Are ratings agencies partly to blame for the financial crisis, or did investors misunderstand what they do? Liz Booth looks at both sides of the argument.

Since the financial crisis erupted back in 2007, many in the financial services, along with politicians and regulators, have been looking for reasons why it was allowed to happen.

And in seeking the answers, many have been looking for someone else to blame. Among those blamed, rating agencies have been accused of conflicts of interests in their close relationship with client firms and of not fully understanding the complexity of some of the financial instruments. The rating agencies have come under close scrutiny and now face formal regulation in place of the voluntary codes under which they have operated for years.

Both the European Commission and the US Securities & Exchange Commission (SEC) have agreed that there have been issues. As the Commission puts it “rating agencies have failed to sufficiently consider the risks inherent in more complicated financial instruments.”

The European Commission is now going through the process of introducing a formal regulation process. The final detailed plans should emerge this spring with implementation likely to follow later in the year.

But Richard Tolliday, chief executive officer of Omega Insurance Holdings Ltd, believes the whole issue needs to be put into context. As a reinsurer, he says, the concerns have been around some of the financial debt products and not around insurance or reinsurance financial strength ratings. He sees further regulation as inevitable, however. “People have been looking at conflicts of interests in relationships so greater transparency has to be a good thing,” he says.

Agencies are asking the right questions, believes Tolliday, and reinsurers and insurers need to be viewed in a slightly different context to organizations dealing with securitised debt. The fact that there appear to be more notices of credit watches or other similar mechanisms, he says, is probably a reflection of “general uncertainty. People are dealing with a very uncertain backdrop.”

Tolliday adds that some of the issues facing agencies are extremely complex and they need to take time to absorb and understand the full nature of the business, while remaining ready to flag up concerns if necessary. “I think they would be subject to equal criticism if they conducted reviews and didn’t react to news as it broke. I am not here as an advocate for agencies but one has to be fair to them.”

He also believes the reinsurers and insurers are generally professional enough not to react to the immediate news of a watching note but to consider the underlying issues. “I don’t think they would stop at the headline but would look further at information about the company. I think if you are a consumer, it is a lot harder to do that and you are reliant on your broker to help you.”

Asked whether agencies are being slightly more cautious in their approach, a spokesman at Moody’s says “As always, our analysts are concerned with providing objective, timely and accurate credit assessments and that won’t change. We review a wide range of analytic areas in our assessments, but right now our primary focus is on asset risk (stress testing etc) and on how companies will fare in the recessionary environment.”

The agency adds: “In the current challenging environment, assessment of credit risk, particularly counterparty reinsurance risk, is especially important.

This has been demonstrated by the fact that our ratings are widely sought by investors, issuers, and other market participants.”

Tolliday continues to see value in ratings. In these uncertain times, he says, “There has not been a flight to quality but a flight to spreading risks.” Rating agencies can help with providing information to help with this but Tolliday warns against anyone who “asks the impossible of the agency”. Having worked on “both sides of the fence”, Simon Martin, international head of the rating agency advisory team at Aon Benfield, also feels that there has been a mismatch between the expectation of what a rating agency does and what is actually delivered.

“There seems to be some misunderstanding as to what the role is,” he says, “an agency does not give investment advice. Their role is to give a rating and these are opinions. On that basis they cannot be condemned. They are not giving a rubber stamp of approval on a company’s ability to meet financial obligations.”

Martin also believes that many people do not appreciate that agencies have been operating under various codes of conduct for years and these cover the very issues under such scrutiny at the moment.

He sees the regulation plans as a tightening up of those codes. Martin acknowledges that perhaps there has been a mismatch between critics understanding of those codes and the agencies education of those critics. “If companies were aware of the voluntary codes and supervision currently, they might not be so quick to condemn the agencies.”


Martin Winn, vice president communications at Standard & Poor’s, agrees there are improvements needed to “help restore confidence in rating agencies and part of that involves regulation and external oversight”.

For the past year, S&P has been implementing a broad set of actions to rebuild confidence in its ratings. These include work on governance issues, including “further strengthening the ratings process, making the effectiveness of our governance even more transparent and educating the market more effectively about the meaning and limitations of ratings”. It is also working on providing more information to investors about ratings of structured finance securities, including assumptions and stress tests used in the ratings analysis.

Winn says: “One of the key lessons of the past 18 months is that the more information we provide and the more transparency we provide about what we do and how we do it, then the better placed investors are to make informed decisions.”

Like the others, he stresses that rating are opinions about creditworthiness over the medium term and should not be driven by short term “noise” and speculation in the market. “Ratings can and do change as our view of creditworthiness evolves, but they should continue to be more stable than market prices.”

Matt Mosher, senior vice president of property casualty at AM Best, finds the whole issue a little frustrating because many of the criticisms have been levelled in very precise directions and are really not concerns for all rating activity. Regulation when it comes will apply across the board and Mosher says the prospect does throw up a few concerns. Expense is one of those along with the prospect of bringing in board members, again because it will add greater costs to the operation.

There is also concern about regulation that makes it harder for rating agencies to continue to provide opinions. Greater supervision is one thing, he says, but regulating opinions is more difficult. “It is something of a frustration,” he says.

Mosher is also aware of issues surrounding flagging up of concerns. He says it is a balance between developing a rating for the longer term and highlighting a bad announcement – something that may or may not affect the longer-term view.

By issuing interim notices, the agency hopes to provide useful information, supported by its longer-term views.

Many of the changes of the past couple of years, he says, have been around increased documentation to ensure the most consistent approach possible.

But the main message, says Mosher, is that “there is no such thing as a black and white position on a rating. There is analytical judgment in a rating. It is all about how you apply the criteria and the key is consistency in applying the criteria.”

Liz Booth is a freelance journalist.