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Which are the Big Three Credit Rating Agencies? What Do they Do? How Important Are They?

Feb 1, 2021 10:20 AM 5 min read

Global credit rating agencies (CRAs) have found themselves in the line of fire from the Economic Survey 2021, which was released yesterday.

The Survey lambasts CRAs as "noisy, opaque and biased" and claims that India’s sovereign credit ratings do not capture its economic fundamentals.

The Government’s ire may or may not be well-founded, but this does give us an opportunity to look at the role rating agencies play in the world economy, and then try to understand if India’s rebuke of them could affect investors’ perceptions.

What Brought this About?

The bone of contention was likely something that happened in June last year, when two CRAs - Moody’s and Fitch - reviewed India’s sovereign rating. While Moody’s downgraded the rating to Baa3 from Baa2, Fitch retained its BBB- grade but changed the outlook to negative. S&P, the other big CRA, retained its BBB- rating.

While all three agencies kept India within the investment grade (BBB and above), the revisions were nonetheless causes of worry. After all, India was flung to the bottom tier of the investment grade and was a stone’s throw away from “junk” or “speculative” territory (BB+ and below). Another downgrade would have made pension funds and investment banks abroad steer clear of Indian markets.

FYI: The agencies cited high debt burden, COVID-19, and the prolonged economic slowdown that preceded the pandemic as reasons for the downgrade.


What Do Credit Rating Agencies Do?

These are companies that issue letter-grade ratings to issuers of bonds and other debt instruments and fixed-income securities. The issuers can be governments, corporations, financial institutions, insurance companies etc. These ratings provide valuable information for retail or institutional investors on whether the issuers would be able to meet their debt obligations in the short-term or long-term.

Basically, CRAs are supposed to provide objective and independent analyses of companies and countries that issue such securities. 


What are the Kinds of Ratings?

It depends on who or what is being graded. The aforementioned sovereign credit rating is issued to countries and it takes into account several macro metrics such as volume of public and private investment, economic growth and foreign exchange reserves.

Credits ratings are also issued to companies and securities like corporate bonds and government bonds. Here too the individual report-cards probe into the entity’s or security’s past performance, financial health and risk of defaulting.


Which are the Global Credit Rating Agencies?

The global CRA market is heavily concentrated. So much so that only three companies - Moody’s, Fitch and S&P - control nearly the entire industry (95%).

All three of these are US-headquartered. Together, they are referred to as the “Big Three”.

FYI: There are many India-based CRAs too. The largest among these is CRISIL. Others include CARE, ICRA, SMERA and ONICRA.


A Brief History of the Big Three

These three companies’ dominance has been a matter of fact since as early as the 1990s, often cemented by law as in the US and Europe.

For a long time, concerns over overreliance on only three CRAs were muted. They seemed to be doing a fine job and commanded a global footprint - all seemed well.

Then came the Great Recession. The 2007-09 financial crisis brought the three companies under intense scrutiny and widespread criticism.


Criticisms of the Big Three

The bulk of the criticism revolved around the Big Three issuing high ratings to actually bad investments, particularly mortgage-backed securities in the US, which were issued AAA-ratings. Investors were falsely led to believe that these were safe bets with low risk of default.

What followed was the subprime crisis and accusations that the Big Three issued positive ratings to junk investments in order to pocket profits and increase market clout. Indeed, a US Congress-appointed commission branded the Big Three as “key enablers of the financial meltdown”. Some were even fined heavily by the US government.

In the following years, these agencies’ reputations took a further hit over their role in the European sovereign debt crisis. The downgrading of Greece, Portugal and Ireland in 2010 worsened the crisis.

Besides shady business practices, the very dominance of these three firms is a matter of risk. The CRA market, it has been often pointed out, is basically an oligopoly right now, ruled by three companies with questionable pasts and stained reputations, and whose supremacy acts as a barrier for small- or mid-sized competitors from ever getting a fair shot.


The Importance of the Big Three

The three main credit rating agencies may be flawed - the very manner in which the CRA market is built may be problematic - but none of these factors absolve the fact that the Big Three remain indispensable to international finance.

That’s because, all said and done, these three companies do a more-or-less good job and provide valuable and informed opinions. They have well-defined methodologies to assign ratings. In most instances, rating outcomes are determined by an intra-agency vote and subject to simple majorities. Moreover, the CRAs’ reports are available to the issuer or to the public for perusal and verification.

In fact, an IMF review suggests that in 1975-2015 all the sovereigns that have defaulted were rated as non-investment grade at least one year before they defaulted. And between 1983 and 2009, no country with investment grade rating has defaulted. As for corporations, only about 1% of those rated as investment grade risk defaulted over this period.

Yes, the CRA market is in dire need of reform. Yes, a lot of the loopholes that led to the Great Recession remain unplugged. And no market should be dominated by only three big players based out of one country in the world.

But until these reforms take place, there’s no escaping the crucial role the Big Three play. Their reports and opinions are sought after by everyone from analysts and banks to global fund houses. And because what they have to say commands rapt attention, not paying attention to what they have to say may prove to be a costly mistake.

Which brings us back to this year’s Economic Survey, where CEA Krishnamurthy Subramanian argued that India's fiscal policy should not fear rating downgrades, and should instead "reflect Gurudev Rabindranath Thakur’s sentiment of a mind without fear”.

But boldness for the sake of boldness can be a reckless path. Because the bottom line is that even if the Government of India ignores CRAs, institutional investors won’t. A rating downgrade into speculative territory can be disastrous. Especially for a country struggling through its worst recession on record. Especially for a country that chooses to ignore the rating (aka warning signs) in the first place.


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