Hands Up Who Wants a DDD Grade; Their Three-Letter Credit Ratings Can Spell Disaster for Companies - but They Failed to Spot the Enron Scandal until It Was Too Late. Now Experts Are Asking: Who'll Judge the Corporate Executioners?

By Fluendy, Simon; Leach, Andrew | The Mail on Sunday (London, England), March 23, 2003 | Go to article overview

Hands Up Who Wants a DDD Grade; Their Three-Letter Credit Ratings Can Spell Disaster for Companies - but They Failed to Spot the Enron Scandal until It Was Too Late. Now Experts Are Asking: Who'll Judge the Corporate Executioners?


Fluendy, Simon, Leach, Andrew, The Mail on Sunday (London, England)


Byline: SIMON FLUENDY;ANDREW LEACH

THEY wield enormous power. Their analyses can break companies and cause massive losses to banks, insurers and pension funds.

Yet they are unaccountable, unregulated and operate a virtual duopoly. And the way their services are paid for raises fears over conflicts of interest.

They are credit rating agencies.

The dominant pair are Moody's Investors Service and Standard & Poor's. The simple three-letter codes they assign to companies are based on how they assess the chances of a business repaying its debts. That in turn governs how much interest the company will pay March 23, 2003 One of the world's richest men, Warren Buffett, is a major shareholder in Moody's, but those whose companies have suffered at their hands do not share his enthusiasm.

Serge Tchuruk, chairman of ailing French telecoms equipment group Alcatel, has called them ' pyromaniac firefighters' while Jean-Rene Fourtou, chairman of fallen media giant Vivendi, called them simply 'executioners'.

For the time being, the critics appear to have the upper hand. In the next few weeks, the Securities and Exchange Commission (SEC), the powerful US financial regulator, will publish a discussion paper that could lead to greater control of the agencies. An SEC spokesman said: 'There are major issues about conflicts of interest and competition and we want feedback on these before issuing rules.' French finance minister Francis Mer has called for a European watchdog to police ratings agencies, and in the UK the prospect of tighter monitoring is also emerging. Following concerns raised by the Financial Services Authority about how the industry is operating, the Treasury is also keeping a close eye on the moves by the SEC.

FSA chairman Sir Howard Davies recently suggested that the industry was too reliant on too few agencies and should be opened up to competition. He may be given regulatory control of a sector over which it has no powers at present.

The credit-rating agencies measure their combined turnover in billions of pounds and they in turn rate debt worth trillions using their simple letter codes. These range from AAA for the companies seen as copperbottomed investments down to the toxic waste warning D for firms that have failed to pay interest on their debts.

The codes are relied on by investment bankers selling corporate IOUs - bonds - and by the massive pension funds that buy them.

Between the extremes is a finely calibrated set of grades reminiscent of the essay marks awarded by university tutors: Aa3, BBB+, Caa1 and so forth. The most crucial level is BBB-, the cut-off point between investment grade debt and junk bonds.

Many pension funds have rules imposed by trustees requiring a proportion of investments to be held only in AAA bonds and only AAA-rated assets can be used by banks to measure their critical solvency levels.

Triple 'A' rated bonds will pay a lower interest rate than an issue with a less esteemed rating.

Over the past two years, the ratings have also had significant effects on share prices. In 2001, BT suffered a double downgrade of its debt rating, increasing its annual interest bill by pound sterling33 million and sending its shares into freefall. BT described the move as 'incomprehensible'.

Last November, a double downgrade of the debt of Cable & Wireless had even more serious consequences. In an undisclosed caveat to C&W's 1999 deal to sell its stake in mobile group One2One to Deutsche Telekom, the British company promised to indemnify the Germans against any future tax liability arising from the deal. If C&W's credit rating fell to junk status, the company would be forced either to get a bank guarantee for pound sterling1. …

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