The war declared by the US and EU governments on the ratings agencies has drawn blood. Standard &Poor’s CEO, Dewen Sharma, was yesterday replaced and the business placed on a ‘strategic review’. This follows an 11% drop in the value of the parent company McGraw Hill since S&P downgraded the US Treasuries’ credit rating.
The result of the strategic review may revolutionise the ratings game. It is universally believed that the ratings agencies have no advantage or special expertise in predicting default. Likewise, having a rating is an almost universal requirement for successful bond issuance. Issuers pay for the rating, so this is how S&P makes its money. How can they protect their revenue base, while softening the impact of the rating itself.
One way is to fashion themselves as a specialist auditor to provide comfort to bond investors that an issues structure and issuance procedures have been followed correctly, as well as ongoing disclosure. S&P could abandon the ‘letter-rating’ altogether and simply apply a pass/fail score to each issue or issuer. Were the other agencies to follow then the major impact would be the fact that all investment mandate guidelines would need to be revised to eliminate the common reference to minimum letter-ratings. In practical terms, an increased onus for credit assessment would fall upon investors and their managers.
Will this happen? If S&P’s internal management take control of the review then no-dice. It has too much to protect. McGraw Hill needs to listen to the market, and the prodding of the US and EU, and force an abandonment of the letter-rating system.