Can Rating Agencies Help Relieve the Pandemic Pressure on African Countries?

Efforts to relieve the financial pressure on the world’s poorest countries since the pandemic started have resulted in very little progress. UN, IMF, and World Bank efforts have led to the establishment of the Debt Service Suspension Initiative (DSSI), that consisted of members of the so-called ‘Paris Club’ and other prominent non-members, like China, suspending the rights to collect payments on their investments into poorer countries. However, there are so many issues with this plan, that not only has it not been entirely successful but it has also led to a lack of inspiration in similar efforts but from the private sector – and the involvement of the private sector is crucial. This has led critics to suggest that credit rating agencies have a role to play and, furthermore, should be more engaged in finding a solution. However, is this really the case, or is it yet another example of onlookers not fully understanding the ‘rating dynamic’ as I like to call it, and calling for action anyway?

 

There is plenty of information on the DSSI, so I will not go into it in any great detail. The World Bank discusses it here, and there has been critique of it here. Essentially, the initiative aims to provide some financial respite for embattled countries facing the COVID-19 pandemic and, in theory, the suspension would allow them to channel the resources that they would have used to service their debts and funnel them into public health initiatives. Sounds good. However, the initiative has only, so far, gained the agreement of countries and their ‘official creditor’ bodies. This does not represent the larger proportion of the total debt held by the 70+ countries in need, with private debt being of massive importance to the system. Although the Institute of International Finance has strongly supported the initiative, its members are cautious and, in light of that, the IIF has declared that any such private involvement should be on a voluntary and case-by-case basis. This makes sense for the concept of private enterprise, as enforcing a jubilee poses a deeper philosophical problem in the long run. However, the reality is that this approach is less than useful – but why? The reality of the rating dynamic is the answer.

 

For those of us concerned with the rating industry, we have heard that their importance has waned since the height of the Financial Crisis and, unless it is in relation to structured finance, there is not actually much to debate on the subject. We know that this is wrong and that credit rating agencies, as a concept, are of vital and central importance to the economy-centred society we live in. This has been demonstrated in real-time recently with the pandemic. Now, rather than numbers on a screen being affected and the connect-the-dots puzzle of financial harm causing human harm being the case, there is now a directly visible human cost to issues within the rating dynamic. The credit rating agencies were quick to declare that the act of engaging with official creditors to restructure or suspend debt repayments would be unlikely to affect that country’s credit rating. However, the same was not said about a country negotiating with a private creditors, and the effect was immediate. Some of the world’s poorest countries made a public point of declaring that they were meeting their debt obligations on time, as usual. Even those countries that had signed up to the DSSI had declared publicly that they had no intention of speaking with private creditors. Nevertheless, a number of African countries have been downgraded for even flirting with the idea, with Cameroon being an example (but by no means a solitary one). The declaration that negotiating with private creditors would likely lead to downgrades has led to a wide range of criticisms. I have been working on this issue for a while now, but a recent article by the Atlantic Council caught my attention. Its authors – Vasuki Shastry and Jeremy Mark – are absolutely right when they say ‘one possible way out is for the three global credit rating agencies to provide the analytical muscle that could help in breaking this impasse’, and I certainly have no issue with their sentiment that something more radical needs to be done. Their approach is based around a couple of proposals that sound simple in their design. One is for a ‘shared public-private understanding for a suspension of payments on African sovereign debt, with a firm commitment by governments to make good on what is owed to the private sector after the IMF raises the green flag that economic conditions have improved’. Another is that rating agencies ‘should crucially suspend rating judgments while the standstill is in progress’. The article ends with the statement that ‘the G20 and global regulators have the power to persuade international investors that a little forbearance could save lives and livelihoods. But that requires more political will than they have demonstrated so far’.

 

There are a number of realities that need to be considered before such proposals are even thought about. One is that a firm commitment by DSSI governments to repay at a later date is simply an extension of their current contract with their creditors. More importantly the issue is with regards to the credit rating agencies. The agencies cannot suspend rating judgments, because they would instantly become liable. Whilst it is admittedly difficult at the best of times to attach liability to the credit rating agencies (note the lengths that CalPERS had to go to in order to reach even the record yet limited financial settlement in 2015/18 with S&P and Moody’s), there is no way that rating agencies would forego their role without legal protection. It is worth pointing out that onlookers, critics, scholars, regulators, and legislators have all called for the rating agencies to do their jobs better, to provide more timely and ultimately more informative ratings for investors, and now people are telling them not to do that. Granted it is within specific circumstances, but the message is the same. Also, what happens if the pandemic is more impactful than analysts hope? What if the said DSSI countries do default? Will the rating agencies then be blamed? Will private creditors be able to sue credit rating agencies for not sounding the alarm as they should do? The one thing we know about the credit rating agencies for certain is that they detest liability for their actions and, historically speaking, will do whatever it takes in order to reduce the liability they are exposed to. If one removes themselves from the situation, the credit rating agencies are actually doing their job well – they are theoretically supposed to provide information for the investor regarding their chances of receiving their investments back, in full and on time. If a debtor is seeking to renegotiate because they are under stress, then surely they are less likely to meet their obligations – if so, then a rating downgrade must occur.

 

Therefore, one proposal that I have been working on is a model whereby private investors agree to act as one, at least on a majority basis, to re-write the rules. Just like administration-like procedures in many jurisdictions around the world, the creditors here face the prospect of not receiving the returns they should. There is therefore an argument that collective action could result in a larger amount of returns for the collective, rather than individual action may garner. So, rather than place the emphasis on rating agencies to make the change in this environment, it is the investor who holds the key. This collective action would allow, potentially, the credit rating agencies to change their role within a certain specified framework that was only applicable to this pandemic situation (the authors do hint at something potentially similar but written into bonds issued by low-income countries, which brings forth more permanency than is probably palatable). A situation could therefore occur where rating agencies could develop pandemic-specific methodology and rating scale that could be applied to members of this imagined ‘programme’. This would allow DSSI countries to renegotiate with private creditors, without the fear of an instant downgrade. The new programme would essentially be layered over the normal rating mechanisms, so that if a DSSI country fell through the investment grade within the new programme, their normal rating would be effected. Aspects such as poor disclosure of financial information within the programme could lead to a new-programme credit reduction, or perhaps seeking to further negotiate once a new arrangement has been put in place.

 

There are other elements to this ‘new programme’ idea that I am currently working, but it could work. However, just like the authors said, there needs to be a widely-held appetite for such change, and there is far too much divergence at the moment. One fantastic example of this (although it is rather depressing in reality) is that the World Bank is pushing for private engagement, and is laying the responsibility to take the lead at China’s door – lest we forget that the World Bank is headed by a President Trump nominee and supporter – all whilst the World Bank is refusing to sign up itself. The remarkable situation simply confirms the lack of trust that is currently enveloping global relations. Why would private creditors forego their returns when DSSI countries have to keep giving the World Bank theirs?

 

Nevertheless, the point still stands that credit rating agencies do indeed need to do more, but that the system within which they operate needs to allow them to do so. Regular readers of the blog and of my work in general will know that I am very critical of the agencies, but in this instance it is difficult to jump on that bandwagon. Criticising them for not doing their job, and then criticising them for doing their job, equates to just criticising. We must seek to promote developed and considered critique, with the aim of promoting movement in the right direction. In this regard, the credit rating agencies need help to provide help, and investors need to step up. Providing models and frameworks for that to occur is one positive step, but there must be more unity when seeking to promote change like the DSSI initiative is doing.

 

Keywords – credit rating agencies, Africa, DSSI, World Bank, @finregmatters