Credit Ratings, Credit Rating Agencies, and their Development in Asia

This conference focuses on issues surrounding the role of global and national rating agencies in Asia. Credit rating agencies are important players in financial markets. Collecting information is expensive and rating agencies are able to process information in an efficient way. Their ratings help to reduce information asymmetry and enhance efficiency of capital markets. In spite of some recent openings, there are only three traditional Global Rating Agencies (GRAs): Moody's, Standard & Poor's (S&P) and Fitch. GRAs have emerged as key players in the functioning of international financial markets. Although GRAs have proved useful in the evaluation of borrowers' creditworthiness, their rating practices in some recent financial crises such as 1997-98 Asian financial crisis, the Enron debacle, recent sub-prime crisis have come under close scrutiny. At the same time, several Asian countries feature the presence of independent National Rating Agencies (NRAs). Though these NRAs do not have long tradition and reputation as GRAs, they might provide a key infrastructure to accelerate financial market development in Asia. Indeed, NRAs may increase the number of rated entities, since compared to GRAs they seem to specialize in rating smaller-sized and less internationalized entities and also charge lower rating fees.

This first session discussed issues of competition, conflict of interest and regulation of rating agencies. The first paper point out few problems with credit rating agencies: (1) credit rating agencies were aggressive in rating structured finance products, and often sign optimistic ratings due to rating shopping; (2) their model and parameters are wrong, underestimating risks of financial products; (3) corporate governance issues like failure of top management to value risk. Moving to rating agencies' regular rating business next paper showed that they often use unsolicited ratings to gain market share. The unsolicited rating usually has low rating and it appears to be quite prominent in Japanese market. Third paper looks at experience of European Union, which made significant inroad in improving regulation by implementing registration procedures for rating agencies, and strengthening regulation on structured finance products. On entry and competition prospective there were two theoretical papers providing different views. One paper shows that new entry is good and depends on whether entry services are substitute or complements. When they are substitutes, then in certain circumstances entry restrictions will be welfare enhancing. When they are complements, encouraging entry will be welfare enhancing. Another paper using incomplete contract theoretical framework finds that in general entry tends to enhance quality of credit rating services even though efforts are not at maximum.

Session II covered countries ceiling effect and its implications on emerging market economies. Paper presented here showed that sovereign ceiling are still binding and with less stronger effect on private corporate rating. This is true for developed economies in general and less for emerging markets in recent years. In addition to that they found that firms' idiosyncratic information also matter in private corporate rating. The other paper on sovereign ratings tries to explore new approaches to this issue. It shows that single grade rating is not very useful for investors and especially not informative to be used in emerging market economy. May be some subsector ratings useful by differentiating financial economic indicators so that those information more informative for investors in emerging market. Conference also includes paper on bank ratings, which was least critical paper on credit ratings. It finds that rating agencies tend to punish banks that take excessive risks relative to their financial conditions. In addition, there are some differences between GRAs in view of individual banks' risk-taking behavior.

Session IV examined performance of GRAs and NRAs in Korea and Japan. Both papers show that NRAs ratings are also credible when look at event studies on downgrading events on Korean bond market and Japanese equity market. In the case of Korea NRAs affiliated with GRAs do not seems benefiting from GRAs reputational capital. In the case of Japan, NRAs are more influential in local markets. This empirical evidence shows that in developed markets like Korea and Japan NRAs are quite good already. However, how NRAs can be further developed in other emerging markets in rest of the Asia? This remains to be answered.

Final policy discussion assessed way forward in terms of the policy recommendations, and future development of credit rating industry, as well as discussion on local credit rating agencies. Discussion varied from rating agencies' regulations to issues of historical development of financial markets and evolution of financial crises; as well as issues of ratings scale difference between GRAs and NRAs. However there were many unanswered questions regarding regulatory context remained. As one of the participant of the conference, Siegfried Utzig, mentioned the distinction between ‘known unknowns' meaning risk and ‘unknown unknowns' meaning uncertainty, and stated: "If crisis teaches us one thing- is that we have to look at ‘unknown unknowns'. Rating agencies are not able to look at uncertainty. We have to look at different solutions. This is the challenge for research community for the future time."