CB BureauLack of cooperation on supervision of sovereign credit raters is undermining Rio+20’s pursuit of new sustainable development goals…
When Cyprus
announced in June 2012 that it was edging closer to being the latest Eurozone
country to seek bailout money, the fragile nature of how the world deals with
sovereign debt was thrust once again into the public consciousness.
As it stands today, sovereign debt is a
huge (and growing) $41 trillion global phenomenon. One in which private firms
called credit rating agencies (CRAs) such as Moody’s have long flourished
during times of economic uncertainty or adversity. And they continue to do so.
CRAs have been a pivotal player in the
global economic system for over a century and date back to the financing of the
US railroad expansion in 1909. However, it took the international banking
meltdown of 2007-08 to push them into media prominence.
The dramatic events of the past five years and the huge power of the
CRAs have thus led many commentators to ask – are these private firms fit to rate countries?
And are they being supervised properly? A report by Infrangilis (a think-tank on resiliency strategies) suggests
not.
In May 2012,
Infrangilis published the research study Rating Sovereign Raters, timed
to feed into policy fora around the world, for example, the EU Economic and
Monetary Affairs Committee and the UK House of Commons Treasury Select
Committee (both of which are hearing evidence on the conduct of CRA industry).
The study concludes
that proposals by regulators in the US, Eurozone, or multi-lateral agencies to
reform or replace the role of the CRAs fail to understand the complex system in
which government borrowing and debt ratings take place – i.e., the
interconnectedness of monetary and financial systems.
For instance, it is argued that CRAs are undeservedly preventing the
flow of capital into the developed world, arguably because the industry tends
not devote time and resources to economies such as Africa because it is not a
lucrative market (bearing in mind their funding model of ‘issuer-pays’). This
means some 58 developing countries find it more difficult to raise money to
grow as they are do not have a credit rating, or the rating is out of date and
does not recognize any positive progress made by a country. This undermines
Rio+20’s pursuit of new sustainable development goals.
Consequently, Infrangilis strongly
believes there is a need for fresh thinking when it comes to moderating the role
of CRAs. This is where the notion of ‘responsible’ sovereign ratings becomes
invaluable if we are to hold the CRA industry to account and ensure it
continues to serve the public good. A more responsible approach to sovereign
debt rating includes considerations of ratings accuracy, competition, conflicts
of interest, capital flows to developing countries, and non-financial
performance such as poverty or environmental resource efficiency.
Key to delivering this is more
effective cooperation between governments on CRA supervision. Most notably,
Infrangilis is recommending the establishment of a new international
observatory on sovereign debt ratings.
Calls to establish a supra-sovereign ratings organization, be it a new
EU- or UN-led one, have not been welcomed by the UK and US governments in
particular. This is mainly due to a perceived lack of market legitimacy and the
tax burden associated with the high cost of set-up. (For example, a proposal by
the Bertelsmann Foundation to resource
a new global non-profit agency for sovereign debt called INCRA requires
an endowment of up to $400 million). Rating Sovereign Raters makes the
case that an accommodating position or hybrid model can be found, by
establishing a new UN platform as a credit rating observatory as opposed
to a credit rating service provider. This could be hot-housed by an
existing G20-approved body that has the respect of the markets, such as a
re-constituted Joint Forum (based at the Bank of International Settlements, whose mission is to act as a centre for
discussion and decision making for the international supervisory community).
The observatory would, for instance, be tasked with monitoring and reporting on
how well the market is functioning, acting as an early warning system, and
securing consensus on international professional standards for rating
methodologies.
Any newly reconstituted Joint Forum would need
to have the trust and endorsement of the BRIC countries and other parts of the
South, a fact reflected in its governance structure. This additional work by the
Joint Forum should aim to avoid the need for extra public subsidy or a
transaction tax. A simplification of the system would realize savings that
could be redirected here, for example, by merging divisions of the IMF or
sharing examiners already at work in the European Securities and Markets
Authority. In short, do more with less.
If our political leaders want to deliver on their bold words for
sovereign debt sustainability, it is this type of international governance
innovation that will be required.
Rating Sovereign Raters: Credit Rating Agencies – Political Scapegoats
or Misguided Messengers? was published by
Infrangilis on 31 May 2012. It can be downloaded for free at http://www.infrangilis.org