S&P has indeed made a bold move by downgrading United States’ sovereign rating. While there may by political opposition, quibbles with the arithmetic, and the like, there is a strong view that those amount to “shooting the messenger”. The downgrading by S&P assumes greater importance because it comes in the wake of determined efforts by governments to tighten their control over credit rating agencies. These agencies had dented their credibility during the financial crisis on account of their stamp of star ratings to securities that were found to be toxic in nature.
The regulatory debate surrounding credit rating agencies has resurfaced barely as it was dying down following the subprime crisis. On that occasion, the allegations against them were on account of their inability to spot weaknesses in the quality of the securities being issued to investors, but this time their role has come into the limelight for taking on the might of a sovereign.
By increasing the friction between credit rating agencies and governments, the US downgrade highlights power games that each can potentially play against the other by flexing their muscles. An op-ed in the New York Times by Professor Jeffrey Manns points to the fact that S&P’s downgrade of the US could be a deliberate strategy to achieve a push back against increasing regulation of rating agencies sought by the US Government. But he warns against any such pushback and advises that “the government should not give in to such extortion.” While that is certainly understandable, the principal issues that continue to affect the regulation of credit rating agencies are the oligopolistic nature of the industry with a handful of players wielding significant influence, and the conflict of interest generated by the financial model where issuers of securities remunerate the rating agencies for their services.
Episodes such as the US downgrade have also expanded the scope of alternative thinking. For example, the idea of doing away with credit rating altogether is also being bandied about. However, as this piece in the Economist notes, that is likely to be a tall order. The requirement of credit rating is now well-entrenched in the financial community as it is both prescribed as a requirement for regulatory purposes (e.g. for listing corporate bonds, for investment by regulated institutions) and also generally followed as a matter of practice in certain types of private contracting (such as in the case of derivative transactions or securities). In other words, credit rating agencies are here to stay because there is no suitable alternative.
As far as India is concerned, the rating agencies have not witnessed the kind of turmoil they experience in other countries. Even on the regulatory front, SEBI seems to have a significant amount of oversight on the Indian agencies compared to its counterparts elsewhere. Nevertheless, recent events have caused SEBI to step up its ante too, as it is keeping a close watch on the developments, and it is reportedly open to making changes to regulations affecting these agencies.
The regulatory debate surrounding credit rating agencies has resurfaced barely as it was dying down following the subprime crisis. On that occasion, the allegations against them were on account of their inability to spot weaknesses in the quality of the securities being issued to investors, but this time their role has come into the limelight for taking on the might of a sovereign.