GATS, financial services and rating agencies

Even as the US financial system reels under damaging disclosures about its deficiencies sparked by the Enron collapse, one major player in the capital markets has thus far largely escaped scrutiny. The little-regulated and all-powerful rating agencies, by issuing pronouncements for which they are ultimately unaccountable, wield an oligopolistic influence that can make or break companies and indeed governments.

by Chakravarthi Raghavan

GENEVA: The Enron scandal, despite the efforts of the Bush administration and others, is no longer viewed as an isolated exception or one confined to the US, but as a scandal that involves corporations (several of them leading manufacturing and service corporations), Wall Street bankers, stockmarket brokers and securities analysts, audit and accountancy firms and lawyers in corporations and audit firms.

It is a betrayal of capitalism, Felix Rohatyn wrote recently in the New York Review of Books.

The Enron scandal and the ever-widening disclosures in its wake have spawned a spate of inquiries and investigations in Washington, but one element of US popular capitalism and the capital markets has received little attention, namely, the rating agencies.

The international financial institutions (led by the IMF and the World Bank at one end, and the Bank for International Settlements at the other) or the various international supervisory organizations trying to evolve an overall policy of norms and their enforcement, seem to be paying little attention to these agencies or engaging in a conspiracy of silence not to touch them and to ignore the havoc they wreak across the world.

Even the GATS Article VI and VII discussions and attempts to evolve professional standards and qualifications do not address the problem.

But in the light of recent revelations and the losses to countries, trade negotiators at the WTO - as they begin to negotiate a further round of national deregulation and liberalization (including of financial services), look at a number of rules and clarifications of the General Agreement on Trade in Services (GATS) or begin the process of assessments and making offers or receiving requests for more market access - should begin to look at this important element of the market system, and how the standards and norms of rating agencies can be set transparently in an international rules-based system.

From time to time, aggrieved developing-country finance ministers and firms and many others have raised questions about these rating agencies, but to no avail. Their voices of anguish and protests are summarily dismissed by the financial media and others.

On the other hand, at one point last decade, the Finance Minister of Canada was accused of having discussed his proposed budget with rating agencies ahead of presentation to the Canadian House of Commons, so as to be sure that his budget and proposals would not be viewed unfavourably by the market!

The rating agencies routinely issue ratings - solicited or unsolicited - and these move the markets. However, there is seldom a case of a country or corporation being downgraded or downrated - except after the event. And the US courts have even held that the unsolicited ratings issued by these firms, despite the severe financial and economic damage they may cause, are immune from legal action, on the ground that they are protected by the US Constitution’s First Amendment, Freedom of Speech!

Who guards the guardians?

A new book, The Ratings Game, by Andrew Fight, a senior financial consultant with the French Bankers Training Institute, throws some light on the workings of the rating agencies.

In one of the chapters of his book, “Quis custodiet ipsos custodes?” (Who guards the guardians themselves?), Fight notes that the rating agencies - Moody’s and Standard and Poor’s are well-known names - have become very powerful and militant in the protection of their oligopoly because of the status they have been accorded by the regulatory agency of the largest economy in the world. They are “nationally recognized statistical rating organizations” (NRSROs), but without the US Securities and Exchange Commission (SEC) ever having defined them!

In 1975, the SEC issued a rule that broker-dealers, when computing net capital, should deduct a certain percentage of the market of their proprietary security positions. However, some of these instruments were to get preferential treatment if they had been rated investment-grade by at least two nationally recognized statistical rating organizations. The SEC did not define these NRSROs but recognized three existing agencies: Moody’s, Standard and Poor’s, and Fitch. It subsequently certified four others, which all merged into Fitch, thus leaving the Big Three in the field. The SEC has not certified anyone else since, and this oligopoly continues.

As there are only a handful of these rating agencies, everyone has a comfortable slice of the economic pie, since issuers of bonds and securities or those attempting to raise loans generally need ratings from at least two agencies.

These agencies raise money by collecting fees from companies they rate, and the current practice is to set the fees proportionate to the bond issue - so that there is a natural incentive to favour the large fundraisers since they bring in more revenues. And the agencies have resisted being designated as “experts”, lest it attract  liabilities, nor are they limited in terms of issuing ratings only when sought.

All these suit the entire edifice of institutions trying to cast in stone the neoliberal model of corporate globalization, a model that generates huge benefits for a few and marginalization and poverty for many.

All over the world, there are regulations by the state or by state-recognized or statutorily-authorized bodies which set qualifications and standards for professions with public impacts, e.g., doctors, lawyers and accountants. But there are no such regulations for rating agencies. No qualification is required for one to be engaged and employed as an analyst in a rating agency (or, for that matter, as an investment counsellor in a bank), and no examination need be passed as in the case of a lawyer, accountant or auditor.

And US rating agencies have become virtual global monopolies, sanctioned and protected by the US system and raking in money and income from around the world. For instance, Standard and Poor’s, according to Fight’s book (which cites a member of that agency), had half-a-dozen analysts in 1968; now they have 1,200 employees and 15 offices worldwide.

Thanks to the US authorities and their regulatory (in)actions, the agencies have a captive market, an oligopoly that imposes its own ideological model and modus operandi in Europe and Asia, although there is an underlying but unresolved ambiguity about their status.

Perhaps, as part of the US system, they too, like the big audit and financial and securities firms, wield influence by way of campaign contributions.

The US government and Congress could regulate them but so far have not - given the fanciful views about the liberal or neoliberal economic model being a solution for all problems.

“The agencies have been granted the franchise to exploit a lucrative gold mine with tremendous barriers to future entrants ... by default they occupy the role of a quasi-official arbiter and gatekeeper to entry [into] the US and international financial system as sanctioned by the (US) Securities and Exchange Commission.”

This oligopoly has in effect been created by the SEC, which has a powerful influence because the US is the world’s largest capital market where countries and corporations seek to raise capital via stocks, debt, bonds, etc.

The SEC has granted the rating agencies a de facto monopoly which has helped fill their coffers, endowing them with the power “to make or break companies or indeed governments, to issue pronouncements for which they are ultimately unaccountable, and to levy fees on a captive market.”

The agencies hide behind the US’ constitutionally protected right to free speech, but their activities encompass predatory pricing, monopoly situations, fostering market inefficiencies, obstructing  free  flows  of   information,  propagation of a corporate ideology as an instrument of regulation by the government and defining professional qualifications.

But the question at the end of it all will still remain: Quis custodiet ipsos custodes? No one. (SUNS5070)

From TWE No. 275 (15-28 February 2002)