Credit Rating Agencies after the Financial Crisis: A Decade of Resilience
As part of the Ten Years since the Financial Crisis campaign being run by Palgrave, this post focuses upon the development of the leading Credit Rating Agencies (CRAs) since the Financial Crisis of 2007/8. After playing a central role on the development of the Financial Crisis, the CRAs were brought into the regulatory limelight in a relatively unprecedented manner; yet, with the benefit of hindsight ten years on, we are now in the position to assess just how effective that regulatory approach has been.
Whilst the Credit Rating Industry was only first formally regulated in 2005 and 2006 (by two pieces of CRA-focused U.S. legislation), the most important piece of legislation with regards to the Credit Rating Industry was The Dodd-Frank Act of 2010, which designated an entire section just to the industry. Its primary aims were to increase competition within the oligopolistic sector, promote liability for the agencies’ “opinions”, and increase transparency with regards to the agencies’ methodologies that were identified as being fundamentally flawed in the lead-up to the Crisis (particularly in relation to Structured Finance offerings). However, there have been only limited developments within these areas, with methodologies now being ever so slightly more transparent, no alteration in the composition of the oligopolistic marketplace, and the quest to increase liability essentially being rejected by regulators (as a result of a vehement reaction from the agencies themselves). Yet, the approach did bring forth the ability to undertake extensive penalties against the agencies for their actions, and in 2015 and 2017 that ability was demonstrated in an unprecedented way.
In 2015 Standard & Poor’s settled with the U.S. Department of Justice (DoJ) for a record $1.375 billion on account of their performance in the lead-up to the Financial Crisis. In 2017, Moody’s settled with the DoJ for $864 million; both settlements marked a drastic alteration in the severity of the punishment usually afforded to the agencies. These massive settlements were declared as a ‘victory’ by the DoJ, but that sentiment is questionable once we consider the wider picture; it may have been a ‘victory’ for those who lost because of the agencies’ actions, but as a regulatory endeavour its effect has been limited. From the graph below, it is clear to see that the Financial Crisis represents only a ‘blip’ in the agencies’ progression, with Moody’s financial figures being representative of the ‘Big Three’:
Moody’s has continued to grow in the post-Crisis era, despite being identified as an important ‘cog’ in the financial machine that brought the world to a standstill in 2007/8. There have been a number of works produced to examine this phenomenon, with the concluding sentiment being that the marketplace is ‘addicted’ to the ratings of the agencies; looking at the graph above it is difficult to conclude otherwise. Yet, the agencies have continued to expand, both in terms of outright revenue and aggressive M&A strategies, which suggests the addiction will only get worse, not better.
If that is the case, that the addiction to ratings has only been strengthened throughout this period, then the future for the CRAs is an important one to consider. Recently, the CRAs have become attached to a movement within the financial sector which may be termed as ‘Responsible Finance’, although specifically they have become attached to the U.N.-developed initiative the ‘Principles for Responsible Investment’ (PRI). The PRI has a very noble cause in that it is aiming to temper the iniquities within the sector and promote a more sustainable and long-term ethos within this societally-vital sector. However, there is concern being raised with regards to how the CRAs may fit into that ethos, particularly in light of their actions over the last decade or two; this author will be examining those concerns and proposing methods of development within a forthcoming Palgrave Pivot work entitled The Role of the Credit Rating Agencies in Responsible Finance – the work will form part of the exciting Palgrave Studies in Impact Finance series.
Daniel Cash is a lecturer in Law at Aston University. He completed his PhD in Durham University’s Law School in 2016 which focused upon the regulation of the Credit Rating Agencies – more specifically, his thesis looked at the regulation of the provision of ‘ancillary services’ by the leading agencies. Since then, his research has focused solely on the Credit Rating Agencies, and his research profile includes a number of articles on the topic.