10:20 pm - Monday December 18, 2017

Best Practices Frame Work for Credit Rating Agencies

Regulating the credit rating agencies is the talk of the town nowadays.

Credit rating agencies provide independent reports on the credit worthiness of a range of institutions, governments, and public bodies, international and domestic active companies. They produce reports and analysis supporting their rating of credit worthiness.

The rating of the institution, by the rating agency, can have an impact on the perception of investors and lending institutions towards it. This can materially affect the rate of interest at which it can borrow funds, make bond issues, as well as influencing the price of its stock if it is a corporation listed on an exchange

The rating agencies compete for business from those institutions which require rating services. The institutions which are rated pay for the services of the rating agencies. The rating agencies also compete in terms of the quality of material they publish for sale to end-user investors and lending institutions.

Some gain a better reputation than others in specific areas. For example, a rating agency may be more highly respected for its country ratings than for its bond ratings. Credit-rating agencies are typically subject to little formal regulation or oversight in most countries.

However, the furor over Enron, Dotcom, Subprime Crisis and other debacles has led to calls for regulatory changes in rating industry.

Regulatory issues are always extremely complex and interdependent. Understanding regulatory issues in extreme detail is a pre-requisite not only for anticipating risks and opportunities but also for building mutually beneficial relationships, based on trust and transparency with regulators.

To handle such regulatory prescription in the coming years, credit rating agencies could on their own evolve a code of conducts or best practices framework for their business and strictly follow them.

Some of these best practices could be

Pre-Rating Requirements

  • Independence
  • Rating Definitions
  • Recognition of Default
  • Publication of Rating Criteria
  • Confidentiality Requirements
  • Computation of Default Statistics
  • Policies and Processes for Ratings
  • Avoidance of Conflicts of Interest
  • Compliance with Policies and Process
  • Market Feedback before Major Policy Changes
  • Use of Ratings updates as Early Warning Indicators
  • Relations with Regulator and Other Rating Agencies
  • Policies for Private, Unsolicited, and Unaccepted Ratings

These best practices will enable the rating agencies to perform still better in any kind of regulatory regime.

The rating agencies depend on the integrity and good faith of the management of the rated companies to disclose all material information to them.  The rating agencies do not disclose the criteria, models and methodologies they employ to determine their rating. They protect this vital information as their trade secrets. The methodologies employed by the rating companies are their intellectual property. The financial market participants arrive at their decision to invest or divest relying upon the ratings awarded by the rating companies.

The rating agencies are mostly commercial organizations. Their independence, integrity and successful track record are very important to their success. They should always be truthful, trustworthy and taint-free. Surely the above listed best practices would enable them to demonstrate that they are in compliance with any possible regulatory prescriptions.

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