Ratings agencies turn tables on global legislators
By Christopher Elias
London, July 20 (Business Law Currents) – Governments around the world may regret the vitriol they cast at rating agencies as these American companies turn the tables on sovereign debt-marred governments and drive the agenda in the U.S. and EU.
Turning the hunted into the hunters, rating agencies have taken aim at political decisions in the U.S. and Europe as they constrain political decisions and break free from the much-promised legislative clampdown to impact euro zone restructurings and U.S. debt ceiling considerations.
HUNTING THE HUNTERS
Recent weeks have seen the battle lines between governments and ratings agencies starkly drawn as sovereign debt problems envelope government proposals. For the ratings agencies, the prospects of Ireland, Greece, Portugal and even the U.S. are distinctly negative, whilst the EU and national governments express outrage at what they see as self-fulfilling and cynical prophecy from these American juggernauts.
In the wake of the credit crunch, ratings agencies were much lambasted for rating financial products and even financial institutions (eg Lehman) as creditworthy even as the financial world collapsed around them. Lest we forget, credit ratings agencies such as Moody’s, Standard and Poor’s and Fitch Ratings all maintained at least A ratings on AIG and Lehman Brothers up until mid-September, with Lehman Brothers declaring its bankruptcy on Sept. 15 and AIG receiving a government bailout the very next day.
This lack of correlation between credit ratings and financial futures led many to criticize the industry for lacking independence from issuers, lacking adequate competition between agencies and using opaque criteria to rate complex financial derivatives.
The result of these accusations was a much-touted but little implemented legislative backlash. Topping the agendas of governments around the world were new disclosures on how securitisations are rated, competition (anti-trust) investigations and making ratings agencies liable to investors should their ratings prove inaccurate.
Despite high expectations, only additional disclosure requirements have yet to come to full fruition. Under SEC rule 17g-5, issuers, sponsors and underwriters of structured finance securities are now required to post, on a password-protected internet website, details of information provided to credit rating agencies. Credit rating agencies in return are required to maintain a password-protected website detailing a list of each structured finance product they are assessing and provide details of how they assess and monitor credit ratings of structured products.
In Europe, regulatory change was at first (unusually) even faster. By Nov. 17, 2009, the European Parliament and Council had approved the Credit Rating Agencies Regulation (1060/2009/EC) (“CRA Regulation”). These regulations introduced a similar system of certification and registration for CRAs and increased disclosure to regulators, including an annual transparency report.
These EU-wide regulations were supplemented by national regulation seeking to fill in the blanks left by the CRA regulation. However, with the newly-formed European Securities and Markets Authority (ESMA) taking over responsibility for oversight of the CRA regulation, progress appears to have stalled as ESMA consults on how the regime should properly operate in the EU.
This gap in the regulatory process has led to some interesting disclosures, with many issuers noting that it is prohibited to use a credit rating agency not registered under Regulation (EC) No. 1060/2009 of the European Parliament but that the credit rating agency mentioned has not yet received a corresponding registration decision.
With the legislative clampdown having failed to get off the ground, rating agencies appear to have turned the tables on national governments as they legislate the legislators. Driving decisions and policies from everything from Greece’s restructuring to the U.S. debt ceiling, governments may be wishing that they had been a little kinder to rating agencies when they had the chance.
Of major significance has been the rating agencies’ role in shaping the restructuring of Greece. With the EU desperately trying to avoid characterizing Greece’s troubles as a “default,” they have been shaping Greece’s “soft restructuring” around what would qualify as a default for rating agencies.
Not confined to semantics, the importance of avoiding a “default” label has originated from the European Central Bank’s refusal to accept defaulted bonds as collateral for its loans, loans which have become the lifeblood of many euro zone banks’ funding. With many European banks holding Greek debt, achieving a non-default restructuring or “soft-restructuring” has taken on an increased significance, as many fear that a default would cripple the ability of EU banks to raise funds. EU banks and governments have therefore been forced to design a restructuring around rating agency criteria.
The importance of rating agencies in the process was seen recently when Standard and Poor’s knocked back a proposal from French banks to roll over certain portions of the Greek government’s debt.
Under French bank proposals, holders of Greek government bonds coming due between July 2011 and June 2014 would have their bonds swapped for:
1. 70% in new 30-year Greek government bonds with a 5.5% coupon plus a GDP-linked surcharge of up to 2.5% and a full principal guarantee in the form of AAA-rated zero-coupon bonds;
2. 30% in cash.
Under the proposals, the Greek government would be able to roll over a significant proportion of its debt while only having to fund the 30 percent cash payment plus the cost of purchasing the AAA-rated zero-coupon bonds.
The $28 billion restructuring plan was thrown into disarray, however, when Standard and Poor’s stated that it would consider the plan to be a “selective default.” Standard and Poor’s noted that the proposal would extend the timetable for repayment of debt and would therefore be on less favourable terms than the original bonds. As such, Standard and Poor’s considered that the proposal would constitute a “selective default” under its credit rating criteria.
With the restructuring plan tarnished, the EU has been forced to shelve the French proposal and now looks forced to consider a restructuring that would either appease credit rating agency criteria or accept that any debt shuffling will likely be a default.
THE SKY’S THE (DEBT) LIMIT
On the other side of the Atlantic, the U.S. government has also been cognizant of the new-found importance of rating agencies in public policy. Moody’s decision to put U.S. AAA rated bonds on notice for a downgrade following disputes over the U.S. debt ceiling has helped to ratchet up the heat on discussions between Republicans and Democrats over the country’s borrowing levels.
On July 13, 2011, Moody’s announced that it was putting the Aaa bond rating of the government of the United States on review for possible downgrade over the inability to agree on a timely increase to the statutory debt limit. Moody’s didn’t stop there either. It also put Fannie Mae, Freddie Mac, the Federal Home Loan Bank and the Federal Farm Credit Banks on review for a possible downgrade due to their direct links with the U.S. government.
Even a timely debt ceiling expansion may be unlikely to fully appease Moody’s. It noted in its announcement that unless a “substantial and credible agreement is achieved on a budget that includes long-term deficit reduction” then it will maintain negative on its outlook for U.S. debt. Going further, Moody’s even dictated some of the terms of the debt ceiling agreement. It requested that such an agreement “include a deficit trajectory that leads to stabilization and then decline in the ratios of the federal government debt to GDP and debt to revenue beginning within the next few years.”
Moody’s was followed by Standard & Poor’s warning that even if an agreement was reached on the debt ceiling it might still downgrade U.S. debt unless there was a credible plan to deal with medium-term fiscal problems.
As clashes between rating agencies and governments continue, rating agencies look increasingly like they have survived a legislative backlash to dictate policies of their own. Demanding fiscal responsibility and transparency from governments, they are turning criticisms of financial irresponsibility and transparency on their heads and are targeting the very same governments who once lambasted financial services for irresponsibility.
(This article was first published by ThomsonReuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at http://currents.westlawbusiness.com.)