Morningstar Seeks to Affect the Ratings Oligopoly, or Does It?

With the Credit Rating Agencies being the exclusive research concern of this author, it is unsurprising that they, as an industry, have featured heavily here in Financial Regulation Matters. As such, we tend to keep abreast of developments within this industry as well as other key financial areas, and in this post we will continue this approach by examining the latest ‘move’ in this particular marketplace. We recently looked at developments within Scope Ratings, the European entity seeking to provide a pan-European alternative, whilst we also looked at recent mergers that potentially concern the so-called ‘Big Three’ (in relation to sale of Acuris). To complement these analyses we looked closer at the concept of an ‘oligopoly’ and its application onto the credit rating industry, which allows us to understand the dynamics between the Big Three and their relationship with the rest of the marketplace. We will soon be analysing a new entrant into the marketplace in the coming weeks, but in this blog we will look at a major move in the lower end of the credit rating marketplace.

The so-called ‘Big Three’ – Standard & Poor’s, Moody’s, and Fitch – account for a combined 96% of the credit rating marketplace. As such, there is very little space at the lower end of the market. In terms of outstanding ratings within the marketplace as of December 2017, the Financial Times (via the Securities and Exchange Commission) confirm that no rating agency even came close to breaching the 100,000 mark – S&P stands way out in front with more than a million ratings outstanding. Of those remaining agencies, only DBRS and Egan-Jones Ratings stand out, with A.M. Best standing out because of their expertise within the insurance marketplace. Towards the very bottom of that list is Morningstar, that has traditionally only been a very small player within the market. However, on the back of recent news, this picture has changed.

Known originally as Dominion Bond Rating Services, DBRS has come a long way since its creation in 1976. The Toronto-based company was acquired by the influential Carlyle Group in 2014 and, in Stephen Joynt, have a former Fitch Ratings CEO as their own CEO. Yet, in keeping with the recent phase of movement within the CRA industry, Morningstar has essentially ‘traded-up’ to acquire DBRS in a deal worth $669 million. Morningstar, founded in 1984 by Joe Mansueto and made public in 2005, has been developing gradually and as of 2018 reported revenue totalling just over $1 billion. Specifically, over the last two years, Morningstar has seen double-digit increases in its revenue for the first time since 2011. It is for this reason that it is interesting to hear Morningstar’s CEO Kunal Kapoor proclaim that the aim is to build a ‘fintech’ rating agency to counter the hegemony of the Big Three – it is clear the aim is to distinguish in order to compete, which in theory is a wise move. However, the marketplace is well versed in this approach and, regrettably, its outcome.

The reality is that a number of agencies offer something specialised. Egan-Jones Ratings offer an investor-pays model that is championed as restricting key dynamics that affect the position of the investor within the credit rating market. A.M. Best is renowned for its services within the insurance sector. Scope Ratings is currently offering a pan-European model that has intense knowledge of the European Sector. Yet, all of this is to no avail. Not one entity has even come close to challenging the Big Three and regular readers will know that the Big Three are getting stronger and stronger – on account of movements into the ESG sphere and now China. It is therefore probably best to change the conversation. Is it the case that there is an unnecessary pressure placed upon these smaller agencies to ‘challenge the Big Three’ when, in reality, that is not their fight? Morningstar and DBRS will be much better off consolidated, and have likely secured their futures in the face of what may be a new wave of M&A activity by the Big Three now the fines have been paid and the new markets are opening up to them. Perhaps, it is only regulators that can challenge the hegemony of the Big Three and the smaller agencies are there to feed on what is left for them. Morningstar’s move is a positive one for them and for the marketplace, because moves like this allow for the existence of some sort of alternative, whereas ‘challenging’ alone will likely reduce the field operating below the Big Three.

Keywords – Credit Rating Agencies, Morningstar, DBRS, Oligopoly, @finregmatters