International credit rating agencies have had their fair share of controversies over the years.
They have been at the centre of the major financial crises from the financial markets collapse of New York City in the mid-1970s, the Asian financial crisis of 1997 – 1998, the Enron scandal of 2001, to the global financial crisis of 2008. All of these cost investors globally billions.
Rating agencies are meant to give comfort about an issuer’s ability to repay debt. Ratings are essential in determining the level of interest rate that a borrower must pay. Inaccurate ratings therefore distort both the prices of debt instruments and the interest rates payable on them. As history has shown, this creates asset bubbles that eventually burst, disrupting the functioning of financial markets.
The three dominant international credit rating agencies – Standard & Poor’s, Moody’s and Fitch – have been accused of many faults including:
encroaching on government policy;
and rating shopping.
These shortcomings originate from their ‘issuer-pay’ business model. The institution being rated pays for the rating which is used by investors. This means that the model has an inherent conflict of interest.
Although this has been evident through various crises – most notably the financial meltdown in 2008 – regulatory mechanisms are yet to address this problem. And, despite these known weaknesses, rating agencies are still being referenced in key financial market decisions.
Why current regulations aren’t working
A number of studies have identified the issuer-pay revenue model as a key driver of conflict of interest. Here are four reasons why I think the current attempts to regulate ratings agencies will not address conflict of interest.
The first big problem is the relationship between the rating agencies and the issuers. This relationship naturally creates pressure for both the lead rating analyst – around which the whole rating process is centred – and the ratings committee to give favourable ratings over time.
This is how the process works: after an issuer contracts a rating agency, the ratings agency assigns an analytical team (lead and support analysts) to gather information about the entity from different sources they deem credible. The analytical team makes recommendations to a ratings committee, convened by the lead analyst. The lead analyst also determines the size and composition of the ratings committee based on the size and the complexity of the credit analysis.
The second problem is that rating agencies are bound to be concerned about the sustainability of their revenue sources because they’re profit driven businesses. They will fight to protect their income at the expense of aggressive or objective ratings that could compromise revenues, although in the long-run will damage their businesses.
The third problem is that the individual employees of a rating agency face no criminal liability. Conflict of interest usually manifests itself through members of the analytical team.
Lastly, the credit ratings industry is highly concentrated. Moody’s Investors Service and Standard & Poor’s together control 80% of the global rating market. Fitch Ratings accounts for a further 15%. The ‘big three’ credit rating firms seek to maintain dominance in the industry through discouraging any activities that may lead to a loss in their market share. They are unwilling to allow competition, suggesting that it could instead lead to poor ratings.
Although strict civil laws are necessary to deter misconduct and encourage compliance, enforcing civil regulations only is both an ineffective and expensive way of curbing conflict of interest. Tighter scrutiny of credit rating agencies by investors, regulators and media is also not effective.
Despite these regulatory responses, rating agencies are still being caught on the wrong side of the law. Recent cases are proof of this. But there’s still the possibility that a great deal of wrongdoings go undetected.
Earlier this year the European Securities and Markets Authority fined the Fitch group of companies in France, Spain and United Kingdom a total of €5 132 000 for failing to maintain independence and avoiding conflict of interest. Fitch UK, Fitch France and Fitch Spain issued ratings on Casino Guichard-Perrachon, Fondation Nationale des Sciences Politiques, and Renault. This was despite the fact that they knew one of their shareholders – which indirectly owned 20% shares in each of the Fitch group companies – was also a board member of the rated companies.
In 2018, China suspended licences held by Dagong Global Credit Rating, one of China’s biggest agencies. Dagong was found guilty of submitting false information to regulators and charging borrowers very high fees, actions that regulators said compromised the rating agency’s independence.
In South Africa, the Financial Sector Conduct Authority recently found the Global Credit Rating Agency guilty of failure to avoid a conflict of interest. The agency was fined an administrative penalty of R487 000. The CEO of the GCR undertook to an issuer, whose credit rating had expired, that the GCR would issue a credit rating. This was contrary to the rules that required the CEO to act separately from the agency’s rating analysis team.
At the time of undertaking, the issuer was the process of procuring the services of a rating agency, a process in which global agency was one of the bidders.
Shortfall in regulatory mechanism
The continuing infringement by credit rating firms on rules and analysts’ actions that compromise the independence of their opinions shows there is a major shortfall in the current regulatory mechanism.
Although problematic, abandoning the ‘issuer-pay’ business model is not the solution and will push some rating agencies out of business.
The only solution is to criminalise rating misconduct such as breaching conflict of interest. The strict monitoring, scrutiny and penalising of credit rating firms alone will not be enough to deter bad behaviour. Individuals responsible for breach of conflict of interest rules should face criminal prosecution. If this does not happen, analysts will not hesitate to take chances.
U.S. energy firm Anadarko Petroleum Corp gave the go-ahead for the construction of a $20 billion gas liquefaction and export terminal in Mozambique, the largest single LNG project approved in Africa.
The announcement, which occurred at an event in Mozambique, was widely expected after Anadarko last month flagged the decision date.
"As the world increasingly seeks cleaner forms of energy, the Anadarko-led Area 1 Mozambique LNG project is ideally located to meet growing demand, particularly in expanding Asian and European markets," Chief Executive Officer Al Walker said in a statement here,
Anadarko has agreed to be taken over by Occidental Petroleum Corp. Once that deal goes ahead, Occidental has agreed to sell assets including the Mozambique LNG project to French oil major and large LNG trader Total SA. Officials at Total were not immediately available for comment.
Natural gas use is growing rapidly around the world as countries seek to meet rising energy demand and wean their industrial and power sectors off dirtier coal.
The project, which has committed long-term supplies to utilities, major LNG portfolio holders and state companies around the world, underscores the industry's conviction that LNG demand will soar in years to come despite a slump in prices this year.
Low prices for the gas that is super-cooled for transportation prompted fears final investment decisions (FIDs) such as Anadarko's would be delayed or scrapped. But the U.S. company gathered enough long-term buyers to underpin the financing of the project.
"Flexible commercial arrangements, including an innovative co-purchase agreement with Tokyo Gas and Centrica, have been instrumental in securing the project a roster of high-quality customers in a crowded LNG market," said Frank Harris, head of LNG Consulting at Wood Mackenzie.
LNG prices slumped this year as a jump in supply from new terminals in the United States, Australia and Russia were not totally met by higher demand in Asia.
The trade is also nowhere near as developed as the market for crude oil, causing erratic price movements.
"At $20 billion, today's FID is the largest sanction ever in sub-Saharan Africa oil and gas," added Jon Lawrence, an analyst with Wood Mackenzie's sub-Saharan Africa upstream team.
The project is also expected to be transformational for Mozambique, one of the poorest nations on earth beset by economic crisis, conflict stemming from a civil war and serious governance malaise, whose annual gross domestic product is just $13 billion.
The government of Mozambique said the project is expected to create more than 5,000 direct jobs and 45,000 indirect jobs.
With a 12.88 million tonne per year (mtpa) capacity, Mozambique LNG is one of the largest greenfield LNG facilities to have ever been approved. It involves building infrastructure to extract gas from a field offshore northern Mozambique, pump it onshore and liquefy it, ready for further export by LNG tankers.
On the African east coast, the liquefaction plant will be able to sell LNG to both the lucrative Asian market, home to 75%of global LNG demand, and to the flexible European market, which helps balance global LNG trade by soaking up excess supply.
Mozambique LNG joins other mega-projects approved in the past year such as Exxon Mobil Corp's 16 mtpa U.S. Golden Pass plant and Royal Dutch Shell Plc's 14 mtpa LNG Canada facility.
Still expected this year are approvals from Exxon for a 15.2 mtpa project also in Mozambique, and from Russia's Novatek for its 19.8 mtpa Arctic LNG-2 plant.
Anadarko's partners in the Mozambique LNG project are Mitsui, Mozambique state energy company ENH, Thailand's PTT and Indian energy firms ONGC, Bharat Petroleum Resources and Oil India.
Sierra Leone’s president opened a tender process last week for building a 7 km bridge at a cost of up to $2 billion to link Freetown to the country’s only international airport.
Freetown International Airport at Lungi is currently accessible only by boat or helicopter, separated from the capital by the nearly five km (three mile) wide mouth of the Rokel river.
“I will closely superintend the entire process and ensure that every tender is compliant and every tender is in the best long-term interest of Sierra Leone,” President Julius Maada Bio said last week in a speech at State House.
Sierra Leone officials have previously estimated the Lungi bridge could cost anywhere between $1.3 billion and $2 billion.
James Turner, an official from Sierra Leone’s transportation ministry, told Reuters the project would take between four and five years to complete, and would likely be financed through a public-private partnership scheme, such as a toll gate.
Bio first proposed the bridge project to the state-funded Chinese firm Power China International during a visit to Beijing last September. A month later, he axed a plan of his predecessor’s to build a new $400 million airport closer to the capital with Chinese labour and loans.