The role and responsibility of credit rating agencies in promoting soundness and integrity
| Pages | 34-49 |
| DOI | https://doi.org/10.1108/JMLC-09-2013-0031 |
| Published date | 07 January 2014 |
| Date | 07 January 2014 |
| Author | Graeme Baber |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
The role and responsibility
of credit rating agencies
in promoting soundness
and integrity
Graeme Baber
BPP University College of Professional Studies, London, UK
Abstract
Purpose – The purpose of this paper is to investigate the role and responsibility of credit
rating agencies in promoting soundness and integrity, especially in the course of their business
activities.
Design/methodology/approach – The paper describes, and uses, the framework for the activities
of credit rating agencies introduced by the International Organization of Securities Commissions
(IOSCO), in order to give effect to this investigation.
Findings – Credit rating agencies have implemented the provisions of the Code of Conduct
Fundamentals for Credit Rating Agencies of the IOSCO on the quality and integrity of the rating
process, to the extent of the resources available to them.
Research limitations/implications – The main source of data is the information collected by the
IOSCO from nine credit rating agencies, including the main three, on the quality and integrity of their
rating processes. The absence of triangulation of research methods limits the robustness of the
findings.
Originality/value – The paper addresses a specific aspect of the credit ratings story since the
financial crisis on which there is currently little in the literature. It also focuses upon the actions of
credit rating agencies, rather than on how these organisations are, or should be, regulated.
Keywords Principles,Analyst, Code, CRA, IOSCO, Rating committees, Methodologies,Credit rating
Paper type General review
1. Introduction
The credit rating of a security is a reflection of the ability of the issuer of that security
to service its payment obligations, as and when they become due. It is crucial that the
rating is assigned after a thorough review process and regularly updated. This is
necessary, because it affects the issuer’s cost of capital, ability to raise finance, and
reputation, and is an indication to investors as to the quality of the security.
In order for a credit rating agency (CRA) to make an appropriate assessment of any
security, the circumstances under which it is offered should be investig ated.
The assessment should include a review of the economy and of the business sector of
the issuer. The latter should be prepared to provide information concerning its products,
competitors’ offerings, and changes in the market size and share for these products.
In addition to providing a suitable commentary on information contained in the annual
report, the issuer should share its strategic and operational capabilities with the analyst,
and demonstrate that it is able to satisfy the warranties and covenants that apply to the
security[1].
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1368-5201.htm
Journal of Money Laundering Control
Vol. 17 No. 1, 2014
pp. 34-49
qEmerald Group Publishing Limited
1368-5201
DOI 10.1108/JMLC-09-2013-0031
JMLC
17,1
34
2. IOSCO principles and code
In September 2003, the International Organization of Securities Commissions (IOSCO)
published a Statement of Principles Regarding the Activities of Credit Rating Agencies
(hereafter the “Principles”). These Principles are to provide high-level guidance for
market participants, in order to improve the protection of investors and the efficiency,
fairness and transparency of the securities markets, and lower systemic risk (IOSCO,
2003, p. 1).
The Principles consider the quality and integrity of the rating process, independence
and conflicts of interest, transparency and timeliness of rating disclosure, and
confidential information (IOSCO, 2003, pp. 2-4). Under the first of these titles , CRAs are
to endeavour to issue opinions that help to reduce the asymmetry of information
between borrowers, lenders and other participants in the market. In particular, a CRA
should:
.implement written procedures and methodologies to ensure that opinions are
based on a fair and comprehensive analysis of all relevant information, and that
CRA analysts act with integrity;
.monitor on a continuing basis, and frequently update, an analysis and rating,
at each point at which new information becomes available that causes the CRA to
amend its opinion;
.keep internal records;
.possess adequate resources to support its ratings; and
.employ analysts that are professional, competent, and of high integrity, an d who
use the CRA’s methodologies (IOSCO, 2003, p. 2).
In December 2004, the IOSCO published a Code of Conduct Fundamentals for Credit
Rating Agencies (hereafter, the “Code”), in response to requests for a specific, detailed
code to provide guidance on how the principles could be implemented. The Code offers
robust, practical measures that are to be a guide to, and a framework for, this
implementation. The IOSCO Technical Committee expects CRAs to fully apply the
Code (IOSCO, 2004, p. 2).
The Code comprises an exposition of the issues in the Principles (IOSCO, 2004,
pp. 4-10). There is also a brief section on the disclosure of the Code and communication
with market participants (IOSCO, 2004, pp. 10-11). The section on the quality and
integrity of the rating process includes, amongst others, the following points:
.CRA rating methodologies should be rigorous and systematic and resul t in
ratings that can be validated objectively[2].
.Analysts involved in the preparation or revie w of ratings should use
methodologies that the CRA has established, and apply them consistently.
.The CRA, rather than any individual analyst, should assign ratings, and should
use persons who, individually or collectively, have suitable knowledge and
experience in developing a rating opinion for the credit type.
.The CRAand its analysts should take stepsto avoid issuing any analysesor reports
that are misleadingas to the general creditworthiness of an issueror an obligation.
.The CRA should structure its rating teams to further continuity and avoid bias in
the rating process.
Responsibility of
credit rating
agencies
35
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