Understanding the Power of the Credit Ratings Agencies

(eToro Blog) Around the world, three companies dominate the credit ratings business, namely Standard & Poor’s (S&P), Moody’s and Fitch. S&P controls about 40% of the market, as does Moody’s, while Fitch accounts for about 14% of market share and the remainder is generally distributed among lesser known agencies like Egan-Jones and A.M. Best.

The remit of the credit ratings agencies is to conduct a rigid due diligence exercise on sovereign assets, including sovereign bonds. The rating which is assigned by the agency will determine in large part how easily a country can obtain funding in the private market; the lower the rating, the more expensive (the higher the interest) that a government will have to pay.

Each of the agencies has their own ranking system with letter designations to represent the quality of the issued security. Moody’s top rated bond will receive an Aaa designation while S&P’s and Fitch’s will receive AAA. Investment grade issuances range from the top rated through Baa3 (Moody’s) and BBB- (S&P and Fitch). Anything below Moody’s Ba1 and S&P’s or Fitch’s BB+ is non-investment grade then bordering on highly speculative. Ratings that fall within the C-range from any of the agencies presents substantial risks, with the possibility of default and little prospect of recovery.

Below is a sampling of some of the credit ratings for key countries (as of this writing).

The credit ratings also provide investors with an indication of their “leaning” for the next ratings review by issuing their outlook, i.e. positive, stable, or negative.

Who uses the credit ratings agencies? All investor types rely on an agencies ratings, from individual traders all the way through institutional investors like mutual fund managers and pension fund operators. But investors are also urged to take up their own due diligence exercise and not rely solely on credit agencies, which have been heavily criticized in recent years for their failures and inadequacies. Moreover, critics contend that the credit ratings agencies have a major conflict of interest with the very entities that they are to appraise; specifically, they are paid by those entities to determine the creditworthiness of the instruments that they themselves have issued. One notable critic is Bill Gross, the co-founder of Pimco, who described the credit reporting agencies as, “an idiot savant with a full command of the mathematics, but no idea of how to apply “them.”

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