Diplomatic Economic Club^{® Since 1997}

It is a tough competition for the title of the biggest villain in the recent series of financial crises. Rating agencies, however, are certainly among the leading candidates.

• Rating agencies have been showered with public anger for causing or at least amplifying the financial crisis in general and the sovereign-debt crisis in particular.
• In the wake of serial downgrades of European countries some observers suspected a conspiracy of US-based rating agencies and fretted that entire countries were helplessly at the mercy of the mischief of some private rating agency.
• Even more cool-headed observers mulled over the danger of speculative attacks and self-fulfilling prophesies triggered by hasty, uninformed rating changes.

Jean-Claude Juncker, then head of the Eurogroup, called «for us to set up our own European credit rating agency in Europe itself so that we have reliable and robust data from Europe itself for rating purposes» (German Bankers Association 2011).

Setting up a European rating agency, at least for sovereign ratings, seemed like a good idea. Then again, there already are European credit-rating agencies.

• In fact, the European Securities and Markets Authority lists 17 (excluding the regional branches of the Big Three) registered and certified European rating agencies.

They are not as large and as well-known as the Big Three, but two of them do produce sovereign ratings from a European base.

• Sovereign Ratings are provided by the Japan Credit Rating Agency Ltd, Feri EuroRating Services AG (Germany), DBRS Ratings Limited (Canada) and Capital Intelligence Ltd. (Cyprus).
• Feri EuroRating Services AG, for instance is a German rating agency, which has published sovereign ratings for 60 countries since 1991.

Therefore the hypothesis that Europe-based rating agencies behave differently from US based ones can actually be tested with existing data.

The literature on credit-rating agencies is large, critical studies have been fashionable after every major crisis. The obvious question always was: why did they get it so wrong? Three different possibilities have been discussed in the literature:

• Flawed models.
• Bad incentives.
• Concentrated market structure.

Consider them in turn.

The first possibility is that rating agencies did not understand or adequately model the economic fundamentals. For instance, Morgan (2002) discusses rating-model uncertainty based on differences in ratings (rating splits), which tend to be frequent for more complex and opaque issuers. Other papers have focused on exploring the causality between bond yields and rating changes and tend to find that ratings do have an influence on bond prices (Afonso et al. 2012). Therefore the conclusion would be that rating agencies are quite influential but frequently wrong.

The second strand of the literature explores structural reasons for systematic misjudgements with conflicts of interest. For instance, rating agencies may have incentives to overrate a product if they are cross selling lucrative consultancy services on how to structure said product (de Haan and Amtenbrink 2011). More generally, rating agencies are suspected of inflating valuations in an attempt to attract issuers and increase fee revenues. This may be the unintended consequence of the ’issuer-pays’ model, whereby the bond issuer pays the rating agency whereas the investor receives the information for free (Mathis et al. 2009). The ’issuer pays’ bias is likely to be more pronounced for corporate issuers than for sovereigns. Sovereign ratings are mostly unsolicited, thus, sovereigns do not pay any fee and shopping for the best rating is not possible.

The third reason for systematic misjudgement of sovereigns by credit-rating agencies could be the oligopolistic market structure. The rating market is dominated by three players, which among them have a 95% market share. Moody’s and Standard & Poor’s each have 40% and Fitch Ratings has 15% of the market. In many cases regulators have sealed the dominance of the Big Three by incorporating their ratings into the regulations, as for instance is the case of capital requirements (Eijffinger 2012). In principle, these are ideal conditions for collusive behaviour. Add to this the observation that the Big Three are all based in the US with their headquarters in New York and you can be forgiven for suspecting that European countries may not be given equal treatment when compared to the US or their English-speaking kin. Our findings suggest that you would be wrong, though.

We analyse the rating performance of Feri, the largest German rating agency and find that Feri was even more aggressive both in terms of a lower level and a higher propensity to quickly downgrade Eurozone problem countries than the Big Three. Feri has made larger downgrades to core members of the currency area. In general, Feri was quicker to downgrade countries from investment to speculative grade; however, it also shows a larger number of reversals. Feri appears to be less stable but also less subject to herding than the Big Three. Finally, we find that Feri tends to have a negative ’neighbourhood bias’, i.e. it was tougher on European countries than its Anglo-Saxon competitors by downgrading them more swiftly and aggressively during the crisis. Overall, Feri’s sovereign ratings tend to be more volatile than the ones of the Big Three and more benign on emerging-market economies.

Overall, the evidence from Feri’s ratings suggests that European countries would have received an even tougher treatment from a European rating agency than from the US-based ones. Now, Feri may not be what politicians had in mind when they called for a European rating agency. Feri is a private, small and independent player. Its main concern has to be for client’s satisfaction and good reputation. Regulatory issues or political pressure are not likely to be of concern and therefore the ratings of Feri can be considered an unbiased European view. If this is what politicians were asking for, they have got an answer but probably not the one they expected.

Bernhard Bartels, Beatrice Weder di Mauro voxeu.org