinancialcrises.Ratingagenciesstrivetorate“throughthecycle”,thoughthereisacademicandotherdebateatwhethertheyaresuccessfulinthis(seebelow).Thismeans,thatmostratingschangerelativelyrarely,exceptinmajorcrises,astheyaredesignedtoreflectfundamentalcreditstrengthsandnottheupsanddownsofthecredit,financial,orcommoditymarkets.Therefore,itisusuallydifficulttoassess,whetherratingagenciesfavoronesetofsovereignsoveranother.Todate,however,thefactualevidenceonthishasbeeninconclusive.WepresentsomenewevidencethatmightsupporttheclaimthatCRAshaveaninherentbiasagainstEEDEs.TheCOVID-19crisishasallthehallmarksofapotentialexceptiontothetypicalgradualism:aglobaleconomicshock,thathitsallcountriesonallcontinentssimultaneously,althoughatdifferentintensities.Lookingatthissuddenandbrutalshockwecanassesswhetherratingagenciesdisplaythebiasagainstemerginganddevelopingeconomies.TheeconomicfalloutfromthepandemichasbeenlargerforAEsthanforEMDEs:AccordingtoIMFOctober2020-estimatesAEeconomiescontractedtwiceasfast
2Foranin-depthlead-laganalysisofsovereignratingsseeKraemeretal.(2020)
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(-4.9%)asEMDEs(-2.4%)lastyear.Similarly,theaggregateAEgovernmentdebtratioincreasedby20percentagepointsto124%ofGDP,versusEMDE’sincreasebyninepercentagepointsto61%ofGDP.Notwithstandingthatbiggershock,betweenJan.31,2020andFeb.28,2021,AEsaccountedforonlysixnotchesofdowngradesbetweentheBig3,against125inEMDEs(seeChart1).Inotherwords,althoughAEsaccountfor29%ofallissuerratingsoftheBig3,lessthan5%ofalldowngradeswereappliedtothem.Ifupgradesduringtheperiodunderinvestigationareincludedinthecount,the“netdowngrades”disappearaltogether.S&PandMoody’sevenhadnetpositive(!)ratingactionsforAEsduringthemostferociouspeacetimerecessioninlivingmemory.
TowardsEMDEs,theratingagenciespandemicresponsehasbeenlesscharitable.Chart2displaystheshareofeachagency’sportfolioofratedsovereignsthatwasdowngradedbyatleastonenotch.SovereignsinSub-SaharanAfrica(41%)andLatinAmericaandtheCaribbean(35%)weremostlikelytobedowngraded,followedbyMiddleEast,NorthAfrica,andCentralAsia(25%)andAsia-Pacific(24%).Non-AECentralandEasternEurope(CEE)includesseveraleconomies,especiallytheEUmembersthatareclosetobeingconsideredAEs.Somearelong-standingmembersoftheOECD.LikeAEs,theCEE
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region,too,wasalmostentirelyspared:Moody’sloweredTurkey’sratingandFitchdowngradedArmenia.S&Ptooknoactionintheregion.Amongthethreemainplayers,Fitchwasthemostsevereagencyalmosteverywhere,especiallyintheMiddleEastandNorthAfricaregion.S&Pwastheratingsfirmofferingmostforbearanceinallworldregions,exceptinSub-SaharanAfrica,whereitwasthedowngradeleaderbysomedistance,loweringtheratingsof50%ofsovereignsintheregion.Whatexplainstheseinter-regionaldifferences,andespeciallytheratingsstabilityofadvancedeconomies?Onecouldarguethatrich,diversifiedcountriesaremoreresilienttoshocksthanpoorer,morevulnerableeconomies.Thatisundoubtedlytrue.However,itisalsotruethattheshockdeliveredbyCOVID-19wasnotevenlydistributedacrosseconomies.Infact,thehittogrowthandpublicdebtaccumulationhasbeentwiceaslargeforAEsthanforEMDEs,nottomentiontheirsignificantlylargerdeathtolls.Giventhatcontext,itisnotatallclearwhyrichcountries’ratingsremainedlargelyuntouchedevenastheirpoorerpeersweresubjecttomoreextensivedowngrades.Moreanalysisisrequiredtosolvethispuzzle.ThesemoreextensivedowngradesintheEMDEs,especiallyifnotjustifiedfromaneconomicpointofview,canhavenegativeconsequencesontheavailabilityandcostofprivatecapitalflows,andthereforelevelsofinvestment,ofthosecountries,withnegativeeffectsontheirdevelopmentprospects,aswellastheirabilitytomeettheSDGs.
2.) Pro-cyclicality of ratings3
Oneofthekeypurposesofcreditratingagencies(CRAs)istoprovideaccurateanalysisofcountries’long-termsolvency,inwaysthatdonotvarythroughthecycleorevenbetterthatarecounter-cyclical.Thiswouldcontributetomakeinternationalprivatecapitalflows,whichthemselvesareinherentlypro-cyclicallessso.However,concernshavebeenexpressedbybothemerginganddevelopingcountriesthemselves,aswellasevidenceprovidedintheacademicliteraturethatCRAsarethemselvespro-cyclical,andthereforecontributetomakeprivatecapitalflowsMOREandNOTLESSpro-cyclical,thuspossiblyincreasingtheriskoffinancialcrisesoccurringanddeepening.Thus,forexample,Ferri,G.,L.-G.LuiandJ.E.Stiglitz(1999),basedontheireconometricanalysis,concludedthatcreditratingagenciesaggravatedtheEastAsiancrisisbydowngradingmorethanneeded,whichthenincreasedthecostsofborrowingforcountries,afterfailingtopredictthecrisis.Ratingsinthatcasecontributedtocreateaself-fulfillingprophecy.
3WearegratefultoSabrinaAxterforhervaluablecontributiontothissection
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Indeed,Ferri,LuiandStiglitz,(op.cit.)arguethatbeforetheEastAsiancrisis,theactualratingsassignedtothefourhighgrowthdynamicEastAsianeconomieswereconsistentlyhigherthantheeconomicfundamentalswarranted.Secondly,afterthecrisis,actualratingsdroppedfarmoresharplythantheeconomicfundamentals,asmeasuredbypaperwriters’modelpredicted,suggestingthatratingdowngradeswerelargerthaneconomicfundamentalspredicted.Thiswouldseemtoimplythatbothintimesofboomandcrisis,economicfundamentalsarenotsufficientlyconsideredbyCRAs.TheaboveauthorsaswellasothersemphasizetheroleofprofitandincentivesofCRAsthemselvesinshapingtheirpro-cyclicalbehavior.Thus,CRAsmightbedriventobemoreconservativeduringcrisistoprotecttheirreputationcapital,whichhasbeenunderminedbythecrisis,andarelessconcernedabouttheirreputationcapitalduringeconomicboomandthusmaybemorelenientintheirratingassignments.Bolton,FreixasandShapiro(2012)complementthisbyarguingthatCRAscaninflateratingswheninvestorsbecomemoretrustingandtherearemoreinvestorswillingtoinvestduringboomcyclesand/orwhenCRAreputationcostsarelower.Goodhart(2008)goesfurtherandismorepessimisticashearguesthatproposalstoaddresspro-cyclicalitybymakingcreditratingsonathrough-the-cyclebasiswillnotdomuchsinceduringboomyearsitismorebeneficialforallactorstoadoptapoint-in-timeapproachandcompetitionwillmakethathappen.Interestingly,bothheandBoltonetalareskepticalofthebenefitsofincreasedcompetition,contrarytootheropinion.Ferri,LuiandStiglitz(opcit.),alsosuggesthowCRAscanintroducepro-cyclicalratings:“Iftheratingsgeneratedfromthepaper’sauthorsmodelofeconomicfundamentalsareconsistentlyhigher(orlower)thantheactualratingsassignedforacountry,thentheratingsassignedfromthequalitativejudgementparttendtoundermine(oroverstate)theratingsgeneratedbytheeconomicfundamentalsand,thus,theyclearlyindicatethatratingagenciestendtousetheiridiosyncraticjudgementtomodifytheratingsgeneratedbytheeconomicfundamentals.Indoingso,ratingagenciesmaybehaveinamannerthatmaypotentiallygeneratepro-cyclicalsovereignratings”(347).AnotherimportantpointmadebytheaboveauthorsisthatdowngradesbyCRAs,especiallyifsevere,giveanegativesignalonthecountrythatisexperiencingthedowngradingtomarketparticipants,whichcanalsoaffecttheexchangerate,thestockmarketandthevalueofotherdomesticassetsandthuscanturnintoself-fulfillingprophecy.ItisinterestingthatIMF(2000),alsobasedonempiricalanalysis,basedontheirownmodel,concludesimilarlythat“CRAbehaviorisasymmetricandyield“proofofthepuddingintheeatingresults”:countriesaredowngradedfollowingmajorcrises,possiblybecausetheydonotperformasexpected”.Therefore,thispaperalsoisconcernedaboutCRApro-cyclicalbehavior,andmakessomeinterestingsuggestionsforalternatives,whichwediscussbelow.PretoriusandBotha(2017)carryoutempiricalresearchfor27Africancountriesforthetimeperiodbetween2007and2014.Theyconcludethat:“pro-cyclicality
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isconfirmedforFitchandMoody’sintheirassignmentofcreditratingsforAfricansovereigns.ThismeansthatthereisanincreasedprobabilitytoAfricansovereignsofgettingupgradedduringboomphasesanddowngradedduringrecessionphasesbythementionedratingagencies”(546).TheiranalysisofS&Pdidnotgiveclearpro-cyclicalresultsfortheirratings,whichisinterestinginthatthereseemtobedifferentbehavioralpatternsforthedifferentCRAs.BrotoandMolina(2016)notonlyfindevidenceofpro-cyclicalitybutalsofindthatpreviousdowngradeshaveanegativeinfluenceonfutureratingsandthatitisdifficultfordomesticvariablestoaffectthepathofratingsifacountryhasbeendowngraded.Thus,theyconcludethatratingsare“lessinfluencedbyeconomicanddomesticindicatorsinthepost-crisisperiodthaninthepre-crisisperiod”.Thislatterpointmeansthatthetaskforthecountries’policy-makerspost-crisisbecomesharder,especiallyindifficulttimes.Thereareadditionallyseveralotherstudiesthathavereportedthereispro-cyclicalityinratingsofsovereigns,suchasLarrain,ReisenandVonMaltzen(1997)andMasciandaro(2011),whereastherearealsosome,butfewerstudiesthathavenotfoundevidenceofsuchpro-cyclicality,suchasKraemer(2014)andMora(2006),forexample.Inconclusion,mostoftheliteratureprovidesfairlystrongevidencethatCRAstendtobepro-cyclical,thattheirincentivestructureencouragestheirpro-cyclicalityandthatthequalitativeaspectsoftheirriskevaluationseemtobeparticularlypro-cyclical.Wereturntothelatterissueinourproposals.
3.) Governance issues and conflicts in sovereign ratings
Itisimportanttounderstandthattheagenciesaresubjecttoregulationsthattrytoinsulateanalystsdecidingontheratingfromanypressureofcommercialcolleaguesoriginatingbusinessandmanagingclientrelationships.Itappearsthatratingagenciesadheretothosestandardsandthe“Chinesewalls”haveheldupsincetheglobalfinancialcrisis.Atleastthatiswhatthelackofanyviolationspublicizedbyregulatorsseemstosuggest.Evenassumingtheintentofinappropriatebehavior,attemptingtosystematicallyletcommercialinterestdiluteanalyticalindependencewouldputthelucrativebusinessmodelatgraverisk.Ifregulatorsweretoexposesuchmisconduct,thereputationaldamagewouldjustbetoohigh.CRAsfearan“ArthurAndersen”-momentmorethananythingelse.Buttherecanbemoresubtlewaysthatcouldallowapro-AEbiastricklein.The“Big3”areUS-headquartered,profit-maximizingfirms,largelyfundedbytheinstitutionstheyrate.Andtheratingsbusinessisextraordinarilyprofitable.Profitmarginshavesteadilyincreasedandreached60%in2020forMoody’sandS&P,bothpubliclylistedcompanies.Itislittlesurprising,then,thattheirsharepriceshaveaccordinglyrisenbetween3.5-fold(Moody’s)and5-fold(S&P),frompre-GFCpeaks,makingtheirgroupparentcompaniesvaluedat$55billionand$85billion,respectively.Theoligopolisticmarketstructure,wherethreefirmsaccountforover90%ofthemarket,(seechart3below)issomethingtheincumbentswouldliketopreserve.
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Mostoftheirbusinessisinadvancedeconomies(AEs).RegulatorsinAEsarethemostpowerfulsupervisorsoverseeingtheratingsindustry.ItisinAEs,therefore,wherethemainriskstotheCRA’sbusinessmodelsreside.Forexample,S&P,hadbeensuedbytheU.S.DepartmentofJusticein2013.Althoughsovereignratingswerenottheunderlyingreasonforthecasebroughtagainstit,S&Psaidatthetimeitconsideredthelawsuitas“retaliation”forhavingstrippedtheUSofits‘AAA’-ratingtwoyearsearlier.Thecaseendedwitha$1.5billionsettlementin2015,wipingoutoveroneyearofprofits.NoagencyhassincedowngradedtheUS,notwithstandingthesignificantdeteriorationinpublicfinancesandunprecedentedthreatstogovernancestandardsduringtheincumbencyofthe45thPOTUS.Thereisthereforeanasymmetryofincentivesanddisincentives,asregardswillingnessofCRAStodowngradeAEs,versustheEMDEs,whoseregulatorshavefarless,ifanyinfluenceontheCRAsdecisions.Additionally,mostratingsmanagersandanalystsarecitizensofadvancedeconomies.Andamongthefewwhoarenot,mostofthoseobtainedtheirtertiaryeducationatWesternuniversities.ThishasgivenrisetosuspicionofAnglo-Saxongroupthinkand“homebias”ofCRAs,discriminatinginfavorofAEstothedetrimentofpoorercountries.Or,asGhana’sMinisterofFinance,KenOforo-Atta,moredramaticallyputsit:“AretheratingagenciesbeginningtotipourworldintothefirstcircleofDante’sInferno?”Asoutlinedabove,sovereignratingsareamixtureofobjectivedataanalysisandsubjectivereasoning.Ifanalystsfeelsomepressure,howeversubtle,fromexecutiveswhoaimforeverfasterbusinessexpansion,theymightsubconsciouslybeinclinedtogiveAEsthebenefitofthedoubtintheirqualitativeassessment.Remote,smallerandlesspowerfulnationsmightwellhavebeendowngradedinsimilarcircumstances.CRAmanagementhasofcoursealsotheabilitytopromoteanalystswithareputationfor“generous”ratingrecommendationsincommerciallykeycountriesandblockthepathaheadfor
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35
16
10
40
33
18
9
MarketshareasestimatedbyEU-regulator(2013and2019in%)
S&P
Moody's
Fitch
Allothers
innerring: 2013outerring:2019
Source:EuropeanSecuritiesandMarketAuthority
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theirmoreskepticalcolleagues.Suchpatternswillnotescapetheattentionofanalyticalstaffwithprofessionalambitions.Thequalityandimpartialityofratingsrequireanunshakableindependenceofanalystsfromallcommercialconsiderationsorfromfearofcareerrepercussions.Theremayalsobefurtherpersonalconsiderationsofpressuresfromoutsidetheratingsorganization:theknowledgethatratinganalystsofseveralagenciesweretried(andonlyaftermanyyearsacquitted)inanItaliancriminalcourtforratingdowngradesperformedduringtheeurozonecrisismayhaveledsomeanalyststothinktwiceaboutloweringrichcountries’sovereignratings.EMDEgovernmentsandregulatorsdonotdisposeofsimilarpowers.
4.) Credit ratings and climate risk
AkeyissueisthetimehorizonofsovereignratingsissuedbyCRAs,asthesearerelativelyshort.Thereseemstobeacaseformorelong-termratingstobeissued,alsotomirrorthelengtheningtenorsofgovernmentsecurities(whichhaveevenforsomeemergingeconomiesincluded100-yearbonds)andtotakeaccountoflonger-termfactorsespeciallyclimatechange,butalsodemographicandotherlong-termtrends.ItseemsespeciallyimportantthatCRAsconsiderclimaterisk,includingbothphysicalandtransitionrisk,indeterminingratings.AfailuretocutcarbonemissionscouldcostgovernmentsaroundtheworldhundredsofbillionsofUS$,accordingtoUniversityofCambridgeeconomistswhousedartificialintelligencetoforecastclimatechange’seffectonsovereigncreditratings.Theyestimatethatifemissionscontinueatcurrentlevels,63countrieswillseeratingsdowngradesofmorethanonenotchby2030,andmanymoreduringtherestofthecentury.Importantly,thisfindingappliesforadvancedeconomiesandEMDEsequally.4Thiswouldalsoimplyratingagenciesreflectingsovereigneffortstoincreaseinvestmentinresilienceandadaptationtoclimatechange,whichcouldbepositiveforsomedevelopingandemergingeconomies.Indeed,failingtoinvestinmakingeconomiesandsocietiesmoreclimate-resilientunderminesfuturegrowth,wellbeing,andsovereigncreditworthiness.Suchanapproachcouldleadtodownwardratingpressureforsomesovereigns,whileothersmightbenefit.Forexample,ratingsforsomedevelopingandemergingcountriescouldbelowered,iftheyareparticularlyvulnerabletoclimatechange,orarefossilproducers,andtheirproductionandexportscouldincreasinglybecomestrandedassetsinfutureyears.Nevertheless,ifratingagenciesaretohavealong-termperspective,suchrisksoughttobeincludedmoreexplicitlyinratings.
4https://www.bennettinstitute.cam.ac.uk/media/uploads/files/Rising_Climate_Falling_Ratings_Working_Paper.pdf
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Inthecaseparticularlyofmajorfossilproducers(seeIEA,2020),butalsoofothercountries,effortsat,andinvestmentin,significantdiversificationofproductiontomorelow-carbonactivities,-bothfordomesticconsumptionandespeciallyforexports-,wouldreducetheproblemofstrandedassets,andshouldthusincreasetheirlong–termcreditratings.Morebroadly,majorinvestmentsmadebydevelopingcountriescontributingtomoredynamic,sustainable,andfairereconomies,andwhichhelpfulfilltheSDGs,shouldbeconsideredpositivelybyratingagencies,astheyarelikelytoincreasecountry’sabilityforfuturerepayment.Indeed,forexample,investmentineducation,healthandsustainableinfrastructure,mayintheshort-termincreaselevelsofpublicdebt,butinthelong-term,ifwellinvested,especiallyinsectorswhichdirectlyorindirectlywillincreasethecapacityoftheeconomytogrow,includingparticularlyintradeables,willthusmakeitmorelikelycountrieswillbeableandwillingtoservicefuturedebt.Animportantexampleoftheimportanceofthelinkbetweensufficientinvestmentinhealthandpandemicpreventionwitheconomicperformanceisprovidedbyinvestment(orlackof)inpandemicpreparationandits’impactoneconomicevolutioninCOVID-19times.ItseemsthatthosecountrieswithbetterresourcedhealthsystemsaswellasbetterpandemicpreparationandresponsehavebeenabletocontroltheCOVIDpandemicbetterandhavethereforeseentheireconomieslessbadlyhit.Thisillustratesthevalueofinvestmentinthesocialsectorsonlong-termevolutionofeconomies.
Indeed,astheUNSecretaryGeneralPolicyBrief(2021)arguesclearly, ,“a more favorable long-term rating might help countries raise long-term capital to invest more effectively in sustainable development”. The availability of ultra long-term ratings, would not just allow a better evaluation of countries ability to service the debt in the long-term, but help enable, in a virtuous circle, higher availability of funds to do such key investment. ItneedstobeconsideredwhetherCRAsshouldalsodosuchultra-long-termratings,orwhetherotherinstitutions,withgreaterfocusandexpertiseonlong-termtrends,wouldbemoreappropriateforthattask.Wereturntotheseissuesbelow(sectionIII.5).
5.) Impact of credit ratings in the DSSI/Common framework context
ShortlyaftertheoutbreakoftheCOVID-19pandemictheG20putinplacetheDebtServiceSuspensionInitiative(DSSI),comingintoeffectinMay2020.UndertheDSSI73oftheworld’spoorestcountriescanapplyfortemporarydebt-servicepaymentrelief(butnotforgiveness)fromitsofficialbilateralcreditors.Thesuspensionistoexpirebymid-2021butmaybeextendedagain.Todate,46countrieshaverequestedDSSIparticipation.Sincecreditratingsspeakonlytomissedpaymentsonnon-officialdebt(e.g.,bondsandcommercialloans),suspendingdebtservicepaymentsisnotadefault.Missingapaymentincommercialdebtwouldbe.TheG20hasencouragedprivatecreditorstoparticipateintheDSSI.Unsurprisingly,eligiblecountrieshavenotrequested
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equaltreatmentfrombondholders,asdebtservicesuspensiononthosesecuritieswillconstituteadefaultundertheratingagencies’definitions.AlthoughmostDSSI-eligiblecountrieshavelostmarketaccessforoveroneyearnow,anyway,thefearofdowngradesstillloomslarge.RatingagencieshavebeencriticizedforsignalingthatratingsparticipatinginDSSIcouldcomeunderdownwardpressure,asparticipationcouldraisetheriskoflossesforinvestorsinthefuture.Infact,therehavenotbeenthatmanyratingactionsexplicitlyreferencingDSSIparticipation.Thiscanbeexplainedbythefactthatpoorcountrieshavemostlyrefrainedfromsolicitingprivatecreditorinvolvement.Forexample,Moody’sputseveralEMDEswithoutstandingEurobondsonreviewforadowngradeonMay28,2020,citingtheG20’scallforprivatesectorinvolvement.Allratings(Pakistan,Coted’Ivoire,Cameroon,Senegal,Ethiopia)werelateraffirmedratherthandowngraded.Moody’shadconcludedthatprivatesectorinvolvementwassufficientlylowsoasnotmeritingadowngrade.Itremainsunclear,however,whyarrivingatthisconclusionwouldhavetakensolongandwhatchangedtheirmind.Bydanglingthe“threat”ofadowngradeinfrontofEMDE’sissuers,Moody’scanbeseenashavingcreatedunnecessarynoiseandfosteringasenseofreluctancetoapplytomechanismdesignedtomakecountries’debtanddebtservicemoresustainable,whichwouldbeimportantforfacilitatingCOVID-19recovery.Ethiopia’sratinghassincebeenloweredanyway,alsobytheotheragencies.ThishasoccurredinthecontextofEthiopiarequesting“treatment”ofitspublicdebtundertheG20CommonFramework(CF).UndertheFramework,whichwasagreedinNovember2020,DSSIeligiblecountriescanrequestamoreprofoundrestructuringofthedebt:debtreductionratherthannet-presentvalueneutralandselectivere-profiling.AconditionforparticipationintheCFis“broadcreditorparticipationincludingtheprivatesector”.ByapplyingforCFdebttreatment,Ethiopiahasthussignaledthatitiswillingtoapproachitsprivatecreditorsfordebtrestructuring.Although,thatrestructuringhasnotyethappened,andmaybeneverwill,ithasobjectivelybecomemorelikely.Andasratingsareverynarrowlydefinedasanassessmentofalikelihoodofdefault(andnothingelse),itishardtofaulttheagenciesoncuttingEthiopia’srating.Distresseddebtrestructuringisadefaultbycapitalmarketconvention.Evenifratingagencieswouldviolatetheircriteriaandnotdeclareadefault,itispossiblethatinvestorswouldbehaveasiftheyhad.Adebtdefaultisahighlyvisibleandwell-understoodeventandwhetheraratingagencycallsitassuchornotmaynotmakeaverylargematerialdifferencetomarketconditions,thoughsomeacademicliteratureprovidesevidencethatdowngradeannouncementsdohaveanimpact,andmaycontributetodeepeningcrisesforexample.ButitremainstruethatgovernmentsinDSSI-eligiblecountriesremainfearfulofthedowngradesthatwillhavetocomeiftheyaskfordebtrenegotiation.Theyshouldnotbe.Proactivelyrestructuringthedebt,evenifitledtoatemporarydeclarationofdefaultbytheagencies,canbebeneficialforhighlyindebted
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governments.Asexcessleverageisremoved,thegrowthanddevelopmentpotentialwillimprove.Thatshouldmakepoorcountries’sovereigndebtmoreattractiveinvestmentsagain.Inalow-interestworldwhereinvestorsfranticallysearchforyield,adebtwork-outwillquicklyrestoremarketaccess,whichiscurrentlyclosedformostpoorersovereigns.Evenmoresoasinvestors(andratingagencies)willunderstandthattherestructuringwouldnotbetheresultofpoorpolicies,butbadluck,beinghitbyapandemicandglobaleconomiccrisis.Someinvestorsstokethefearofrestructuringandallegedlossofprolongedmarketaccessoutofperceivedself-interest.Butitmaybeanactofself-harminstead:Weknowfromexperiencethatdelaystosovereignrestructuringleadstodeepercrisesindebtorcountries,deeperhaircutsforcreditors,andlongerexclusionfromcapitalmarkets.Procrastinationisalose-loseproposition.
6.) Role of Credit Ratings in financial market regulation
TheratingsbyCRAShaveabroaderindirectimpact,thantheonetheyhavedirectlyonthevolumeandcostofcredit.ThisindirecteffectrelatestotheuseofCRAratingsinseveralaspectsoffinancialregulation.Themostimportantone,whichwewillfocusonhere,istheuseofratingsaspartoftheBasleCapitalAccord,whichregulatesbanklending,nationallyandinternationally;thisisespeciallyimportantfortheirlendingtoemerginganddevelopingeconomies(EEDEs).Therearealsootherregulations,includinginternalones,which,forexample,determineinvestmentpoliciesofinstitutionalinvestors-increasinglyimportantintheirinvestingandlendingtoemerginganddevelopingeconomies,whichwewilldiscussbelow.Afterthe2007/09majorfinancialcrisis,regulatorsagreedthattheuseofCRAratingsinregulationswasnegativebecauseitmade-forexample-theBasleAccordmorepro-cyclicalandthereforecontributedtodeepenthecrisis,andthatthislinkshouldbeeliminatedorreduced;however,unfortunately,thishasnotoccurredtodate.Inbroadterms,thisuseofCRAratingsinBaselregulationisproblematicforthreereasons(Becker,2021).First,theBasleCommitteeforBankSupervision(BCBS)externalizedsub-issues,suchascreditriskmeasurement,thatareoffunctionalimportanceforitsobjectiveofglobalbankingstability.Second,itestablishedaone-sideddependenceonexternalforumssincetheperformanceofbankingregulationisdependentoncreditriskmeasurementbutnotviceversa.Third,theBCBShaslimitedcontrolmechanismstoinfluencegovernanceintheCRAs,leavingthemautonomyforinconsideratebehavior.BaselIIandIIIincludeaweightingsystemthatallowschangeinriskassessment.Thisdynamicriskweightingsystemrequiresconstantupdatesaboutthecurrentprobabilityofdefault(PD)andotherriskparametersofeachfinancialassetinthebank’spossession.SuchdetailedandregularupdatingrequiresspecializedknowledgeandconsiderablecapabilitiesthatlieoutsidetheBCBS’competenceasaperiodiccommitteewithlittleresources.Thelackofcapacitiestogovern
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riskassessmentitselfcausedtheBCBStohandtheresponsibilityoverthisimportantsub-issuetoCRAs.Thus,theapproach“outsources”theactualassessmentofriskweightsofborrowerstoCRAs.TheseassessmentscanchangeovertimeandaresubjecttotheevaluationoftheCRAs.Hence,theBaselCommitteedecidedtousetheexpertiseofCRAsasprovidersforprobabilityofdefaultestimatesinthestandardizedapproach,whilenotprescribinganydetailedmethodologicalmeansonhowCRAshavetorateassets.TheAccordonlyspecifiessoftcriteriaofwhatpropertiesaCRAmustfulfilltoreceivealicense.Thus,theAccordgaveCRAsmuchdiscretionintheirratingsystem.Akeyproblemisthatwiththis,amultiplicativeaspectisthatBaselIIandIIInotonlyexposedthevalueoffinancialassetstomarketdevelopments,butalsotherelatedriskweights.UnderformerBaselIrules,thepro-cyclicalinfluenceoffairvalueaccountingwerelimitedtotheactualvalueoftheassets,buttheriskweightswerefixedandriskassessmentwouldnothavechangedwiththebusinesscycle.However,theintroductionofdynamicriskweightsandtheimportofriskassessmentfromCRAsinthestandardizedapproachconnectedthepro-cyclicalnatureofbothpolicies,therebymultiplyingtheirpro-cyclicality.Creditratingagencieswereshowninabadlightduringthecreditcrisisof2008/09,mainlyduetoratingsonsecuritizeddebt.However,BaselIIIhasnotoutlawedtheuseofcreditratings.BaselCommitteehadtwoconsultationsforrevisingthecreditriskframework.Inthefirstconsultation,theytriedtodoawaywithcreditratingsforrisk-weightingbutlaterbacktrackedfromtheidea.Inthe2ndconsultationtheyhavegiventheoptionofassigningriskweightsbasedoneithercreditratingsorotherfactorsdependinguponwhetherthejurisdictionallowsuseofcreditratings.Butthatdoesnotstopcertainjurisdictionstonotallowuseofcreditratingsforriskweightingpurpose.Forexample,intheUSyoucannotuseexternalcreditratingsforriskweightingofassets.IntheEU,youcanuseexternalcreditratingstodetermineriskweights,butonlyfromratingagenciesapprovedbyESMAandmeetingcertainstandards(Li,2021).Ratingsandratingchangescancontainvaluablesignalsforitsusers,suchasinvestors.Somesignalsaremuchmorepowerfulthanother.Downgradesofratingsalongtheratingsscalereflecttheassessmentonincrementallyincreasingcreditrisk.Historically,ratingdowngradesatthetopofthescaleincreasedefaultrisklessthanatthelowerendofthespectrum(ofcourse,theoppositeappliesforupgrades).Butthereisnoempiricallydiscerniblecliff,wheredefaultprobabilitieswouldsuddenlychange.Itisasmoothgraduation.Unfortunately,thatisnothowthecapitalmarketsworkandreflectthoseratings.Investorsgenerallysubdividetheratingspectrumintoinvestmentgrade(BBB-orabove)andspeculative(ornon-investmentgrade,BB+orbelow)issuersandinstruments.Avastbodyofinvestmentguidelines,suchasofinstitutional
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investorstypicallyareforbiddentoinvestinnon-investmentgradepaper,andofficialregulation,suchastheBaselCapitalAccordfocusesonthisartificialdivide.Bydoingsoacliffeffectisintroduced.Bylosinginvestmentgradestatus,anissuermayfaceawaveofforcedsellingasinvestmentmandatesofmanyassetmanagersandfundsonlyallowforinvestmentin“investmentgrade”.Thiscanleadtodisruption,financialdistressand,intheworstcase,toself-fulfillingpropheciesofadowngradeacrosstheinvestmentgradedivide.Suchamovecanleadtorefinancingproblemsandweakercreditfundamentals,whichinturnwouldcallforfurtherdowngrades,therebyincreasingdifficultiesforcountriestorecover.Theinvestmentmandatesandregulationsarewrittenbyinstitutionalinvestorsandregulators,notbyratingagencies.Buttheagenciesarefullycognizantofthecliffeffectandthatknowledgecaninfluencetheirdecision-making.Acreditcommitteewillbemoreinclinedtogivemorebenefitofthedoubtbeforedowngradinganissuerto“junk”(asnon-investmentgradeissometimesreferredto)thanatanyotherofthetwentypossiblelocationoftheratingscale(withthepossibleexceptionwhenitcomestotheiconiclossoftop-notchAAA).Itknowsthattheimplicationscouldbesevere.Therefore,itmayprefertowaitandhopethatsomegoodnewsmayshowupthatwillmakethedowngradeunnecessary.Suchhesitancytocrossthedividebluntstheratingssignalandcandilutethequalityandobjectivityoftherating,aswellaspotentiallypromotingpro-cyclicalityoftheratings.Ratingstransitiondatareleasedbytheagenciesdemonstratethatthereisconsiderable“stickiness”attheinvestmentgradedivideforcorporateratings.Thismeansthattherearefewer“crossings”fromtheBBBratingscategoryintotheBBcategorythanwhatcouldbeexpectedwhenobservingcategorycrossingselsewhereontheratingsscale.Giventhesmalleruniversetherearefarfewerobservationsonsovereignratingchanges.Nevertheless,Chartxxxshowsthatonecanalsoobservesomestickiness,althoughlesspronouncedthanwhenratingcorporates.ThedatareferstoS&Ponly,whichhasbeenthefirstmoverwhenloweringsovereignsacrosstheinvestmentgradedividein80%ofthecases(2000-2019).Whilecomparabledataisnotreadilyavailable,thesovereign“stickiness”attheinvestmentgradecliffcouldbemorepronouncedforotheragencies.
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III. Policy Recommendations 1) Refocus regulatory scrutiny
Regulatorsneedtosharpentheirview.Theregulationoftheratingsindustryhastightenedsignificantly,atleastintheformalsenseintheaftermathoftheglobalfinancialcrisisandthewidelyshareddiscontentabouttheroleplayedbythecreditratingagencies,especiallyinthefieldofratingsub-primemortgagesegment.IntheEU,apan-Europeanregulationandregulator(ESMA)wasintroducedforthefirsttime.Agencieshavebeefeduptheirinternalrulesandcomplianceandqualitycontrolfunctions.Regulatoryfinesbecauseofbreachofregulationsorpoorlymanagedconflictsofinteresthavebeenfewandfarbetween.Inlinewiththeirmandates,regulatorshavebeenfocusingmoreontheformoftheratingsprocessthanonthesubstanceofdecisions.Agencieshaveprovendiligenttoadheretoallformalrulesofengagement,satisfyingregulators.Butasoutlinedabovetheremaybemoresubtlewaysinwhichconflictsofinterestcouldmanifestthemselvesandlead,e.g.,toananalyticallydiscriminatorypracticefavoringtheeconomieswhereagenciesreapmostoftheirprofits.Regulatorsdonotassessthoserisks.Andsinceregulatorsareagentsofadvancedeconomies’governments,theymightbeconflictedthemselvesifaskedtoensurecomparabilityofanalyticaltreatment.ThefactthatthechairoftheEUwatchdoghasreportedlycautionedratingagenciesagainst“quick-firedowngrades”ofsovereignscanberegardedasareflectionofthisinherentconflict,exacerbatingaprivilegedtreatmentofadvancedeconomies.Aglobal“super-regulator”ofCRAswouldbebestplacedtoaddresssuchissues.Theglobalregulator,whereEMDEswouldbeadequatelyrepresented,would
13.1
11.6
13.5
11.4
6.9
11.2
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
A BBB BB
Stickinessattheinvestmentgradedivide
Sovereigns
Corporates
Shareofissuersdowngradedinto thenextlowercategoryin3years(S&P,1975-2019).
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complementtheactivitiesofnationalregulators.Itshouldbespecificallytaskedwithensuringglobalcompatibilityofratings.Itcouldrequireratingagenciestodisclosemoreinformationonhowdecisionshavebeenmade,includingmoremeaningfulminutesofcommittees.Rightnow,thereisacompleteregulatoryvoidtothatregard.Also,theglobalregulatorshouldberequestedtoassesstheadequacyofthequantityandprofessionalqualityofanalyticalstaff.Thisisacomplexundertaking,astheassessmentof“professionalskills”istoalargedegreeasubjectiveone.Butthisisnotthecaseentirely.Theregulatorshouldbeabletotrackmetricsofanalysts’objectiveprofessionalexperience(degrees,yearsofexperience,diversityofexperience)andcareerprogress.Thisshouldcontributetodiscouragingratingsfirmsfrompickingandpromotingwhattheyconsidermoremalleableanalysts.Thequantitymeasureofstaffisimportantasanalyticaloverstretchofanalystsmakesmistakesmorelikely,whichisanotherlessonfromthesubprimecrisis,butalsointhecaseofsovereignratings.
2.) Reducing dependency on credit ratings in regulation
IMF(opcit.)whenstudyingempiricallyhowratingagenciesrespondtoacrisis,concludethatratingagenciesdonotquiteseethroughacrisis.Ratingagencies,moreover,reactstrongerwhenthecrisisisdeeper,andexceedsaminimumthreshold.Onecouldargue,asIMF(opcit.)doesthatbankcapitalrequirementsshouldinsteadbecountercyclical:duringadownturninthebusinesscycle,someofthefactorsforwhichacapitalcushionisneededarematerializingandcapitalshouldbeappliedforthesepurposes.Capitalrequirementscanbesmallerduringdownturnswhenwrite-offsarerelativelyhighbutexpectedtodecline.Consequently,thereisaneedformechanismstodeterminecapitalrequirementsthatsufferlessfrompro-cyclicalityandcontagionsensitivityofratings.Regulatoryinitiativesinthewakeoftheglobalfinancialcrisisaimedatreducingthehardwiringofratingsintoregulation.Sofar,however,littletangibleprogresshasbeenmade.Apossibleinstitutionalsolution,insteadofusingCRAstodeterminecapitalrequirements,inthecontextoftheBaslecapitalaccordcouldincludeforexample:establishmentbybankingsupervisorsofasmallcountrycreditbureauthatdoestheabove,whiletappinginformationfromIFIsandexportcreditagencies.Suchanewinstitutionwouldhavetobeindependent,bothofprivateactorsandgovernmentsinitsdecision-making.Thissolution,orsimilarwouldcutthelinkbetweenCRAratingsandtheBaselCapitalAccord,whichevidencesuggestsincreasespro-cyclicalityinfinancialregulation,insteadofpromotingcounter-cyclicality.Suchasolutioncouldbringaboutthedesiredunlinkingregulatoryrequirementsfromcreditratingsissuedbyprivatefirms.However,it,too,comeswithgovernancechallengesregardingtheinstitutionalandpoliticalindependenceofsuchaninstitution.
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3.) Reduce cliff effects
Standardsettersacrosstheglobeshouldworktowardssofteningtheinvestmentgradecliffeffect.Theartificialdivisionoftheinvestableuniverseintotwodistinctreservesofinvestmentandspeculativegradeisanoversimplification.Itdoesnotonlynotdojusticetothemuchfinergradationsoftheratingsscale,butalsocreatesself-inflictedrisksforfinancialstability.Whatwasoncedesignedasaneasyshorthandmarketconventionhastakenonasupersizedlifeofitsown.Policymakersshouldtakebackcontrolandreducetheundesirablesideeffectsofthedivide.Anyreformwillhavetoconsiderthatsomedegreeofaggregationofcreditriskswillberequiredforasmoothfunctioningofthecreditandbondmarketsandtoaccommodatethelackofdeeperfinancialeducationofmanyretailinvestors,thataremeanttobeprotectedbysuchclassificationsfromoverlyriskyexposures.Amiddlewaycouldconsistofdividingtheratingsuniverseintohigh-,mid-andlow-graderatings.Ideallytherewouldbesomeoverlapintheratingsscalesothatadowngradedoesnotleadtoacompletelossofonesetofinvestors(whichare,forexamplerestrictedtohighgrade),beforeanothersetofinvestors(mid-grade)comesin.Anoverlapwouldpermitforasmootherentryandexitofinvestorclasseswithdifferentriskappetites.Thedangerofsuddendownwardspiralsfollowingratingactionswouldbereduced.Agenciescouldagaintakeratingactionsinlinewiththewaytheyseecreditrisksevolving.Theynolongerwouldhavetoworryabouthowaratingactionacrossthecurrentlyexistinginvestmentgradedividecouldcreateaviciouscirclebyitselfunderminingthecreditqualityoftheissuerunderconsideration.Removingthecliffwouldenhancethequalityandcomparabilityofratingsignals,whileminimizingstabilityrisks.
4.) Improving transparency of CRA methodologies
Thiscouldbedonebyseparatingmoreexplicitly:a)analysisofsimulationsandstresstests(whilstmakingunderlyingmodelexplicitonwhichbased)andb)morejudgement-based(qualitative)analysis;a)andb)wouldbepublishedseparately,butwithinthesamereport.Thiswouldclarifywhatthejudgementelement,e.g.,ongovernanceandpoliticsofcountry,oftheratingis,asopposedtomorequantitativeevaluationofriskofdefaultis.TheglobalregulatorrecommendedinIII.1shouldberequiredtoopineontherobustnessofratingmethodologiesappliedandthetransparencyinitsworldwideapplication.Currentlynationalregulatorsonlylookatindividualratingactionsinisolationonacase-by-casebasis.Thisexpandedremitmustnotremovetheabilityofratingagenciestodesignandmodifythecriteriaunderwhichtheyassignratings.Thatisoneoftheircoreresponsibilities.Buttheglobal
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regulatorneedstobeempowered(bothinstitutionallyandprofessionally)toscrutinizeandchallengethemethodologicaldecisionstakenbytheagenciesmoreforcefully.
5.) Long-term ratings
Thelong-termcreditratingissuedbytheagenciesaresupposedlycalibratedtoreflectcreditriskupto3to5yearsintothefuturefornoninvestmentgradeissuersanduptotenyearsforinvestmentgrade.Thisisamuchlongerhorizonthatwhatnormallyprevailsinfinancialmarkets.Buttheaspirationaltimehorizonpostulatedbytheagenciesdoesnotchimewithobservablereality.Inthefieldofsovereignratings,theeconomicandfinancialforecastsappliedforthisforward-lookinglong-termratingrarelyextendsbeyondthreeyears.Inotherassetclassesitisless.Itappearsthattheactualratinghorizonismuchshorterandtypicallynotbeyondtwotothreeyears.Atthesametimelonger-termtrends,fromageingsocietiestoclimatechangeareboundtobecomemorebindingcreditrisksforsovereigns.Andsovereignissuershavetakenrecoursetoeverlongertenorsintheirbondissuance,pushingtheyieldcurveinsomecasesoutto50oreven100years.Overthepastdecadeaveragetermtomaturityhasincreasedinmostcountrieswherethecorrespondingdataisavailable.Incombination,thesetrendsmakealonger-termperspectiveofratingsincreasinglyurgent.Ratingagenciesshouldbecompelledtomakemoreexplicitlong-termcreditanalysisorstopratingbondsaboveacertaininitialmaturity,e.g.,10years.Therelativeshort-termperspectiveoftheratingscanbemisleadingwhenratingsareappliedtoratepaymentstreamsdecadesintothefuture.Suchlonger-termratingsshouldexplicitlyreflectplausiblecreditimpactsofclimatechange.AswasshowninsectionII.4,researchhasshownthatlong-termsovereignratingimplicationscanbesubstantial,forrichandpoorcountriesalike.Establishingsuchlonger-termratingswillallowinvestorstogaugetheireffectiveriskexposuremorereliably.Currentlytheyarewithoutanyreliableyardstick.Anadditionalbenefitwouldconsistinincentivizinggovernmentstoengageinlessmyopicpolicies:arobustclimatemitigationpolicy,forexample,couldimproveasovereign’sratingrelativetoitspeers.Rightnow,nosuchincentiveexists.
6.) Alternative ownership models
Callstocreateneworpubliccreditratingagencieshaveresonatedfromdifferentcorners,withparticularstrengthaftercrises,andespeciallyduringtheCOVIDinducedcrisis(Li,opcit;Gosh,2021).Indeed,Gosh(opcit.)hasrecentlyarguedthatthecaseforanindependentpublicratingsagencyhasneverbeenstronger.InitsTradeandDevelopmentReport2020,UnitedNationsConferenceonTradeandDevelopment(UNCTAD)advocatedforaninternationalpubliccreditratingagencytoprovideobjectiveexpert-basedratingsofthecreditworthinessof
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sovereigns,includingdevelopingcountries.UNCTADhaslongarguedthattheworldneedssuchanindependentpublicratingsagency.SuchapublicCRAagency,whichcouldberegionalorglobal,deservesseriousconsideration,especiallyasacomplementtoexistingprivateCRAs.Afterall,competitioncanintroduceefficiency.Indeed,itispossiblethatthecreationofapublicCRAcouldencourageimprovementsintheefficiencyofprivateCRAs.Furthermore,apublicCRAwouldnothavethetypeoffinancialincentives,whichcouldencourageprivateCRAstobetoolenientinboomyears,asthisismorelikelytoattractclientsfortheirbusiness,whichisanimportantadvantageofpublicCRAs.However,apublicratingagencywouldcomewithpotentiallyitsownsetofconflictsofinterest,whichrequirecarefulmanagementtoallowanalyststooperateatarmslengthfromgovernments’influence,orthatofanyotherpublicbody.Apubliclysponsoredratingagencycouldbefounded,specializingontheverylong-termratings.Thisagencycouldbeusedasabenchmarkthroughwhichtheincumbentagencies’ownlong-termratingscanbeassessed.Theverylong-termnatureoftheratingsmaylessenthepotentialforconflictofinterest,butitdoesnotremoveitcompletely.Stronggovernancestandardswillthereforeberequiredtoensureanarms-lengthrelationshipwithgovernmentsandavoidconflictsofinterest.Analternative,especiallyforissuingultra-longcreditratingssuchasdiscussedabove,couldbeanindependentfoundation-basedmodel,withanot-forprofit-institution,thatwouldhaveitsowngovernance,beingarmslength,bothfromgovernmentsandtheprivatesector,buttrustedbyboth.Initslong-termcreditratings,suchanagencycoulddevelopexpertiseandincorporatelong-termelementssuchascountries’vulnerabilitytoclimatechangeandtheirinvestmenteffortsatadaptationandbuildingresilience;morebroadly,itcouldevaluatetheimpactofcountries’investmentonthefuturegrowthanddevelopmentofthesecountries,whichwillinfluencetheirfutureabilitytoservicedebt,dimensionsnotcurrentlytakenaccountofbyexistingratingagencies.
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Broto,CarmenandLuisMolina.2016.“SovereignRatingsandtheirAsymmetricResponsetoFundamentals.”JournalofEconomicBehavior&Organization.130:206-224.Ferri,G.,L.-G.LuiandJ.E.Stiglitz.1999.“TheProcyclicalRoleofRatingAgencies:EvidencefromtheEastAsianCrisis.”EconomicNotesbyBancoPaschidiSiena.28(3):335-355.Ghosh,Jayati(2021)“Credit-RatingAgenciesCouldDerailEconomicRecovery”ProjectSyndicate,March2021Goodhart,Charles.2008.“TheRegulatoryResponsetotheFinancialCrisis.”CESIFOWorkingPaperNo2257.InternationalEnergyAssociation(IEA)2020“WorldEnergyOutlook”IMF(2000)BrieucMontfortandChristianMulder“UsingCreditratingsforcapitalregulationonLendingtoEmergingMarketEconomies:PossibleimpactonBaselAccord.WB/00/69Kramer,Moritz(2014)“Standard & Poor's Sovereign Ratings Anchored Expectations In The Depths Of Eurozone Crisis”, June 14, 2014 Larrain,Guillermo,HelmutReisenandJuliavonMaltzan.1997.“EmergingMarketRiskandSovereignCreditRatings.”OECDDevelopmentCentreWorkingPaperNo.124.Paris:OECD.Li,Yuefen(2021)“Theroleofcreditratingagenciesindebtrelief,debtcrisispreventionandhumanrights”February.UnitedNationsHumanRights.OfficeoftheHighCommissioner.A/HRC/46/29Masciandaro,Donato.2011.“WhatifCreditRatingAgenciesWereDowngraded?Ratings,SovereignDebtandFinancialMarketVolatility.”“PaoloBaffi”CentreResearchPaperSeriesNo.2011-107.Mora,Nada.2006.“SovereignCreditRatings:GuiltyBeyondReasonableDoubt?”JournalofBankingandFinance.30:2041-2062.Pretorius,MarindaandIlseBotha.2017.“TheProcyclicalityofAfricanSovereignCreditRatings.”InNicholasTsounisandAspasiaVlachvei(eds.)AdvancedinAppliesEconomicResearch.Springer:Chapter35.537-546.
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