China should not ‘open’ market to credit rating monopolists

By Ed Zhang Source:Global Times Published: 2017/7/26 20:23:39

Illustration: Peter C. Espina/GT


Recent business news seems to point to a more open China market for overseas investors and financial services. A more open market will generally accommodate more competition, and will bring about a greater benefit to customers.

But how China will open its market to the three largest international rating agencies - Moody's, Standard & Poor's, and Fitch - is perhaps a different matter, because they are the world's largest monopolies and are likely to stifle, rather than promote, fair competition.

It is already too late to argue whether China should open up its market to the "Big-Three" raters. Through their joint-ventures and collaborators, which all carry Chinese names, the three big raters are already active in the China market, although not so straightforwardly.

People in the industry commonly say they dominate 95 percent or so of the global credit rating market, with 80 percent shared by the Moody's and Standard & Poor's, and another 15 percent taken by Fitch.

There are stories that once Japan opened its door to them, they conquered Japan's whole market. There is an estimate that the three big raters and their China connections can already claim two-thirds of the market in the Chinese mainland. One has reason to doubt whether their higher presence can in any way benefit healthy competition in the rating sector.

To check their historical records - which is, by the way, an important method for rating credit - people can see those rating "superpowers" played a very ugly role in the 2008 crisis, most notably in the Wall Street meltdown caused by the sub-prime loans that they rated.

No one needs to demonize them. They ruined their own credit by giving many financial instruments the top AAA rating, only to lower them to the junk level and to see more than two-thirds of them default. And the result was a trillion-dollar loss for the US financial market.

Similar dramas repeated in Europe during the euro zone sovereign debt crisis in the early 2010s, when their downgrades added trouble, instead of giving any help, to the countries struggling to reorient their fiscal and financial policies.

As for emerging market economies, when Brazil and South Africa are crippled by the big raters' downgrades, there is also criticism of the raters' stubbornness in not being willing to revise their per capita-GDP criteria in measuring the credit standing of a populous nation such as India.

The continuing criticism provides evidence that despite their repeated statements about mending their ways, the big three raters have not really done anything of the sort.

They don't really have a clue on how to uphold objectivity in their rating operations. In their basic methodology as well as habitual behavior, they continue to give either absurdly high or unreasonably low ratings to assets that have significant bearing on the state of the global financial market.

Although there is new legislation in the US and EU to regulate their business, there is no fundamental change in the global credit rating market. Their traditional pay structure, in which issuers of bonds pay for the rating of their issues, remains a hotbed of conflict of interests.

Their standard rating methodology, which forecasts an issuer's future performance by checking its past records, is inadequate in explaining the issuer's ability to honor its credit, especially under rapidly changing market conditions.

What China truly needs is not to concede a larger market share to monopolistic raters with proven poor records, but to encourage competition among financial houses with innovative services and higher levels of customer satisfaction.

The author is a Beijing-based financial services executive.

Posted in: INSIDER'S EYE

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