The extraordinary and undeserved power of private rating agencies – Jayati Ghosh

On March 10, Moody’s rating agency put Ethiopia under scrutiny for a possible downgrade. The problem is not the repression in the Tigray region. The fact is that the Ethiopian government, which benefits from the suspension of debt service (DSSI), has pledged to deal with private creditors within the G20 common framework on debt treatment. And that, according to Moody’s, creates the risk of those creditors making losses. Apparently the country, for this reason, must be punished. The DSSI aims to support poor countries during the pandemic, while the common G20 framework was designed to help states restructure their debt. But now the threat of rating downgrades casts a shadow over the future of these countries.

The story highlights a problem in international finance: the extraordinary and undeserved power exercised by a few private rating agencies. Three of them – Moody’s, Standard & Poor’s, and Fitch Ratings – control more than 94 percent of benchmark credit ratings. And they have significant cross-holdings. These companies determine the market trend, influence the distribution of financial portfolios, the valuation of debt and the cost of capital. In a move that strengthened their authority, the Security and Exchange Commission (SEC, the US stock exchange supervisor) recognized them as official statistical rating organizations. And many institutional investors have to bow to their decisions.

Concerns about rating agencies were first voiced at the time of the Enron scandal in 2001. Enron, an energy services company, was accused of using accounting tricks and complex financial instruments to deceive investors, creditors and supervisory authority about its value. The three major rating agencies released positive ratings of Enron just days before the company collapsed. They have also been accused of making the mortgage bubble possible subprime in the United States, whose outbreak triggered the 2008 crisis. It is also known that they made some assessments on the basis of ideological positions.

Yet, as Yuefen Li, the UN expert on foreign debt and human rights, points out in a recent report, rating agencies are not accountable to any of their mistakes. Their assessments are legally described as “opinions”, therefore protected by the laws on freedom of expression, and their methods are not public. Simply put, they don’t take the responsibility they should have for the enormous power they wield. Also, Li points out, conflicts of interest abound. Rating agencies are private companies, mostly funded by the institutions they are supposed to judge. And because they are part of the markets they evaluate, their private interest inevitably shapes their decision-making processes. The rating agencies were, for example, involved in the creation of financial products whose rating was up to them.

Regulators try to limit conflicts of interest in finance, yet they have no problem with rating agencies regulating themselves. This lack of controls reflects in part the strong lobbying capacity of Moody’s, Standard & Poor’s and Fitch Ratings. And it is generating serious risks, which the pandemic has accentuated. As Li points out, for example, the rating tends to follow the economic cycle, that is, to be more severe during crises: this makes the financial market conditions inhospitable for developing countries, which see their economic prospects downgraded. Now, with Moody’s latest move, these countries will be afraid to start debt restructuring talks with private creditors.

If G20 governments want to improve the debt positions of developing countries during the covid-19 crisis, they should start by calling for the temporary suspension of credit ratings. In the medium term, regulators need to ensure that rating agencies play their market stabilizing role. And it is crucial to address conflicts of interest.

But regulating private rating agencies may not be enough. The United Nations Conference on Trade and Development has long argued that the world needs a public, independent rating agency that makes objective assessments of states and companies. It would also serve to assess the tools used to finance public investment, for which there will be great demand in the coming years.

A global agency would make sense, because ratings, especially those referring to sovereign debt, are international by vocation. And it would provide a necessary counterweight to private agencies that are accountable to anyone.

(Translation by Federico Ferrone)