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Finance: Credit Rating Agencies

Volume 736: debated on Wednesday 14 March 2012


Asked by

To ask Her Majesty’s Government what is their assessment of the influence exercised by the credit rating agencies in the world ewDebaeconomy.

My Lords, investors value the role of credit rating agencies to provide market participants with a neutral opinion of credit quality. However, to reduce the procyclical effects of ratings changes, it is important that market participants do not rely mechanistically on credit rating agency opinions and that those ratings are not hardwired into legislation. Therefore, the Government strongly support G20 efforts to reduce the overreliance on credit rating agency ratings, and fostering competition through reducing barriers to entry.

I thank the Minister for that Answer. In the excellent report that was produced in this House, a whole range of proposals were made for the reform of the credit rating agencies, which I see as urgent and important for the world economy. One of those proposals was that the cartel of the big three agencies should be opened up to greater competition. How in practice does the Minister think this will be achieved? Has any progress been made to that end? Does he by any chance support the idea of compulsory rotation with some of the smaller agencies, a proposal that has been endorsed by a Treasury Select Committee inquiry that is going on at the moment?

The noble Lord, Lord Giddens, has gone absolutely to the heart of the matter. Certainly your Lordships’ Committee, the Government and most commentators would like to see competition introduced, but that is extremely difficult, as the noble Lord knows. It is a highly concentrated industry and entry is difficult because it takes time to build up a track record. A number of steps need to be taken. As I have already said, the hardwiring of credit ratings needs to be taken out wherever possible from investor mandates and from legislation and regulation in many countries.

We need to improve the transparency and comparability of the ratings of the agencies and generally lower the regulatory barriers to entry. I believe that Europe has taken some steps, but it needs to take more. For example, under the new registration processes, 16 credit rating agencies are already registered in Europe and another 15 more have applied to be registered, so there are a lot more out there already than the three that get all the focus. As to rotation, it is actually part of one of the two rounds of European directives that have come in since the financial crisis that analysts need to be rotated within firms, which is probably the proportionate response.

My Lords, will my noble friend indicate what view he thinks the credit agencies will take of the Government’s proposal to issue 100-year bonds. If these bonds are bought by the Bank of England as part of a quantitative easing process, what will be done to avoid the problem of the value of the bonds falling as interest rates rise and being eliminated by inflation over that period of time?

My Lords, my noble friend conflates a number of interesting questions. The key point is that the UK is in a very strong position to look at ultra-long or perpetual bonds. We have historically very low rates of interest and significant investor demand, particularly from the domestic funds, for very long-dated gilts. In response to that situation, we think that it is right to consult the market, as my right honourable friend the Chancellor of the Exchequer has indicated we will do, and to see what it has to say, but we will not make any issue unless it represents good value for the taxpayer.

My Lords, given that the credit rating agencies have demonstrated a consistent lack of accuracy, have failed in their governance, are flawed in that the person paying for the rating has to ask for it, and competition is non-existent, will the Minister encourage investors in the City to establish their own credit rating agencies on a not-for-profit basis? At a stroke, they would remove conflicts of interest, introduce healthy competition and establish accurate credit rating figures. Let us remember that all the credit rating agencies gave Northern Rock a AAA rating immediately before its demise.

My Lords, while we should not underestimate the difficulties with the credit rating agencies historically, equally we do not want to make the situation sound more dramatic than it is. On sovereign ratings, the IMF’s analysis in the autumn of 2010 indicated that the rating agencies had performed relatively well and that, in all cases of sovereign default since 1975, they had had those sovereigns on speculative grade ratings at least one year ahead. I have already given some answers as to how we should introduce competition. If one of the vehicles that comes in is of the sort which the noble Lord, Lord McFall, mentioned, that would be up to the market and it should not be prevented from using it.

My Lords, I know that the Minister has read closely our report on the sovereign credit rating agencies, which was published last November and is available to Members of the House, but does he share my concern that the three major credit rating agencies are American? Does he also share our concern, as expressed in the report, that to generate an agency from within the European Union would not be well received by the markets and that it is therefore essential to ensure that there is open, free and fair competition to establish markets for new players to come in and compete with the existing three?

I am certainly very happy to commend again the report, Sovereign Credit Ratings: Shooting the Messenger?, to which the noble Lord, Lord Harrison, referred. It is an excellent report, which said among other things:

“The criticism that credit rating agencies precipitated the euro area crisis is largely unjustified”—

so it offered a very proportionate and measured response to the criticism. I do not think that we should mind the nationality of the rating agencies; it is the competition that we want. In that connection, the Government believe that it would be wrong to create a public European credit rating agency because that would just serve, among other things, to crowd out the competition.

My Lords, until the mid-1970s, investors paid the credit rating agencies, not the issuers. The change was driven very much by the awareness of credit rating agencies that they could gouge more money from issuers. Does the Minister agree that there is no evidence that the so-called private conversations that now take place between the credit rating agencies and the issuers because of their relationship have in any way improved the quality of credit rating? Does he further agree that returning to an investor-paid system would take out the key conflict of interest?

My Lords, I agree that the conflict of interest question is important. I draw my noble friend’s attention to the fact that in the two rounds of legislation to date since the crisis, one of the things that has been done is to ban credit rating agencies from providing a paid advisory service. So some attention has already been given to this issue by Europe.