Rating Agency Flashpoint

On May 8, 2013, Sohu Business picked up an article in the HK press about a JV ratings agency between SEC-designated Egan-Jones, a Chinese agency, Dagong, and a Russian agency, RusRating, targeted for listing June 25 in HK. It is called, appropriately, “World Ratings.”

Perhaps not coincidentally, the SEC’s credit rating roundtable is scheduled for May 14 with some industry and academic participants selected by the SEC as well as the heads of the Big Three participating. The goal is to eliminate “ratings shopping,” ie, the search by financial intermediaries for ratings on new structured bonds that impose the absolute lowest capital cost regardless of the actual risk.

The search for cheap substitutes is not a crime; in finance, it keeps the price of capital competitive. A problem arises only when cost and price become decoupled. The cause is usually asymmetrical information. Ratings shopping in structured finance is precisely that: an information problem arising from the failure to develop and promulgate credit risk measurement standards that are valid over the life of the security.