Rating Agencies

The focus is back on them after 7 long years…

The recent fiasco that happened with Amtek Auto has once again put the spotlight on the reactive approach of rating agencies. Add Bhushan Steel and Jaypee Infra and you have 3 companies that enjoyed fairly privileged ratings shortly before these companies came to the verge of default.

Back in 2008, this became a global issue as investment banks with AAA ratings suddenly found themselves on the verge of bankruptcy. Why did the rating agencies not flag off such concerns well in advance? Obviously, such concerns could not have arisen overnight and must have built up over time.

Conflict of interest story…

It is probably ironic that the rating agencies are hired and paid by the very company whose debt instruments are rated. This creates a classic conflict of interest. Can a rating agency be absolutely objective while rating a company that is paying for their service? There may not be clear answers but conflict of interest is surely raising doubts over the ability of raters to be absolutely independent in their opinion.

Wider business role…

The conflict of interest we spoke about in the previous point tends to get underlined when we consider that most rating agency today go beyond their pure rating role. The rating business allows companies to build a very valuable database of companies. This results in a variety of spill-off business opportunities. Selling customized corporate reports, offering consultancy services are some of the service offerings that can be offshoots of their existing database. Here again, the commonality of customers creates a conflict of interest.

Should rating agencies be listed?

This is once again a moot question. Should rating agencies be listed entities or should they be unlisted? In India 3 of the key rating agencies are listed on the exchanges. A stock exchange listing puts additional pressure on the stock. A rating agency needs to ensure that any opinion that they express does not result in the stock price reacting negatively. Also these rating agencies are answerable to their own shareholders for the performance and growth of the company. While there may be no direct correlation, the fact remains that listing surely puts additional pressure on rating agencies.

It is time the global rating business requires a rethink! For too long the rating business has been an esoteric business that has lived behind alphabet combinations. It is time to come out in the open. Rating agencies need to be seen as sounding boards of bigger problems creeping in balance sheets. That will be a good first step! ©

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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