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Alternatives for Issuer-Paid Credit Rating Agencies
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Alternatives for Issuer-Paid Credit Rating Agencies

Dion Bongaerts
ECB, 2014
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Editorial Rating

8

Qualities

  • Analytical
  • Innovative

Recommendation

Imagine paying someone to rate you and then expecting their evaluation to be entirely objective. As inane as it sounds, that’s the current setup between issuers and the credit rating agencies that assign those all-important letter grades to structured securities. There ought to be a better way, but – as economist Dion Bongaerts points out in his erudite analysis – alternatives may not be as cost-effective or competitive as the existing issuer-paid system. getAbstract recommends this seminal report to investors, issuers and analysts involved in assessing securities risk.

Take-Aways

  • After the 2007–2009 subprime crisis, the effectiveness and objectivity of credit rating agencies (CRAs) such as Standard & Poor’s, Moody’s and Fitch came into question when some highly rated debt securities collapsed, leaving investors with massive losses.
  • Issuers pay CRAs to assign ratings to their structured products. These payments can serve as an enticement for agencies to amplify ratings to gain favor with clients, calling into question CRAs’ impartiality and accuracy.
  • While mandating investor-paid or investor-produced ratings or requiring CRAs to invest in the securities they rate might reduce rating inflation, implementing these alternatives to issuer-paid ratings would be impractical and prohibitively expensive.

About the Author

Dion Bongaerts is an associate professor of finance at Erasmus University’s Rotterdam School of Management.

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