It ain’t easy being an oracle.
Pilloried for going too easy on the mortgage-backed securities that eventually sparked off the global financial crisis, credit rating agencies have been accused more recently of being trigger-happy on euro zone sovereign ratings downgrades that have roiled global markets.
But other than credit ratings, do investors have alternatives to assessing credit risk?
Not many, argues ING in a recent report.
Internal rating-based models used by investors and banks are hardly better at predicting credit events, ING finds in a study of 55 bond defaults among 448 rated emerging-market companies over a five-year cycle.
Over a three- to 12-month range, however, investors appeared more prescient than the rating agencies but this edge may have more to do with investor herd behaviour ahead of any default event.
“Market versus ratings differences in the final 12-month period (before the credit event) suggest that herd behaviour was not ratings driven, even in the speculative-grade space,” writes ING’s Global Head of Emerging Markets Strategy, H. David Spegel.
Reducing the market’s over-reliance on rating agency risk assessments may appear to bring benefits but eliminating the use of credit ratings could create new problems, Spegel warns.
Credit rating agencies are often “the only external lever available to ensure that creditor-friendly government policies are pursued”. Their cross-border reach and influence on borrowing costs means they have greater leverage compared to individual investors in ensuring basic levels of transparency from borrowers.
“Rating agencies may therefore be said to pose some threat to a government’s sovereignty. It is therefore little wonder why so many are now keen to eliminate them. If the market clout of the agencies is diminished too far, their ability to serve investors in this capacity will also be reduced,” Spegel concludes.
The predicament that credit rating agencies face evokes the ancient Greek mythical figure of Cassandra.
The most beautiful of daughters of the king and queen of Troy, Cassandra was blessed with the gift of prophecy by Apollo. But when she spurned Apollo’s advances, the angry god placed a curse on her so she was doomed to be right but never believed.