OPINION: In 2018, China suspended licences held by Dagong Global Credit Rating, one of China’s biggest agencies. Dagong was found guilty of submitting false information to regulators and charging borrowers very high fees.
These shortcomings originate from their ‘issuer-pay’ business model. The institution being rated pays for the rating which is used by investors. This means that the model has an inherent conflict of interest.
Although this has been evident through various crises – most notably the financial meltdown in 2008 – regulatory mechanisms are yet to address this problem. And, despite these known weaknesses, rating agencies are still being referenced in key financial market decisions.have identified the issuer-pay revenue model as a key driver of conflict of interest. Here are four reasons why I think the current attempts to regulate ratings agencies will not address conflict of interest.
The first big problem is the relationship between the rating agencies and the issuers. This relationship naturally creates pressure for both the lead rating analyst – around which the wholeThis is how the process works: after an issuer contracts a rating agency, the ratings agency assigns an analytical team to gather information about the entity from different sources they deem credible. The analytical team makes recommendations to a ratings committee, convened by the lead analyst.
The second problem is that rating agencies are bound to be concerned about the sustainability of their revenue sources because they’re profit driven businesses. They will fight to protect their income at the expense of aggressive or objective ratings that could compromise revenues, although in the long-run will damage their businesses.. Conflict of interest usually manifests itself through members of the analytical team.
Lastly, the credit ratings industry is highly concentrated. Moody’s Investors Service and Standard & Poor’s together control 80% of the global rating market. Fitch Ratings accounts for a further 15%. The ‘big three’ credit rating firms seek to maintain dominance in the industry through discouraging any
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