A brief history of credit rating agencies

Credit ratings provide information for retail and institutional investors to help them determine whether issuers of bonds and other debt instruments and fixed income securities can meet their obligations.

When issuing letter grades, a credit rating agency (CRA) conducts an objective analysis and independent evaluation of the companies and countries/regions that issue such securities. The following is a basic history of how ratings and agencies have developed and developed in the United States to help global investors.

Key points

  • Credit rating agencies provide investors with information about whether issuers of bonds and debt instruments can perform their obligations.
  • The agency also provides information about the country’s sovereign debt.
  • The global credit rating industry is highly concentrated, with three agencies: Moody’s, Standard & Poor’s and Fitch.
  • CRA is regulated at several different levels-the Credit Rating Agency Reform Act of 2006 supervised its internal processes, record keeping, and business practices.
  • Because of the role these institutions played in the financial crisis and the Great Recession, these institutions have been subject to strict review and regulatory pressure.

Credit rating overview

The country is awarded a sovereign credit rating. This rating analyzes the overall credibility of a country or foreign government. Sovereign credit ratings consider the overall economic conditions of a country, including the amount of foreign, public and private investment, capital market transparency, and foreign exchange reserves. Sovereign ratings also assess political conditions, such as overall political stability and the level of economic stability that a country will maintain during a political transition period. Institutional investors rely on sovereign ratings to define and quantify the overall investment climate of a particular country. Sovereign ratings are usually pre-requisite information used by institutional investors to determine whether they will further consider specific companies, industries, and types of securities issued in specific countries.

Credit ratings, debt ratings, or bond ratings are issued to individual companies and specific types of personal securities, such as preferred stocks, corporate bonds, and various types of government bonds. Ratings can be assigned to short-term and long-term debt separately. Long-term rating analysis and evaluation of the company’s ability to fulfill all its responsibilities for issued securities. In view of the company’s current financial status and general industry performance, short-term ratings focus on the performance capabilities of specific securities.

Three major institutions

The global credit rating industry is highly concentrated, and the three major institutions, Moody’s, Standard & Poor’s and Fitch, control almost the entire market. Together, they provide much-needed services to borrowers and lenders and lenders. They intend to provide the market with reliable and accurate information about the risks associated with certain debts.

Fitch Rating

Fitch is one of the world’s three largest credit rating agencies. It has operations in New York and London, and ratings are based on company debt and its sensitivity to changes in interest rates. When it comes to sovereign debt, countries require Fitch and other institutions to assess their financial situation and political and economic climate.

Fitch’s investment grade ratings range from AAA to BBB. These letter grades indicate that the probability of a debt default is very small. Non-investment grade ratings range from BB to D, the latter means that the debtor has defaulted.

history

John Knowles Fitch (John Knowles Fitch) founded Fitch Publishing Company in 1913 to provide financial statistics for the investment industry through the “Fitch Handbook of Stocks and Bonds” and “Fitch Handbook of Bonds”.In 1923, Fitch introduced the AAA to D rating system, which has become the basis of the entire industry rating.In order to become a full-service global rating agency, Fitch merged with London’s IBCA, a subsidiary of French holding company Fimalac, in the late 1990s. Fitch also acquired market competitors Thomson BankWatch and Duff & Phelps Credit Ratings.Fitch acquired Algorithmics, a Canadian company in 2005, and founded Fitch Solutions and Fitch Training (now Fitch Learning), and began to develop operating subsidiaries specializing in enterprise risk management, data services, and financial industry training.

Moody’s Investor Services

Moody’s assigns country and company debt credit ratings, but in a slightly different way. Investment-grade debt ranges from Aaa, the highest level that can be allocated, to Baa3, which indicates that the debtor is capable of repaying short-term debt. The debt below investment grade is speculative grade debt, often referred to as high-yield or junk bonds. These grades range from Ba1 to C. As the letter grade decreases, the possibility of repayment decreases.

history

First published by John Moody’sThe Moody’s Handbook was published in 1900. The manual publishes basic statistics and general information on stocks and bonds in various industries. From 1903 to the stock market crash of 1907, the “Moody’s Handbook” was a national publication. In 1909, Moody’s began publishing “Moody’s Analysis” Railway Investment”, which added analytical information about the value of securities. The expansion of this idea led to the creation of Moody’s Investor Service in 1914, which served in the next 10 years. In the middle of the year, ratings will be provided for almost all of the government bond market at that time. By the 1970s, Moody’s began to rate commercial paper and bank deposits, becoming today’s comprehensive rating agency.

Standard & Poor’s

Standard & Poor’s has a total of 17 ratings, which can be awarded to corporate and sovereign debt. Anything rated from AAA to BBB- is considered investment grade, which means it has the ability to repay debt carefree. Debts rated BB+ to D are considered speculative and the future is uncertain. The lower the rating, the greater the probability of default, and the D rating is the worst.

history

Henry Varnum Poor (Henry Varnum Poor) first published “The History of American Railroads and Canals” in 1860, a pioneer in securities analysis and reporting that will develop in the next century. Standard Statistics was established in 1906 and issued ratings for corporate bonds, sovereign debt and municipal bonds. Standard Statistics merged with Poole Publishing Company in 1941 to form Standard & Poor’s, which was acquired by McGraw Hill in 1966. Investor analysis and decision-making tools, as well as U.S. economic indicators.

Nationally recognized statistical rating agency

The credit rating industry began to undergo some important changes and innovations in 1970. Investors subscribe to the publications of various rating agencies, and issuers do not need to pay for research and analysis, which are a normal part of the development of public credit ratings. As an industry, credit rating agencies have begun to realize that objective credit ratings are of great help to issuers: they promote access to capital by increasing the value of securities issuers in the market and reducing the cost of obtaining capital. The expansion and complexity of the capital market, coupled with increasing demand for statistics and analysis services, has led the industry to decide to charge securities issuers for rating services.

In 1975, financial institutions such as commercial banks and stockbrokers tried to relax the capital and liquidity requirements imposed by the Securities and Exchange Commission (SEC). Therefore, the Nationally Recognized Statistical Rating Organization (NRSRO) came into being. Financial institutions can meet their capital requirements by investing in one or more securities that are highly praised by the NRSRO. This allowance is the result of registration requirements and the strengthening of the supervision and supervision of the credit rating industry by the US Securities and Exchange Commission. Increasing demand for rating services from investors and securities issuers, coupled with increased supervision, has led to the growth and expansion of the credit rating industry.

Regulation and legislation

Since large credit rating agencies operate on an international scale, supervision takes place at several different levels. Congress passed the Credit Rating Agency Reform Act of 2006, allowing the SEC to supervise the internal processes, record keeping, and certain business practices of credit rating agencies. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as the Dodd-Frank Act) further strengthened the SEC’s regulatory powers, including requiring disclosure of credit rating methods.

Credit rating agencies are subject to multiple levels of supervision.

The European Union (EU) has never enacted specific or systematic legislation, nor has it established a single agency responsible for overseeing CRA. There are several EU directives, such as the 2006 Capital Requirements Directive, which affect rating agencies, their business practices and disclosure requirements.Most directives and regulations are the responsibility of the European Securities and Markets Authority.

financial crisis

After the financial crisis and the Great Recession from 2007 to 2009, credit rating agencies came under strict review and regulatory pressure. People think that the ratings provided by credit rating agencies are too positive, leading to poor investment. Part of the problem is that despite the risks, these institutions continue to give mortgage-backed securities (MBS) an AAA rating. These ratings convince many investors that these investments are very safe and risk-free. These agencies are accused of trying to increase profits and market share in exchange for these inaccurate ratings. This helped lead to the collapse of the subprime mortgage market that led to the financial crisis.

To make matters worse, the European sovereign debt ratings of these institutions have also been reviewed. After Greece, Portugal and many other European countries’ debt crises triggered disasters, institutions have downgraded the ratings of other EU countries.

Some believe that regulators have helped support the oligopoly of the credit rating industry and provided rules that constitute barriers to entry for small and medium-sized institutions.The new EU regulations make credit rating agencies liable for improper or negligent ratings that cause damage to investors.

Bottom line

Investors can use information from a single agency or multiple rating agencies. Investors expect credit rating agencies to provide objective information based on reasonable analysis methods and accurate statistical measurements. Investors also hope that securities issuers will abide by the rules and regulations established by the regulatory agencies, which are the same as credit rating agencies complying with the reporting procedures established by the securities industry regulatory agencies.

The analysis and evaluations provided by various credit rating agencies provide investors with information and insights, helping them to examine and understand the risks and opportunities associated with various investment environments. With this insight, investors can make informed decisions about the countries, industries, and securities they choose to invest in.

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