| Rating Agency Business Heading For New Era |
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| martedì 17 ottobre 2006 | |
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Monopoly. Cartel. Price-fixing. The words conjure images of workers toiling in African diamond mines or of the imperious black-hatted robber barons of a century ago. These days, those colorful descriptors are being applied to far more mundane characters: credit rating analysts, the bespectacled pencil-pushers responsible for assigning letter ratings to companies' debt issues and credit-worthiness. Yet, these ratings are a billion-dollar business. Not only do they influence how investors value a company's bonds, but they are also key to how expensive it will be for corporate borrowers when they raise funds in the bond market. The business is currently dominated by Standard & Poor's, a division of McGraw-Hill Cos. (MHP) and Moody's Investors Service, part of Moody's Corp. (MCO), but some smaller raters and independent analysts are hopeful that a new law will break - eventually - what has been a duopolistic grip on the lucrative market.Investors cried foul when the dominant ratings agencies still considered Enron Corp. and WorldCom Inc. investment grade just days before their respective collapses. In the years that followed, calls for greater competition among the rating agencies grew louder, reaching a feverish pitch recently as lawmakers overhauled how companies apply to join the elite world of the credit raters and expanded the scope of rating agency oversight. And elite it is. Despite stunning profits - Moody's Investors Service enjoys an operating margin of around 50% and its stock is worth more than double what it was three years ago - companies haven't been able to flock to the marketplace because of a practically insurmountable barrier to entry: the government. Under the old arrangement, which began in 1975, companies that wanted to become an official rating agency had to prove to the Securities and Exchange Commission that they were "nationally recognized," which was virtually impossible to do without being an official rating agency. Under the terms of the Credit Rating Agency Reform Act of 2006 signed by the president a few weeks ago, the SEC has explicit authority to regulate credit rating companies and to address possible abusive or anticompetitive practices. The act also establishes clearer standards that need to be met for companies that want the official rating agency designation - a response to years of criticism that despite all of the money being made, ambiguous requirements stymied growth and competition in the sector. The final bill replaced the pointedly-named House version: the Credit Rating Duopoly Relief Act. "A number of people have indicated they can't use our ratings without the [official] designation," says Sean Egan, managing director at Egan-Jones Ratings Co., which first applied to be a designated ratings agency nearly a decade ago. While Moody's has more than 2000 employees, Egan-Jones has about 15. Egan says he met the requirements to become an officially recognized ratings agency years ago, and he expects to receive the designation under the new law. Ratings, Ratings Everywhere? The law's passage capped months of heated testimony - not to mention accusations from market participants that leadership at the dominating ratings firms would all but tie themselves to Capitol Hill trees to prevent the bill's passage. In the end, the big two said they supported "reasonable" legislation opening the door to competition. But the question remains just how much impact the legislation will have. Charlie Brown, general counsel at Fitch Ratings, long the third-place laggard in the ratings marketplace, says the new bill makes strides simply because "it recognizes that Moody's and S&P are monopolists." Fitch - as well as some members of Congress - accuses the two companies of "notching," a practice where the raters demand that in order to rate a structured finance vehicle like a collateralized debt obligation, the company must also rate the underlying securities - in effect demanding additional ratings purchases. "We believe it's designed to perpetuate at least an 80% market share," Brown says, noting that Fitch made strides in the structured finance realm through the late 1980s and 1990s, until the rise of products like CDOs. Fran Laserson, Moody's vice president of corporate communications, says that notching arises because "no one should be forced to rely on the work of others for the foundation of their opinion." "Investors expect Moody's opinions to be based on our own methodologies," she says, which differ from the those employed by other ratings firms. S&P officials weren't available to comment. Even if so-called "notching" and other similar practices are prohibited - and that still has to be decided by the SEC - expectations as to what the new ratings marketplace will look like vary. Sean Egan, whose firm charges investors for ratings and research, rather than the issuer pay model used by Moody's, S&P and Fitch, envisions a "bifurcation in the market" between issuer and investor pay models. Many investors, he guesses, "will be strongly encouraged to use non-conflicted ratings." Fitch's Brown, for his part, says he doesn't see an end to the issuer pay model, which he says is more efficient because of the intensity of the ratings process. That may be, but both Brown and Glenn Reynolds, chief executive and founder of independent credit research firm CreditSights, see room for increased competition in specialized niches. With growth outside the United States and in alternative investments like hedge funds, "people will be looking for input for new firms in generating return and managing risk... It will be a lot about the information context in ratings, not just a few letters," Reynolds says. At some point, Reynolds said, issuing credit ratings may become a "competitive requirement" for CreditSights, though that's not a simple road to travel. "You need good analysts, quantitative models, technology, marketing and brain power. Otherwise, you are just another ugly face." Reynolds and others contemplating a dive into the ratings space have some time to figure it out: the SEC isn't required to finalize the new rules for almost nine months. After that, it'll take months, if not a few years for new raters to beef up their offerings and put a package together for the SEC. By Simona Covel |
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