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Competition and Credit Rating Agencies 2010 Competition and Credit Rating Agencies 2010 The Competition Committee holds occasional “hearings” to address strategic issues outside the core competition domain and to improve the analysis in such areas where competition can be meaningful. A hearing on Competition and Credit Rating Agencies was held in June 2010. This document includes an aide-memoire as well as contributions and presentations from the following panellists: Prof. John C. Coffee, Columbia University Law School (United States) and Prof. Karel Lannoo, Center for European Policy Studies (CEPS). Credit ratings provide an opinion on the relative ability and willingness of parties with debt obligations to meet financial commitments. They have three functions; to measure the credit risk of the issuer, to provide a means of comparison and to provide a common standard. The credit rating market is a natural oligopoly, with three Credit Rating Agencies (CRAs) accounting for more than 90% of the market. The recent financial crisis has bought attention to the role of CRAs. While CRAs were not the actual cause of the crisis, their failings have highlighted the need for reform in the credit rating market and of the business models used. Increased due diligence by CRAs is required to ensure the verification of all information used in business models, and a decrease in regulatory reliance on ratings may be advisable. The use of an „investor pays‟ model was suggested as an alternative to current models in order to reduce conflicts of interest and promote CRA independence. Exit Strategies (2010) Competition, Concentration and Stability in the Banking Sector (2010) Competition and Financial Markets (2009) Unclassified DAF/COMP(2010)29 Organisation de Coopération et de Développement Économiques Organisation for Economic Co-operation and Development 05-Oct-2010 ___________________________________________________________________________________________ _____________ English, French DIRECTORATE FOR FINANCIAL AND ENTERPRISE AFFAIRS COMPETITION COMMITTEE Unclassified DAF/COMP(2010)29 COMPETITION AND CREDIT RATING AGENCIES This document compiles documentation related to a hearing on Competition and Credit Rating Agencies held in the Competition Committee meeting on 16 June 2010. It includes the summary of discussion [DAF/COMP/M(2010)2/ANN3] which was approved by Competition Delegates under written procedure. This compilation is circulated FOR INFORMATION. English, F JT03289562 rench Document complet disponible sur OLIS dans son format d'origine Complete document available on OLIS in its original format DAF/COMP(2009)39 COMPETITION AND CREDIT RATING AGENCIES Note from the Secretariat The Competition Committee decided to hold occasional “hearings” on selected topics which might call for further input from Competition delegates. This initiative results from delegates‟ perceived need to address strategic issues outside the core competition domain and to improve the dialogue in such areas where competition can be meaningful. Experts on the selected topic are invited to present their views on what they believe are the important issues in this area, and particularly what issues might involve a significant competition element and would therefore deserve further consideration by the Committee. The Competition Committee held a hearing on Competition and Credit Rating Agencies on 16 June 2010 with the following experts: Professor John C. COFFEE, Columbia University Law School (USA) Professor Karel LANNOO, Centre for European Policy Studies – CEPS (Belgium) Professor Patricia LANGOHR, ESSEC Business School (France) This document compiles the documentation related to this Hearing. LA CONCURRENCE ET LES AGENCES DE NOTATION FINANCIÈRE Note du Secrétariat Le Comité de la Concurrence a décidé d‟organiser des auditions (« hearings ») occasionnelles sur des sujets choisis, susceptibles de générer des contributions ultérieures des délégués du Comité. Cette initiative résulte de la nécessité perçue par les délégués d‟aborder certains sujets stratégiques au-delà des questions clés de concurrence. L‟objectif est d‟améliorer le dialogue entre responsables publics dans des domaines où la concurrence peut être déterminante. Des experts dans les sujets choisis sont invités à présenter leurs points de vue sur les questions qu‟ils jugent importantes dans le domaine traité, en particulier dans la mesure où elles comportent une dimension de concurrence significative, et, à ce titre, justifier une attention particulière du Comité à l‟avenir. Le Comité de la Concurrence a tenu une audition sur la Concurrence et les Agences de Notation Financière le 16 juin 2010 avec la participation des experts suivants : Professeur John C. COFFEE, Columbia University Law School (États-Unis), Professeur Karel LANNOO, Center for European Policy Studies (CEPS) Professeur Patricia LANGOHR, ESSEC (France) Ce document rassemble la documentation relative à cette audition. Visit our Internet Site -- Consultez notre site Internet http://www.oecd.org/competition 2 DAF/COMP(2010)29 TABLE OF CONTENTS Summary of the discussion By the Secretariat .............................................................................................. 5 Compte rendu de la discussion Par le Secrétariat ...................................................................................... 21 Ratings reform: The good, the bad, and the ugly Note by Prof. John Coffee, Jr......................................... 39 What reforms for the credit rating industry? A European perspective Note by Mr. Karel Lannoo ............. 67 3 DAF/COMP(2010)29 4 DAF/COMP(2010)29 SUMMARY OF THE DISCUSSION By the Secretariat The Chairman of the Competition Committee explained the hearing discussion was held on 16 June 2010 in the context of the Competition Committee‟s more general discussions about the financial crisis and as a result of a specific interest about infrastructures which support financial markets, and their competition implications. Chairman Jenny introduced the panellists who had been invited to contribute to the discussion: Professor John Coffee (Columbia University), Professor Patricia Langohr (ESSEC Busines School) and Mr. Karel Lannoo, (Chief Executive at the Centre for European Policy Studies). He also welcomed the participation of Professor Hans-Helmut Kotz, Chair of the OECD Committee on Financial Markets. At the invitation of Chairman Jenny, Professor Langohr 1 started the discussion by emphasising the important economics behind the Credit Rating Agency (CRA) industry, and outlining the definition of a credit rating. Credit ratings provide an opinion on the relative ability (and willingness) of an obligor to meet financial commitments. They aim to be (i) ordinal ratings on an alpha-numeric scale, (ii) stable, that is, CRAs aim to rate through the cycle, (iii) consistent and comparable across instruments, maturities, industries and countries and (iv) objective and transparent. Ratings deal with defaults and place an issuer or an instrument on a scale from least likely to default to most likely to default. The current CRA industry started in 1909, with Moody‟s. By 1924 Fitch and S&P had entered the market, but the industry remained concentrated. Until 1970 the investor-pays business model prevailed. There were some regulatory uses of ratings, and demand for ratings was relatively stable. From 1970 – 2001 a switch was made to the issuer-pays business model. In 1975 the SEC created the NRSRO2 status and by 2000 Fitch had become the third global CRA. There was a huge expansion of the role of CRAs due to financial disintermediation3, institutionalisation of investments and the increasing rate of industry change. From 2002 to today financial innovation and globalisation have extended the role of CRAs even further. 2007 saw the end of the closed NRSRO status. For 35 years only three CRAs achieved the status (some CRAs achieved the status temporarily before merging with one of the dominant ones) and today there are eleven CRAs with NRSRO status. Fundamental ratings have three functions: A rating‟s original economic function is to objectively measure the credit risk of the issuer and to resolve the fundamental information asymmetry between issuers and investors. This assists issuers in accessing funding through markets. 1 See also “The Rating Agencies and Their Credit Ratings: What They Are, How They Work, and Why They are Relevant” by Herwig Langohr and Patricia Langohr, John Wiley & Sons, 2009. 2 Nationally Recognised Statistical Rating Organisation. 3 Withdrawal of funds from financial institutions in order to invest them directly. 5 DAF/COMP(2010)29 The second function is to provide a means of comparison across all issues of embedded credit risk and provide a consistent global rating scale to help build a portfolio. This is essential for the investor. Finally ratings provide market participants with a common standard or language to refer to credit risk. A rating is an independent credit opinion expressed in a single contractible measure i.e. it is a measure which is observable and verifiable by all, and can therefore be included in contracts and regulations. This is essential for prescribers i.e. private contracts, investment guidelines and regulations. These three functions together provide value to the market. They are complementary, with each function increasing the value and utility of the others. Historically these functions were separated, but fundamental ratings evolved endogenously, eventually providing all three together. The comparability and contractibility
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