Big Three (credit rating agencies)

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The Big Three credit rating agencies are S&P Global Ratings (S&P), Moody's, and Fitch Group. S&P and Moody's are based in the US, while Fitch is dual-headquartered in New York City and London, and is controlled by Hearst. As of 2013 they hold a collective global market share of "roughly 95 percent" [1] with Moody's and Standard & Poor's having approximately 40% each, and Fitch around 15%. [2]

Contents

According to an analysis by Deutsche Welle, "their special status has been cemented by law — at first only in the United States, but then in Europe as well." [1] [3] From the mid-1990s until early 2003, the Big Three were the only "Nationally Recognized Statistical Rating Organizations (NRSROs)" in the United States — a designation meaning they were used by the US government in several regulatory areas. (Four other NRSROs merged with Fitch in the 1990s.) [4] The European Union has considered setting up a state-supported EU-based agency. [5]

The Asian credit rating market is relatively diverse. Due to the regulation by the Chinese central government, the Big Three penetration into the domestic market especially in China is considered less competitive than the local well-recognized agencies, namely China Chengxin International (CCXI), China Lianhe Credit Rating (Lianhe Ratings), Dagong Global Credit Rating, and Pengyuan Credit Rating.

Influence

2007–2010 financial crisis

The Big Three have been "under intense scrutiny" since the 2007–2008 global financial crisis following their favorable pre-crisis ratings of insolvent financial institutions like Lehman Brothers, and risky mortgage-related securities that contributed to the collapse of the U.S. housing market.

In the wake of the financial crisis, the Financial Crisis Inquiry Report [6] called out the "failures" of the Big Three rating agencies as "essential cogs in the wheel of financial destruction".

According to the Financial Crisis Inquiry Commission, [7]

The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have happened without the rating agencies.

In their book on the crisis, journalists Bethany McLean and Joe Nocera criticized rating agencies for continuing "to slap their triple-A [ratings]s on subprime securities even as the underwriting deteriorated – and as the housing boom turned into an outright bubble" in 2005, 2006, and 2007. McLean and Nocera blamed the practice on "an erosion of standards, a willful suspension of skepticism, a hunger for big fees and market share, and an inability to stand up to" investment banks issuing the securities. [8] The February 5, 2013 issue of The Economist stated "it is beyond argument that ratings agencies did a horrendous job evaluating mortgage-tied securities before the financial crisis hit." [9]

Recent downgrades

In August 2011, S&P downgraded the long-held triple-A rating of US securities. [1] On August 1st, 2023, Fitch downgraded its credit-rating of United States Treasuries from AAA to AA+, as S&P had twelve years earlier, leaving only Moody's to still assign its highest rating to the country's debt (https://budget.house.gov/resources/staff-working-papers/us-debt-credit-rating-downgraded-only-second-time-in-nations-history).

Since the spring of 2010, one or more of the Big Three relegated Greece, Portugal and Ireland to "junk" status – a move that many EU officials mentioned has accelerated a burgeoning European sovereign-debt crisis. In January 2012, amid continued eurozone instability, S&P downgraded nine eurozone countries, stripping France and Austria off their triple-A ratings. [1]

Overreliance on the Big Three

A common criticism of the Big Three, and one that was highly linked to bank failure in the 2008 recession, is the dominance the agencies had on the market. As the three agencies held 95% of the market share, there was very little room for competition. Many feel this was a crucial contributor to the toxic debt-instrument environment that led to the financial downturn. In a preliminary exchange of views in the European Parliament Committee on Economic and Monetary Affairs, held in late 2011, it was advocated that more competition should exist amongst rating agencies. The belief was that this would diminish conflicts of interest and create more transparent criteria for rating sovereign debt.

There are over 100 national and regional rating agencies which could issue ratings if they can build up their credibility by meeting the conditions for being registered by European Securities and Markets Authority (ESMA). They could also use data from the European Central Bank and the International Monetary Fund to help with their analyses. Reliance on the "Big Three" could also be reduced by big companies assessing themselves, MEPs added. [10]

In November 2013, credit ratings organizations from five countries (CPR of Portugal, CARE Rating of India, GCR of South Africa, MARC of Malaysia, and SR Rating of Brazil) joint ventured to launch ARC Ratings, a new global agency touted as an alternative to the "Big Three". [11]

With the strategy of business internationalization as instructed by the Chinese central government, the Chinese rating agencies began establishing international branches in Hong Kong since 2012. As of 2020, the major Chinese international credit rating agencies are Lianhe Rating Global, China Chengxin (Asia Pacific) and Pengyuan International. They are regarded as domestic rivals against the Big Three. [12]

In 2023, the Indian government's Chief Economic Advisor, V Anantha Nageswaran questioned India's sovereign credit rating of BBB- by S&P and Baaa3 by Moodys and called for a review of the big three's rating methods. [13] In January 2024, CareEdge Ratings issued its Sovereign Ratings Framework for public consultation. [14]

In issuing the framework, CareEdge CEO, Mehul Pandya said, "This is an important step in our journey towards evolving into a global knowledge-based organisation. The ratings assigned using our methodology, in the future, will aid the investors and enhance the diversity of opinions in the market. The understanding of global markets so gained will enable CareEdge Ratings in incorporating such trends in our domestic ratings as well.”

Related Research Articles

<span class="mw-page-title-main">S&P Global Ratings</span> American credit rating agency

S&P Global Ratings is an American credit rating agency (CRA) and a division of S&P Global that publishes financial research and analysis on stocks, bonds, and commodities. S&P is considered the largest of the Big Three credit-rating agencies, which also include Moody's Investors Service and Fitch Ratings. Its head office is located on 55 Water Street in Lower Manhattan, New York City.

<span class="mw-page-title-main">Credit rating agency</span> Company that assigns credit ratings

A credit rating agency is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may rate the creditworthiness of issuers of debt obligations, of debt instruments, and in some cases, of the servicers of the underlying debt, but not of individual consumers.

<span class="mw-page-title-main">Moody's Corporation</span> American business and financial services company

Moody's Corporation, often referred to as Moody's, is an American business and financial services company. It is the holding company for Moody's Ratings, an American credit rating agency, and Moody's, an American provider of financial analysis software and services.

A credit rating is an evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting. The credit rating represents an evaluation from a credit rating agency of the qualitative and quantitative information for the prospective debtor, including information provided by the prospective debtor and other non-public information obtained by the credit rating agency's analysts.

Fitch Ratings Inc. is an American credit rating agency and is one of the "Big Three credit rating agencies", the other two being Moody's and Standard & Poor's. It is one of the three nationally recognized statistical rating organizations (NRSRO) designated by the U.S. Securities and Exchange Commission in 1975.

<span class="mw-page-title-main">Structured finance</span> Sector of finance that manages leverage and risk

Structured finance is a sector of finance — specifically financial law — that manages leverage and risk. Strategies may involve legal and corporate restructuring, off balance sheet accounting, or the use of financial instruments.

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS). Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.

A nationally recognized statistical rating organization (NRSRO) is a credit rating agency (CRA) approved by the U.S. Securities and Exchange Commission (SEC) to provide information that financial firms must rely on for certain regulatory purposes.

Moody's Ratings, previously known as Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Ratings provides international financial research on bonds issued by commercial and government entities. Moody's, along with Standard & Poor's and Fitch Group, is considered one of the Big Three credit rating agencies. It is also included in the Fortune 500 list of 2021.

Sovereign credit is the credit of a sovereign country backed by the financial resources of that state. Sovereign credit is the opposite of sovereign debt. Fiat money is sovereign credit and sovereign bonds are sovereign debts. When money buys bonds, sovereign credit cancels sovereign debt.

In investment, the bond credit rating represents the credit worthiness of corporate or government bonds. It is not the same as an individual's credit score. The ratings are published by credit rating agencies and used by investment professionals to assess the likelihood the debt will be repaid.

Credit rating agencies (CRAs)—firms which rate debt instruments/securities according to the debtor's ability to pay lenders back—played a significant role at various stages in the American subprime mortgage crisis of 2007–2008 that led to the great recession of 2008–2009. The new, complex securities of "structured finance" used to finance subprime mortgages could not have been sold without ratings by the "Big Three" rating agencies—Moody's Investors Service, Standard & Poor's, and Fitch Ratings. A large section of the debt securities market—many money markets and pension funds—were restricted in their bylaws to holding only the safest securities—i.e. securities the rating agencies designated "triple-A". The pools of debt the agencies gave their highest ratings to included over three trillion dollars of loans to homebuyers with bad credit and undocumented incomes through 2007. Hundreds of billions of dollars' worth of these triple-A securities were downgraded to "junk" status by 2010, and the writedowns and losses came to over half a trillion dollars. This led "to the collapse or disappearance" in 2008–09 of three major investment banks, and the federal government's buying of $700 billion of bad debt from distressed financial institutions.

<span class="mw-page-title-main">2000s European sovereign debt crisis timeline</span>

From late 2009, fears of a sovereign debt crisis in some European states developed, with the situation becoming particularly tense in early 2010. Greece was most acutely affected, but fellow Eurozone members Cyprus, Ireland, Italy, Portugal, and Spain were also significantly affected. In the EU, especially in countries where sovereign debt has increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany.

Several credit rating agencies around the world have downgraded their credit ratings of the U.S. federal government, including Standard & Poor's (S&P) which reduced the country's rating from AAA (outstanding) to AA+ (excellent) on August 5, 2011.

The Credit Rating Agency Reform Act is a United States federal law whose goal is to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.

China Chengxin Credit Rating Group was founded in Beijing on 8 October 1992 through the incorporation of China Chengxin Credit Management Co Ltd, which is the first nationwide credit rating company of China. Subsequently, it formed subsidiaries and established branches across China, including China Chengxin International Credit Rating Company Limited. The share-holder structure of the joint venture company was changed in 2006 when Moody's came in to take over the equity positions of Fitch and the supranational institution. The company is one of the few major credit rating agencies currently operating in China.

<span class="mw-page-title-main">Greek government-debt crisis timeline</span>

The Greek government-debt crisis began in 2009 and, as of November 2017, was still ongoing. During this period, many changes had occurred in Greece. The income of many Greeks has declined, levels of unemployment have increased, elections and resignations of politicians have altered the country's political landscape radically, the Greek parliament has passed many austerity bills, and protests have become common sights throughout the country.

The corporate debt bubble is the large increase in corporate bonds, excluding that of financial institutions, following the financial crisis of 2007–08. Global corporate debt rose from 84% of gross world product in 2009 to 92% in 2019, or about $72 trillion. In the world's eight largest economies—the United States, China, Japan, the United Kingdom, France, Spain, Italy, and Germany—total corporate debt was about $51 trillion in 2019, compared to $34 trillion in 2009. Excluding debt held by financial institutions—which trade debt as mortgages, student loans, and other instruments—the debt owed by non-financial companies in early March 2020 was $13 trillion worldwide, of which about $9.6 trillion was in the U.S.

<span class="mw-page-title-main">Chinese property sector crisis (2020–present)</span> Financial crisis

The Chinese property sector crisis is a current financial crisis sparked by the difficulties of Evergrande Group and other Chinese property developers in the wake of overbuilding and subsequent new Chinese regulations on these companies' debt limits. The crisis spread beyond Evergrande in 2021 to such major property developers as Country Garden, Kaisa Group, Fantasia Holdings, Sunac, Sinic Holdings, and Modern Land.

References

  1. 1 2 3 4 Alessi, Christopher. "The Credit Rating Controversy. Campaign 2012". Council on Foreign Relations. Archived from the original on 27 July 2013. Retrieved 29 May 2013.
  2. ↑ Hill, Claire A. (2002), "Rating Agencies Behaving Badly: The Case of Enron", Conn. L. Rev. 35, 1145
  3. ↑ "S&P warning puts damper on Eurogroup plans". 05.07.2011. Deutsche Welle.
  4. ↑ "U.S. SEC Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets" (PDF). January 2003. Retrieved 5 April 2012.
  5. ↑ The Times , 3 June 2010, Europe launches credit ratings offensive
  6. ↑ the ten-member commission appointed by the United States government with the goal of investigating the causes of the financial crisis of 2007–2010
  7. ↑ CONCLUSIONS OF THE FINANCIAL CRISIS INQUIRY COMMISSION
  8. ↑ McLean, Bethany and Joe Nocera. All the Devils Are Here: The Hidden History of the Financial Crisis , Portfolio, Penguin, 2010 (p.111)
  9. ↑ TE (5 February 2013). "Free speech or knowing misrepresentation?". The Economist.
  10. ↑ "Credit rating agencies: MEPs want less reliance on "big three"". The European Parliament. December 2011. Retrieved 19 January 2012.
  11. ↑ Reuters , 12 November 2013, " (Reuters) – Credit ratings organisations from five countries are launching a new global agency, touting it as an alternative to the Big Three agencies which they say no longer meet the needs of the new globalised world. In a statement on Tuesday, ARC Ratings said the agency would launch in London as a joint venture between CPR of Portugal, CARE Rating of India, GCR of South Africa, MARC of Malaysia, and Brazil's SR Rating."
  12. ↑ people.cn , 2 November 2012, " (people.cn) – 中国评级机构挑战美国统治“三巨头”"
  13. ↑ "India's economic adviser calls for review of sovereign ratings methods". Reuters. Reuters. 22 December 2023. Retrieved 29 February 2024.
  14. ↑ "CareEdge Ratings unveils its Sovereign Rating Methodology for Public Consultation" (PDF). Care Edge Ratings. 30 January 2024. Retrieved 29 February 2024.
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