Credit rating agency

CRAs ( credit rating agency English, CRA, to German credit rating agency ) are private, for-profit companies, which carry out the creditworthiness (solvency ) of companies from all sectors and of States and their subordinate authorities review. The agencies summarize the results of their investigation (rating) in a combination of letters ( Rating Code, short only rating), which is usually from AAA or Aaa ( highest quality ) to D ( insolvent ) is sufficient. The rating codes initially reflect this represents only a ranking. Rating agencies also evaluate the probability of defaults. In addition, the rating also the resistance to economic fluctuations is taken into account, so that at least indicate higher ratings to lasting stable company. Rating agencies, which have within the European Union such as the evaluation of certain risks on financial markets formally recognize are referred to as External Credit Assessment Institution ( ECAI ).

Rating agencies are generally subject to state supervision. Thus it can be established without the approval of the EU in Europe no rating agency. The EU can withdraw the license agencies for breaches of EU law. The supervision of the agencies lies with the European Securities and Markets European Securities and Markets Authority ( ESMA) and the authorities of the Member States.

Rating requirements

Investors and creditors have an interest in ensuring that the creditworthiness of their borrowers will be investigated by independent and competent third party. The aim is to find out how likely it is fully get back the loaned money on the due date. The same is true for the interest payments.

History

Even Henry Varnum Poor pursued these goals in the first rating experiments, published in 1868, Manual of the Railroads of the United States, the investors and potential investors informed about the railway companies. A systematic rating for the U.S. railway companies followed in 1909 by John Moody, founder of Moody's.

In February 1936, the U.S. banking supervision ( Comptroller of the currency ) ordered that the banks only allowed to take over emissions and receivables with a minimum rating ( investment grade ), which triggered a clause requiring the acquisition of external ratings from.

In July 1975 informed the U.S. Securities and Exchange Commission (United States Securities and Exchange Commission ) noted that the rating agencies should be the only ones allowed to meet the legal obligation of the company to seek review before they are approved for the American capital market. This had to be done by at least two approved rating agencies. Were approved for explicitly only Standard & Poor's, Moody's and Fitch Ratings.

1988 was led by Deutsche Bank and the Börsenzeitung the German rating initiative. It went on for a European rating agency. Therefore, In 1991, the project company for European rating mbH with the aim to establish a European agency. The sole shareholder was the editor of Community securities releases Keppler, Lehmann GmbH & Co. At this shareholders several banks were involved. The initiative, however, remained without success. Rather, the U.S. rating system prevailed. This means that the agencies are mandated by law to assess the credit-worthiness of all market participants, all must act accordingly. Although the U.S. Financial Security Exchange Commission (SEC) to oversee the agencies, but gives them a free hand in the definition of the criteria. The self-financing Reviewed the rating. The agencies remain released from liability even when intentional false reviews because they can take the basic right of " free speech " (1st Amendment to the U.S. Constitution of 1791, part of the Bill of Rights ) to complete. This trained initially in the U.S. and for the U.S. system (IMF ) first forced upon the developing countries in the 80 years of the International Monetary Fund, globalized in the 90s through the Bank for International Settlements (BIS, central bank of central banks, Basel office ) ( Basel II Agreement ), the EU has been subjected to.

Other national and international financial and banking supervisory authorities recognized the importance of ratings and built- in gain in the regulations for the banking and financial supervision. Thus engages in Germany the Solvency Regulation in January 2007 as part of the credit risk standardized approach to external ratings back. According to § 41 of this Regulation, the rating agencies for risk weighting purposes of credit institutions by the Federal Financial Supervisory Authority ( BaFin) must be recognized. The regulatory approval follows the criteria of § § 52 and 53 of the Solvency Regulation.

In the 1990s, the German banking industry tried together with Bertelsmann, to form their own rating agency. 1996 worked the Hessian Ministry of Economics and the German Stock Exchange, but it did not come to an institutionalization. At times, a kind of credit should guard be installed at the European Central Bank, however, what these rejected.

As the first German rating agency Credit Rating Reform was approved by the BaFin as a rating agency for supervisory risk weight under the Solvency II and Basel in August 2009. Approval is valid for the market segment Other receivables ( including credit ratings of the company and corporate bonds ). As the first and currently the only European rating agency Euler Hermes was in November 2010, recognized and registered Rating GmbH by the BaFin and the Committee of European Securities Regulators. This registration will allow institutional investors - in accordance with Regulation (EC ) No 1060/ 2009 of the European Parliament and of the Council on credit rating agencies - the future to invest in securities that were rated by EU registered credit rating agencies. Thus, the BaFin is currently reworking the system regulation for insurance companies to meet the new EU regulation requirements. [ Bafin 1]

Through the Federal Financial Supervisory Authority for regulatory risk weighting following ( capital adequacy ) rating agencies are recognized, although this was still not given permission for the performance of credit rating activities according to the new EU regulation [ bafin 2]

• Credit Reform Rating AG, a German rating agency, based in Neuss ( reference agency Credit Reform Association)
• Dominion Bond Rating Service ( DBRS ), a rating agency based in Toronto
• Fitch Ratings, part of the Fitch Group, majority owned by Fimalac S. A., with headquarters in New York
• Scope Rating GmbH, a European rating agency, based in Berlin
• The McGraw -Hill Companies under the brand Standard & Poor's Ratings Services, based in New York
• Moody 's Investors Service, with headquarters in New York

The European Central Bank uses only the three big agencies also add the Dominion Bond Rating Service. These four rating agencies are guided by the BaFin homes for a " usefulness of unsolicited credit ratings ." Without approval from the EU can be founded in Europe no rating agency, it can present agencies for breaches of EU law revoke the license. The supervision of the houses located in the European Securities and Markets European Securities and Markets Authority ( ESMA) and the authorities of the Member States.

International will turn the contrary. Thus, the Dagong Global Credit is recognized in China, as the United States not einstuften with the highest level of AAA, but in view of the public debt only with A . Dagong ( " Great Work " ) sees itself as an alternative to western rating system that is dominated by the "Big Three" in the U.S., Standard & Poor's, Moody's and Fitch. Dagong, founded in 1994 on the initiative of the Chinese central bank as a private company under Chinese law. According to the founder and current heads of Guan Jiazhong the Big Three have finally discredited by their misjudgments before the financial crisis. Its principle is wrong, because they are interested in is not primarily for the income situation of a country or company, but only for the ability to raise loans. The guiding principle of Dagong was against loans that serve the real economy and ultimately serve the welfare of the population.

The ECB accepted In May 2010, Greek government bonds regardless of their credit rating as security. Here, however, she took haircuts on the face value. This is now also for Portuguese bonds. Should the Agencies Greece, however, declared insolvent, and the ECB would buy any more bonds.

Ten companies are listed as nationally recognized statistical rating organizations in the U.S. whose credit assessments may be used for capital market purposes (as of 2011 ). These are Standard & Poor 's, Moody's, Fitch Ratings, Kroll Bond Rating Agency, AM Best Company, the Canadian Dominion Bond Rating Service ( DBRS ), Japan Credit Rating Agency, the Japanese Rating and Investment Information (R & I), Egan -Jones Rating Company and Morningstar.

Rating Process

The rating process begins with the application of an issuer or borrower to an agency, the so-called mandate agreement. Basically, however, an investor or lender can give the order to the rating agency. The contract is the contract to the Agency, the credit quality of the obligor published against publishing information, but also not publicly available internal company check. Internal company are as accurate information or information on the ten largest customers, suppliers, etc., through financial plans and the main competitors, accurate cost and revenue structures and planning. Internal Agency concurs with the analysis of quantitative and qualitative factors; this analysis can be supplemented by interviews with the Chief Financial Officers of the debtor.

Then give two analysts ( junior and senior analyst ) a rating recommendation; this decides the rating committee concluded. Its decision shall be submitted first to the Principal and published subsequent to its approval.

Also about each Rating Update, which takes place at least once a year, but the rating committee decides autonomously, then without consultation with the debtor. Secret information are taken into account in the rating, but not in the verbal justifications. It is company secret agency which factors they considered and how they are weighted. Also underlying mathematical formulas are not publicly available.

By updates is to ensure that the rating corresponds to the current creditworthiness. The non- mandated agencies evaluate only from the publicly available corporate information and analyze these also for the purpose of creating a so-called secondary ratings (unsolicited ratings). The different degree of information can therefore have a lower level of reliability than the mandated ratings.

The agencies have developed for various types of debtors different rating methods to meet the individual business characteristics of each debtor needs. Despite the informational advantages of mandated the Agency and the secondary agencies the past has shown that agencies differ only one or at most two notches or rating grades for the same obligor as a rule. The different methods of rating agencies appear over time not materially impact on the rating result.

A study by the University of Heidelberg on the assessment of the creditworthiness of countries by credit rating agencies provides evidence of frequent amendment of the submitted proposal at the final rating decision by the rating committee.

Rating levels

The agencies use different names for their reviews. The most important agencies use these ratings:

Problems of the rating process

Using single large scandals was documented exactly how the agencies come to misjudgments in its credit rating classifications. They were concerned with complete imbalances of the agencies in connection with the spectacular cases of Enron (1997), WorldCom (2001), Parmalat (2003) and the misjudgments in the state crises in Asia (1997 ) and Argentina ( 2001), or about the largest municipal bankruptcy of Orange County in California in December 1994. These are not isolated cases, such as the widespread mispricing of securitized mortgage securities and banking 2007/8 showed in the run-up to the last financial crisis as well as the sudden downgrading of the European crisis countries of Greece, Spain, Portugal, Ireland and Spain. The work also revealed that these defects are not predominantly agency -specific, but that other financial institutions or other investors were thereof partially affected.

Transparency of information gathering

Rating agencies need to gain access to the debtor and its latest rating-specific and matching with the corporate reality information. Here are the agencies, especially in critical cases, confronted with the same information retrieval problems such as credit institutions and other creditors. This is due to the here applicable by analogy Akerlof'schen adverse selection theory, according to which debtors tend to withhold that information to play down to late, or not to publish, having an economic disadvantage (higher loan rate or even credit termination) result for them could. In the case of Enron, the agencies persisted about the fact that their ratings accurately reflected the credit quality, which resulted on the basis of available information " available information " were the agencies to access information, but not the withheld information.

Conversely, it is also advised in the view point that rating agencies in order to increase the transparency of their rating models made ​​publicly available; also been headhunted by interested investment banks rating expert. The latter were characterized to be able to validate to product look much better in terms of the assessment criteria than it actually was (see also " creative accounting ").

Vicious circle "trigger event"

Cause of a corporate crisis are internal company factors in many cases. However, it can quickly get through the evaluation of the corporate credit rating by rating agencies to further problems that are mutually dependent in the form of a vicious circle.

Terms and Conditions, and credit contracts include regular different types of adaptation and termination clauses, which are linked to the ratings agency. Each rating deterioration ( downgrading) may, at contractually agreed terms or ancillary agreements ( financial covenants ) an Event of Default of the creditor and thus trigger a trigger event. In addition, the so-called cross - default clauses lead to termination of credit agreements, which themselves contain no rating conditional trigger. A credit rating agency may, by lowering the rating of a company crisis quickly worsen (or even just create ), it should be conditional rating, coming automated loan facilities.

Furthermore, each rating downgrade via automated rate hikes ( margin- grids ) can contribute to an increase in lending rates. This solves also a vicious circle, because of the increased credit costs ( ceteris paribus ) decrease the profits of the debtor or its losses increase - which the creditworthiness of the company continues to fall. Institutional Investors is an investment in prohibited companies below a certain rating level, so that funds and insurance companies are subject to such rating requirements in their buying and selling decisions.

Ultimately, creditors or potential business partners of the company are downgraded cautious, invest less or even rise from the company and do with this behavior further downgrades in the sense of a self-fulfilling prophecy likely. This vicious circle was in the Enron bankruptcy - among other causes - crucial. This trigger had there triggered the repayment of loans in the amount of 690 million dollars.

Conflicts of interest

The agencies are sometimes criticized that they tend to close relations with the (financial ) Board of borrowers (issuers ), which can lead to exaggerated mutual influence or exposes them to even the risk of misleading. In regular meetings with debtors they are influenced so as by the agencies, what action to take or be to refrain in order to obtain or maintain a particular rating. Since the debtor and not investors represent the largest source of income of the agencies, is here near the danger of a conflict of interest: Impending downgrades could lead to disputes or even a loss of fees paid by borrowers change the agency. The risk of conflict of interest is classified as low, if an agency has many clients. In the market for structured finance products but about control since 2002, the six largest purchasers half and the twelve largest four-fifths of the rating market.

See: principal-agent theory

Fraud

With intentionally false information, at worst in the financial statements, the interested public to be feigned a better economic situation. In this case, however, the fraud efforts must be created so plausible that analysts long time not suspect and keep the available information to be accurate and plausible. Enron and Parmalat were such cases of accounting fraud. The fraudulent, certified by prestigious auditors manipulations were initially neither the auditors nor the analysts of the agencies nor the analyzed banks. The agencies have also cheated. As demonstrated by investigations of the U.S. Congress and in numerous publications unchallenged, have the Big Three complacency ratings issued bullied unwilling analysts and forced to departure, issuing banks at a time using subsidiaries advice. They have in particular the investment banks that wanted to bring all fast new financial products to the booming market, a " rating hopping and shopping " allows: If an agency hesitated with a best rating, the Bank moved quickly to the next agency or threatened. This was made easier, inter alia, through the practice of "revolving door": employees of banks and the State Inspectorate SEC move to the rating agency and back.

Rating agencies as a certifying

Lenders such as banks or commercial investors must expect as active creditors with credit default at faulty own ratings. Thus, their ratings have a living, autonomous status. However, rating agencies create borrower grades without giving the debtor loans. Their status is therefore that of a certifier without own risk. This secures them on the one hand some of their objectivity, but on the other hand reduces the personal responsibility for the rating.

Rating errors of the agencies thus act for they do not threaten the existence of. The agencies thus refer to their ratings simply as " opinions " do not represent a buy, hold or sell recommendations. This is now - triggered by the bankruptcy of Orange County - also clarified constitutional court in the United States. After a district court had ruled that rating agencies will not issue financial advice, but are subject to their ratings of the constitutionally protected freedom of expression. In Germany, the Berlin Court of Appeal dealt with the question of whether credit rating agencies have to answer legally for their published announcements. It took the view that the messages are so far covered by the freedom of expression, as they are based on the basis of neutral, qualified and created in an effort to objective accuracy analysis. For banks, however, provide a rating may dar. existential decision basis for the grant, property management and early recovery of loans

Criticism

Since the Enron crisis, it has come again and again to criticism of rating agencies. 2003, there was criticism of the rating agencies on the part of the Economic and Monetary Committee of the European Parliament. Key elements of the submitted report he dated 6 October 2003, which had been given as a result of the Enron crisis in 2002 in order, were conflicts of interest and lack of transparency in decision-making basis, were added allegations that the agencies acted to pro-cyclical, that is, they reinforced exclusively ongoing developments. In the context of the financial crisis starting in 2007, criticism of the rating agencies has greatly increased and triggered a political debate at the highest level in the U.S. and Europe. The agencies are accused with the award partly unrealistically good ratings, often even the top AAA rated securitized securities, market participants have indicated a low risk to the financial markets and, thereby a false incentive. The credibility of the rating agencies or the validity of the ratings awarded by them are also made in connection with charges of securities fraud against Goldman Sachs in question, since the securities in question were provided with the best rating. The role played by the ratings in the Greek sovereign debt crisis and the euro crisis, ensures that the rating agencies collide with political interests. The loss of credibility in the bond prices and the risk premium reflects on the stock market, which often deviate from the related ratings strong.

Critical is seen that the rating agencies are paid by entities whose financial products they are asked to evaluate the same time, which may cause conflicts of interest. CRAs are accused they were subject to this conflict of interest by featured to good ratings in view or vergäben to secure business or repeat business. The conflict of interest between agencies and issuers as their clients not would occur when instead of the issuer, the investor will provide the ratings in order. If, however, investors must publish paid ratings to themselves to justify their customer investment decisions, other equity investors can get this information for free ( free rider problem ). Therefore, now the rating agencies relate almost exclusively through contracts with issuers of their income.

From economists in particular the lack of transparency of the rating process is criticized. For reasons of industrial secrecy, give the rating agencies not known, due to which data and reviews they come to their assessment. The calculated ratings can be characterized not understand clearly, you just have to believe it. According to some economists, the data from annual reports and economic indicators in terms of hit rate in terms of a default, much better than the ratings of credit rating agencies. Also, country ratings, as for Iceland, met with criticism. Iceland was a result of the collapse of its banking sector in 2008 shortly before the bankruptcy. But a few months earlier it had been rated by Moody 's its highest rating of AAA. In this case, there had been rumors in 2006 to potential problems of the banks in the country, which designated rating analysts exaggerated.

In addition, it was criticized that the small number procure these oligopolistic power of globally relevant rating agencies. The main criticism is, however, in the demonstration of the close -ownership of the rating agencies with today's financial market dominant actors, the hedge funds and large asset managers. Thus, the well-known U.S. speculator Warren Buffett has long been involved with varying concentrations of Moody's, through its holding Berkshire Hathaway. So are the world 's largest asset managers such as Capital Group, BlackRock, Vanguard, State Street, and T. Rowe Price, the main shareholders of Standard & Poor's and Moody's, either simultaneously or with varying proportions. Thus, insider trading are programmed even by those links, if there is the fact that about Black Rock rated the creditworthiness of states and also advises on debt management. Because the credit rating market to 97 percent dominant Big Three are so closely intertwined with Wall Street, they are not able to take an objective view from the outside. The former head of Standard & Poor's, Deven Sharma, presented by the financial crisis of 2007/8, therefore, stated: " We are well located next to it, we have the subprime securitizations to well rated. It has the dramatic drop in the U.S. property market but hardly anyone anticipated. "

A study by the University of Heidelberg with comparison of the work of nine credit rating agencies on the creditworthiness of states revealed that the agencies do not docked, the same criteria for all countries. The respective home country and countries that were similar to the home country in their characteristics, were comparatively better grades than other countries.

Political consequences

As a reaction to the assumed joint responsibility of the rating agencies for the financial crisis on 16 September 2009, the EU - rating regulation ( Regulation No 1060/ 2009) entered into force, the various measures relating to conflicts of interest, rating quality, transparency and internal governance of credit rating companies provides. In particular, the government draft of the implementing law to this Regulation suggests that rating agencies continue to supervision by the BaFin subject as the supervisory authority, which in the case of a violation of the regulation can impose fines.

In early 2010 various politicians expressed the need for a European ratings agency in order to create a counterweight against the American. The German economy Peter Bofinger argued in May 2010, in view of the Greek financial crisis and the risk of contagion to other countries for the establishment of a " European, non-profit rating agency " from. The three major agencies Standard & Poor 's, Moody's and Fitch had " so far failed massively in every crisis ," but had not yet been brought to justice. There is no real competition among the rating agencies still they stuck to their assessments.

After the downgrade of Portuguese and Italian bonds, the EU Justice Commissioner Viviane Reding called for in July 2011, either to destroy or to encourage the creation of additional agencies the three major agencies.

On 15 November 2011, the EU Commission has presented new proposals for stricter rules for credit rating agencies. After that financial institutions should no longer base their investment activities solely on ratings, sovereign ratings should be created transparent and more frequent and rating agencies should be independent, be exposed to higher competition and adhere more strongly for the ratings they create. The temporary pursued idea of ​​introducing a legal basis through which the publication of credit ratings of European states should be temporarily banned, but was not pursued further.

In November 2012 Italy raised before an Italian court for market manipulation charges against seven managers from two rating agencies (S & P and Fitch).