When Cyprus announced in June 2012 that it was edging closer to being the latest Eurozone country to seek bailout money, the fragile nature of how the world deals with sovereign debt was thrust once again into the public consciousness.
As it stands today, sovereign debt is a huge (and growing) $41 trillion global phenomenon. One in which private firms called credit rating agencies (CRAs) such as Moody’s have long flourished during times of economic uncertainty or adversity. They continue to do so.
CRAs have been a pivotal player in the global economic system for over a century and date back to the financing of the US railroad expansion in 1909. However, it took the international banking meltdown of 2007/08 to push them into media prominence.
The dramatic events of the past 5 years and the huge power of the CRAs have thus led many commentators to ask – are these private firms fit to rate countries? And are they being supervised properly? A report by Infrangilis (a think-tank on resiliency strategies) suggests not.
In May 2012 Infrangilis published the research study Rating Sovereign Raters, timed to feed into policy fora around the world, for example, the EU Economic and Monetary Affairs Committee and the UK House of Commons Treasury Select Committee (both of which are hearing evidence on the conduct of CRA industry).
The study concludes that proposals by regulators in the US, Eurozone or multi-lateral agencies to reform or replace the role of the CRAs fail to understand the complex system in which government borrowing and debt ratings take place – i.e. the interconnectedness of monetary and financial systems.
For instance, it is argued that CRAs are undeservedly preventing the flow of capital into the developed world, arguably because the industry tends not to devote time and resources to economies such as Africa because it is not a lucrative market (bearing in mind their funding model of ‘issuer-pays’). This means some 58 developing countries find it more difficult to raise money to grow as they are do not have a credit rating, or the rating is out of date and does not recognise any positive progress made by a country. This undermines Rio+20’s pursuit of new Sustainable Development Goals.
Consequently, Infrangilis strongly believes there is a need for fresh thinking when it comes to moderating the role of CRAs. This is where the notion of ‘responsible’ sovereign ratings becomes invaluable if we are to hold the CRA industry to account and ensure it continues to serve the public good. A more responsible approach to sovereign debt rating includes considerations of ratings accuracy, competition, conflicts of interest, capital flows to developing countries, and non-financial performance such as poverty or environmental resource efficiency.
Key to delivering this is more effective co-operation between governments on CRA supervision. Most notably, Infrangilis is recommending the establishment a new international observatory on sovereign debt ratings.
Calls to establish a supra-sovereign ratings organisation, be it a new EU or UN led one have not been welcomed by the UK and US governments in particular. This is mainly due to a perceived lack of market legitimacy and the tax burden associated with the high cost of set-up. (For example, a proposal by the Bertelsmann Foundation to resource a new global non-profit agency for sovereign debt called INCRA requires an endowment of up to $400 million).
Rating Sovereign Raters makes the case however that an accommodating position or hybrid model can be found, by establishing a new UN platform as a credit rating observatory as opposed to a credit rating service provider. This could be hot-housed by an existing G20 approved body that has the respect of the markets, such as a re-constituted Joint Forum (based at the Bank of International Settlements, whose mission is to act as a centre for discussion and decision making for the international supervisory community). The observatory would, for instance, be tasked with monitoring and reporting on how well the market is functioning, acting as an early warning system, and securing consensus on international professional standards for rating methodologies.
Any newly reconstituted Joint Forum would need to have the trust and endorsement of the BRIC countries and others parts of the South, a fact reflected in its governance structure. This additional work by The Joint Forum should aim to avoid the need for extra public subsidy or a transaction tax. A simplification of the system would realise savings that could be redirected here, for example, by merging divisions of the IMF or sharing examiners already at work in the European Securities and Markets Authority. In short, to do more with less.
If our political leaders want to deliver on their bold words for sovereign debt sustainability, it is this type of international governance innovation that will be required.
Rating Sovereign Raters: Credit Rating Agencies – Political Scapegoats or Misguided Messengers? was published by Infrangilis on 31st May 2012. It can be downloaded for free at http://www.infrangilis.org