The role of credit rating agencies and their regulation in the context of global crisis" Lic. Alejandro Vanoli Chairman Argentine National Securities Commission Buenos Aires - March 2012
Crisis and the development of a new regulatory agenda 2
Although the last international crisis hit mainly in years 2008 and 2009, many developed economies are still unable to resume a path of growth and the risk of another recession is becoming stronger. This context opens the possibility to rethink the design of the international financial architecture in order to regain stability and foster production, trade and employment. 3
15,0% Crisis Impact: GDP annual % change 2003-2011 10,0% 5,0% 0,0% -5,0% Argentina United States United Kingdom Euro Area (27) Japan China Brazil India -10,0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 4 Source: IMF, Eurostat
The role of the regulator & the financial crisis In 1975, the United States introduced the figure of NRSRO (Nationally Recognized Statistical Rating Organization), a condition which must be approved by the SEC. In the rest of America, the experience has been heterogeneous across countries. As an example, until 2010, Brazil did not have any specific regulations in this matter, while Argentina has regulated the activity since 1992. At the international level, in 2004, IOSCO presented the Code of conduct fundamentals for credit rating agencies. The recent crisis revealed the need for comprehensive regulation of the financial industry. Given the severity of the crisis, countries have increased the degree of international cooperation. Many countries have undergone similar problems such as the sudden reversal of capital flows. In this context, securities regulators have reviewed the regulation of credit rating agencies in order to improve it. 5
Credit Rating Agencies 6
The credit rating agencies (CRAs) are partly responsable for the outbreak of the subprime crisis. Currently, in the context of the economic crisis in Europe, agencies are back in the center of the global financial scene for their lack of timming and disparate criteria in evaluating sovereign risk. Uneven criteria Business model Conflicts of interest Market structure Bad timing Prociclical effects 7
Migration of MBS AAA originally rated (S&P 2005-2007) as of July 2010. 8 Source:Financial Stability Report, IMF 2010
CRA present a dependency issue Downgrades from the investment grade can trigger massive sells from institutional investors. There s a cliff effect in the sense a downgrade can become self fullfilling since the rising funding costs. Banks, according to Basel rules, are referenced to CRA ratings to set their capital requirements. Central Banks can experience problems when implementing their monetary policy. 9
Policy responses 10
Policy responses to the crisis In the European context, in 2009 the European Commission made amendments to the Credit Rating Agencies (CRAs) Regulation, in order to improve it. In the U.S. the Dodd-Frank Wall Street Reform and Consumer Protection Act increased internal controls for CRAs. In Japan, the Financial Instruments and Exchange Act was amended in 2009 and introduced a set of regulations on CRAs. Actually, and in response to the last financial crisis, the FSB has promoted the implementation of Principles for Reducing Reliance on CRA Ratings. 11
Reducing reliance on CRA ratings in standards, laws and regulations Argentina s CNV removed the regulatory requirement of securities being rated by at least two different credit rating agencies prior to being sold to market participants. Therefore it is no longer mandatory to have securities rated in order to offer them to the public. Exception applies to equity securities issued under securitization schemes. In order to increase transparency, CNV s Board issued a new resolution that provides that from September 2011 onwards, all CRA are required to make public an updated full text of all procedures manuals, as well as the methodologies used in their rating process. Actually, there is a project of a new Securities Regulation Law (reform act 17.811) which establishes that National State Entities (such as universities, state organizations, etc.) can be authorized by the CNV to act as a CRA, in addition to the private corporations, introducing other alternatives to credit risk assessment. 12
Argentina s experience 13
The case of Argentina is paradigmatic, not only the current macroeconomic variables show the solvency of its economy, but also the path of growth that started several years ago occurred together with a systematic debt reduction, fiscal and current account surpluses and massive reserve accumulation. However, ratings have remained consistently below investment grade. 14
%GDP growth 2003-11 and risk assessment by S&P 130% 120% 110% 100% 90% Argentina India 80% 70% 60% 50% 40% Indonesia Turkey Russia Brazil Korea Saudi Arabia 30% 20% 10% 0% Greece Portugal South Africa Mexico Spain Italy Australia France United States Canada United Kingdom Germany -10% BB- BBB- A- D 1 CCC- 4 B-7 10 13 16 AA- AAA 19 22 15 Source: IMF, Eurostat, S&P
Current Account/GDP 2003-11 and risk assessment by S&P 190% 180% 170% 160% 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% D 1 CCC- 4 B-7 10 13 16 19 22 Saudi Arabia Russia China Germany Korea Argentina Indonesia Brazil IndiaMexico Canada Italy United Kingdom France United States Turkey South Africa Australia BB- BBB- A- AA- AAA 16 Source: IMF, Eurostat, S&P
Debt/GDP and risk assessment by S&P 160% 150% 140% 130% 120% Italy 110% 100% Portugal France United States 90% 80% 70% 60% IndiaBrazil Spain Germany United Kingdom Canada 50% 40% 30% 20% 10% Argentina Turkey Indonesia Mexico Russia Korea South Africa China Saudi Arabia 0% BB- BBB- A- D 1 CCC- 4 B-7 10 13 16 AA- AAA 19 22 Australia 17 Source: IMF, Eurostat, S&P
Accumulated Fiscal Balance 03-11/GDP and risk assessment by S&P 120% 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% -70% -80% -90% Greece Argentina Turkey Portugal Indonesia India Russia Korea Mexico Brazil South Africa Italy Spain China -100% BB- BBB- A- D 1 CCC- 4 B- AA- AAA 7 10 13 16 19 22 Australia Canada Germany France United States United Kingdom 18 Source: IMF, Eurostat, S&P
Final Remarks 19
Final Remarks The liberalization and privatization processes of regulation which have been underway in recent decades have demonstrated serious shortcomings. The responsibility of national regulators is to design schemes that overcome the mentioned issues. In 2009, during the Toronto meeting, the G-20 stressed the need to work on the design of objective, fair, uniform and reasonable methods for sovereign credit risk assessment, trying to reflect, as far accurately as possible, the economic situation of a country. So far, there hasn t been substantial progress in the field. We are witnessing a strong process of globalization without a worldwide government to oversee it. In this sense, we need to rethink the role CRA s should play in the international financial system from a broad perspective. If decisions are not taken to break this regulatory dependance, authorities will be jointly liable for any error of judgement in ratings that the CRA s may make. 20
MUCHAS GRACIAS. THANK YOU. Buenos Aires - March 2011