July 2 (IFR) - The markets may have dismissed the recent decision by Moody’s to downgrade 15 of the world’s largest banks, but the influence of international ratings agencies is here to stay.
The lack of objective information sources, as well as falling investment in research, is expected to ensure the agencies play a vital role in global financial markets.
After Moody’s announced its much-anticipated cuts, the affected banks said the agency was wrong about the health of the US banking industry.
Citigroup called its downgrade “arbitrary and completely unwarranted”, and railed against a “disproportionately adverse treatment of US firms relative to banks in Europe”. It said the US financial system was stronger, not weaker, than before the crisis.
RBS also protested, calling the Moody’s action backward-looking, while Morgan Stanley said the downgrade did not fully reflect the key strategic actions it had taken in recent years.
The banks were not alone in their criticism. One banker said that some fund managers were increasingly asking clients for the flexibility not to peg investments to credit ratings.
One questions raised is whether the market should continue to be as reliant on ratings decisions. Many think the answer is clearly no; and while credit spreads, stock prices and CDS of the downgraded banks reacted positively to the Moody’s downgrades, some believe the influence of the agencies may not diminish.
Citi alluded to this in its response, saying that market participants had become more sophisticated in their credit analysis in recent years, and that few react solely on ratings - particularly from a single agency - to make credit decisions.
But it added that some clients and investors would be affected by the Moody’s decisions in view of their historical reliance on such ratings as fiduciary advice.
“Like it or not, international ratings agencies are here to stay,” said Mike McGonigle, head of credit research at global investment management company T Rowe Price, which manages US$550bn in assets.
“We always use our own internal ratings and analysis to determine our investment strategies,” he said.
“If international ratings agencies were not around, we would still do well. But what would worry me then is the risk of operating in a market that is less disciplined - and lacks this research capability.”
McGonigle said that investment in research has dwindled over the years, especially as institutions have grappled with slowing supply while regulators have imposed restrictive investment rules to reduce systemic risk.
On the buyside, internal due diligence of credit risk is still important for top fund managers, but many lack sufficient resources to rely on it. Information provided by S&P, Moody’s and Fitch - deemed to be independent of the sellside - thus has a ready market.
For the first quarter of 2012, Moody’s reported revenues of US$646.8m compared with US$577.1m a year earlier. Global revenue for Moody’s Analytics for the first quarter of 2012 was US$194.1m, up 18% from the first quarter of 2011. Revenue from research, data and analytics increased by 9% from the prior-year period, primarily due to increased sales of credit research and related data.
This rising influence of “independent research” by ratings agencies thus means that credit rating decisions are achieving an added level of importance in current markets.
“Instead of drumming up rhetoric, market players should understand that every model has conflicts, which is not an issue if that is visible and understood,” said one ratings agency official.
“The market should ideally be at the mid-point of being too influenced by ratings and completely ignoring what a ratings agency has to say, but that is an ideal world.”