Thursday 30 September 2010, Larry Elliott, Economics editor
• IMF says agencies must be clearer about conflicts of interest and risk assessment mechanisms
• EU finance ministers to discuss tightening rules governing credit rating agencies
Credit rating agencies should act to lift the "cloud of suspicion" that has hung over them since the sub-prime mortgage crisis broke three years ago, the International Monetary Fund said today.The fund's half-yearly Financial Stability Report said the three big ratings agencies – Moody's, Fitch, and Standard and Poor's – need to come clean over potential conflicts of interest and provide further clarity on how good they are at assessing risk. It also warned that the agencies were not always nimble enough in changing their views.
The report has been published as EU finance ministers are to meet tomorrow to discuss toughening up the rules governing the industry, including possible fines for agencies that issue inappropriately harsh judgments on a country's debt – they have been accused of making the situation worse in countries including Greece and Ireland. Brussels is also looking to open the market to competition, with countries including Germany pushing for the creation of "home-grown" agencies.
Proposals under discussion in Brussels include requiring agencies to explain better the timing, extent and underlying reasons of a sovereign rating – and reducing the maximum time period after which sovereign debt ratings have to be reviewed.The G20 group of developed and developing nations has already agreed that agencies must be registered and undergo direct supervision, warning there was an urgent need to ensure they were more transparent.
Credit rating agencies came under intense scrutiny after the complex derivative products they had strongly endorsed turned out to be so-called "toxic waste". Some policymakers blamed rating agencies for taking fees from financial institutions to assess the quality of potentially risky products and then giving them a clean bill of health with top-notch ratings.The fund said rating agencies "should continue to provide additional information on the accuracy of their ratings, the underlying data, and their efforts to mitigate the conflicts of interest that are associated with their 'issuer pay' model of charging issuers for their ratings".It added that it saw no immediate prospect of the issuer pay business model being changed, despite calls for it to be scrapped.
The IMF did not roundly criticise the agencies, suggesting they play a key role in international markets. "Credit ratings can play an important and positive role in capital markets, primarily by using their economies of scale to provide cost-effective information services that increase the pool of potential borrowers and promote liquid markets," the IMF said."For the most part, they have been a positive force in fixed-income markets, particularly in their traditional corporate markets, as well as in the markets for sovereign bonds," the fund said.
The IMF warned, however, that the financial crisis had exposed "some flaws in the system", including an over-reliance on ratings and a tendency for them to change their opinions slowly. The fund said these flaws could be rectified but said it would "not be easy"."In particular, reducing rating over-reliance will require finding appropriate replacements, and it will be important that the authorities remain wary of unintended adverse consequences."
The IMF's report added: "Although rating agencies have been under a cloud of suspicion following their role in structured credit markets, it should be acknowledged that ratings serve several useful purposes.".They aggregate information about the credit quality of borrowers, including sovereign entities, corporations, financial institutions, and their related debt offerings. They thus allow such borrowers to access global and domestic markets and attract investment funds, thereby adding liquidity to markets that would otherwise be illiquid."