This is a guest blog by Philip Monaghan, CEO of Infrangilis, who has a long track record of work on issues of corporate accountability.
It is the job of ratings agencies to make judgements. Recently, one example was when Moody’s joined Standard & Poor in June 2013, announcing a downgrade of the credit rating of the Co-operative Bank.
There is no credit or benefit in shooting the messenger, but it is legitimate to ask whether the ratings agencies are effective and balanced in what they do. Are these private firms ‘fit’ to rate businesses, countries, cities or individuals?
A rating of raters produced by the research agency Infrangilis last year suggests not. Infrangilis’ study compared and contrasted the performance of rating agencies. Each agency was rated according to their performance with regard to responsible leadership, good governance, public disclosure, and ratings performance.
The study concluded that there is a negative outlook for the industry as a whole, in terms of it being fit for purpose. Ratings agencies emerge as comparatively poor across the board, but in particular in relation to aspects of ‘responsible leadership’ and ‘ratings performance’. In terms of responsible leadership, this appears to be because ratings agencies have a narrow understanding about the impact of their actions: they have failed to respond in terms of their accountability for the onset and the depth of the credit crunch, but they also fail to integrate other, non-financial problems too – not least, environmental resource constraints.
These findings are supported by the damning verdicts on ratings performance that 6 of the leading 7 ratings agencies have received in annual checks made by both the European (ESMA) and US (SEC) regulators.
There can be little assurance for those in the private sector that ratings agencies understand enterprise models that are not shareholder owned. According to respected financial commentators such as Money Week the severity of the downgrade of the Co-operative Bank overlooked the fact that it was part of a bigger mutual (The Co-operative Group) with a diverse balance sheet, values and history of looking beyond short-term profit.
The ratings agencies, of course, have a longer track record of getting judgements wrong. If you are in the business of judgement, that may appear to be an occupational hazard. But the real questions are whether those mis-judgements are hardwired into the business model of the ratings agencies so that it is their own financial incentives and starting assumptions rather than evidence that at times drives what they do. Their failure to warn investors in advance, or if at all, about US sub-prime mortgages, the Lehman Brothers collapse, the Greek default during the 2007/08 banking crisis, or the subsequent Eurozone crisis of the past two years are just recent latest examples. Around the credit crunch, ratings agencies gave AAA ratings to 75% of the $3.2 trillion sub-prime mortgages that subsequently lost sizable valuable just months later. The 1997 Asian financial bubble and the 2001 Enron scandal are other examples of a list of miscalculations that stretches over decades.
The flaws of the ratings industry are of concern not just for member-owned enterprises but for the economy more widely. If you exclude environmental risks, you encourage pollution and unsustainable resource extraction. If you ignore unconventional businesses, you add costs to enterprises for little benefit.
The campaign for social responsibility across companies has moved forward in a very constructive and practical way in recent decades. A debate on the social responsibility of ratings agencies now needs to follow.
Rating Sovereign Raters: Credit Rating Agencies – Political Scapegoats or Misguided Messengers? was published by Infrangilis on 31st May 2012. The study recommends a number of key policy changes to remodel the rating of debt which will make the system resilient to future shocks and more productive. It can be downloaded for free at http://www.infrangilis.org