Although credit ratings agencies received plenty of criticism and a temporary decrease in profits after the 2008 financial crisis, they have quickly recovered. Earnings are back to pre-crisis levels, and no new regulations or competition has weakened the big three firms.
Ratings agencies have been criticized for rating mortgage-backed securities incorrectly and for allowing issuers to pay their fees, which seemed to lead to inflated ratings. But regulations discourage the sales of unrated bonds, thus strengthening the investment industry’s dependency on ratings agencies. Although there was strong momentum after the crisis to change regulations, so far little has been done.
How Is This Article Useful to Practitioners?
Recently, profits have risen to record levels for ratings agencies because of a record amount of bond issues. Companies that receive ratings are still paying for this process because lower borrowing costs offset the charges. Questions have been raised about whether these private companies should be allowed to play such a pivotal role in a public market.
A new regulator in Europe (European Securities and Markets Authority) and regulation in the United States (the Dodd–Frank Act) are both designed to increase the monitoring of ratings agencies and reduce references to ratings. Although the US SEC intended to introduce new regulations for ratings agencies by May 2011, this process is still ongoing. So far, it has proven difficult to find viable alternatives.
Furthermore, research may indicate that letting investors pay for ratings might not solve the problem either because irregular market information might result in mispricing.
Currently, ratings are influential indicators throughout the financial industry. They not only influence yield and return decisions but also credit risk and default decisions. Because many banks, insurance companies, and pension funds partly decide their portfolios based on ratings analysis, the way the ratings industry is structured has a huge influence on many other financial sectors.
Ratings agencies still play a documentation role in the financial industry. For example, many regulators still require insurance companies and pension funds to have portfolios of defined credit quality, in which ratings play a central role. The author shows that ratings agencies have suffered from the financial crisis with a loss in profits and reputation. But it seems that at the moment, there is no viable alternative to their services. In addition, the lack of action from regulators is resulting in a status quo much like before the crisis. Because bond ratings affect many financial professions, this article will appeal to a wide variety of financial professionals.