News broke late yesterday that the US Securities and Exchange Commission was suing Morningstar for its ratings of commercial mortgage-backed securities that were issued from 2015 to 2016.   Reuters reports that ‘ Morningstar’s credit ratings business allegedly violated disclosure and internal controls requirements in 30 commercial mortgage-backed securities transactions from 2015 to 2016 when the agency allowed analysts to make undisclosed adjustments to key stresses in its modelling, the SEC said ’. Morningstar, who now issue ratings via their subsidiary DBRS Morningstar after their acquisition of DBRS in 2019, responded that they had complied with all regulatory requirements. However, the SEC alleges that Morningstar allowed its analysts to ‘frequently’ alter their ratings, with those changes being undisclosed and out of alignment with their published methodologies. The result of this was that issuers were subsequently able to lower their interest payments to investors withou...

The Board of the International Organisation of Securities Commissions (IOSCO) recently published a report regarding the effect on the credit ratings of the Big Three credit rating agencies (S&P, Moody’s, and Fitch) of the use of ‘Government Support Measures’ (GSM) relating to the Covid-19 pandemic. Interestingly, IOSCO combed public information and also liaised with the credit rating agencies themselves to study the methodological changes, and also the real effect changes to the ratings produced since the onset of the pandemic. The result is not really surprising, but there is a clear warning from the credit rating agencies, via IOSCO and this report, that the withdrawal of GSM across the board needs to be very gradual indeed.   The report, available here , contains the review of ratings from the Big Three in a variety of categories, ranging from structured finance ratings to sovereign ratings. IOSCO start by stating that ‘the analysis includes a review of any changes made ...

In today’s very brief post, information on Moody’s’ latest acquisition is introduced although, at the time of writing, not much information is available regarding the specifics of the deal – it is unlikely to be a costly acquisition, but it further boosts the agency’s offerings on small business-related information.   Moody’s, via its Moody’s Analytics arm, partnered with Cortera in 2018. Cortera, a company which analyses small business mainly (under 500 employees), has built one the world’s largest databases on such entities . In 2018, Moody’s Analytics partnered with the firm to accentuate their ‘small business lending solution ’. At the time, the founder of Cortera – Jim Swift – noted that a ‘ lender’s ability to assess the credit risk of small private companies can be challenging with traditional sources… incorporating our trade credit data will enhance the Moody’s Analytics solution by offering its clients a wealth of insight into these businesses ’. The service, which rem...

As we discussed in a previous post , the calls for the regulation of the ESG ratings sector, particularly in the EU, are growing louder by the day. ESMA have recently responded to the European Commission regarding this point – see here – via its response to public consultation regarding the Renewed Sustainable Finance Strategy, but it has now attempted to provide further detail. In a letter addressed to the EC at the end of January, ESMA provide more detail on its regulatory vision for the sector, and the obstacles that exist.   ESMA starts by noting that there will be difficulties in moving towards a more formal regulatory framework surrounding the ESG Rating Agencies. That the ratings and the ‘agencies’ themselves are complex in nature does not help. Also, as the industry attempts to innovate to meet the ever-growing need for its services, this has also been identified by ESMA as being problematic. They even note that ‘estimating the number of firms in the market for ESG rat...

Earlier this month, research was published which spectacularly suggests that some analysts of the Big Three rating agencies are guilty of ‘informed trading’, which in this context means leaking information to institutional investors ahead of the publication of rating actions by their respective credit rating agencies. In this post, we will look at this researched claims and assess the potential impact such findings may have upon the industry, if any.   Dr Omri Even-Tov of Berkeley Haas Business School and Dr Naim Bugra Ozel , Visiting Associate Professor at Wharton Business School have co-authored an article that can be read here . The article, entitled What moves stock prices around credit rating changes? seeks to extend the studies that have found that credit rating changes lead to significant stock price reactions by examining whether informed trading may affect the stock price before the rating announcement. One of the key elements that the researchers look for is wheth...

In March 2020, when discussing concerns that had been raised regarding the ESG Ratings arena , we saw how an article developed by Professor Roberto Rigobon, Dr Florian Berg, and Dr Julian Kölbel argued that there are inherent divergences witnessed between the ratings within the ESG rating arena, and provided for a number of reasons as to why. Recently, via MIT and the MIT Sloan Sustainability Initiative, the team are launching the Aggregate Confusion Project to tackle those issues.   The paper, published in August 2019, is entitled ‘ Aggregate Confusion: The Divergence of ESG Ratings ’ and is certainly worth reading. Its findings are particularly important, particularly in relation to the effects of measurement divergence in a range of contexts. Without spoiling the paper for those that have not read it yet, the key to the paper is understanding and demonstrating the ‘rater effect’ and how that is currently impacting upon the stunted development of the industry. More worryingly, ...

The European Joint Board of Appeal (BoA) of the European Supervisory Authorities – the European Banking Authority, European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority – were recently asked to decide on an appeal from Scope Ratings regarding their recent penalty from ESMA – see here for the blog post on the penalty.   Yesterday, the decision was made and publicised . Scope had appealed upon the belief that the decision by ESMA to penalise them was not ‘well founded in law’. ESMA had contested that Scope had negligently applied its methodologies to a number of rating actions, whilst also failing to revise and update their methodologies accordingly, and summarily fined the agency €640,000. Specifically, Scope argued that Article 8(3) of the ‘CRA Regulation’ (EU/462/2013) had not been breached as ESMA had contested because the section of the regulation only concerns the design of the methodology, not the application. Furthermor...

The ESG Rating Agencies, or Corporate Sustainability Systems as they have also been labelled as to convey the differing elements of the industry, are becoming ever more important in theory. This is because, as Refinitiv found recently, 98% of global institutional investors are now actively considering ESG in their investment decisions. However, there are massive issues within the industry and its multitude of models, which has now led the Autoriteit Financiële Markten (AFM) and Autorité des marchés financiers (AMF) to issue a joint paper calling for regulation at the European Level. However, what would a new regulatory framework look like, what could it achieve, and what effect would it have on the development of this relatively nascent industry?   Whilst the EU have started a study on the ESG rating marketplace and its intricacies, as of yet the market is essentially unregulated. The market they exist to serve is exploding and growing at an incredible rate but, ju...

We have reviewed the credit rating situation in China extensively here in Financial Regulation Matters (see here ) and it is well known that the Chinese rating agencies are under massive pressure, both from the Chinese State and also the opening up of the domestic marketplace to the international credit rating agencies for the first time. However, the underlying political dynamics within the Chinese marketplace means that the credit rating agencies within the country are between a rock and a hard place and, yesterday, one of the Chinese credit rating agencies found themselves being thrown between the two.   The Chinese domestic marketplace is in a precarious position at the moment, as a number of defaults rock the confidence in domestic corporate debt market. Whilst this is a trend across the world of course, there have been a number of high profile defaults recently within a relatively short space of time. What increases the pressure is that a number of ‘State-Owned Enterpr...

Today’s post reacts to comments recently from Christine Lagarde, relating specifically to the role and neutrality of the European Central Bank and its position with regards to advancing European policies. We have discussed, on a number of occasions recently, the perilous position of the sustainable rating environment and, as I suggest, the potential importance of European sustainable-related developments to the health of that particular industry. In that regard, the recent comments on the role of the ECB in potentially enforcing the EU’s climate-related policies not only marks a controversial turn in sentiment, but potentially impacts the development of the sustainable rating marketplace.   Lagarde spoke recently and in emphasising her unhappiness with the development of sustainability in the marketplace, declared that ‘ climate risks are not adequately priced ’. The article in Bloomberg’s Quint offering suggests that she may lead the ECB in a new direction, with the decisions...

Here in Financial Regulation Matters , we are more than aware of the pressure that credit rating agencies have been piling on the African continent on account of the pandemic. We looked recently at the dynamic here , and have also reviewed the views of many current and former rating analysts – a representative example of the argument is here – that consists of the understanding that investors in African debt knew the risks, and should subsequently suffer the consequences. However, there is more to the story than that and, even more importantly, that view maintains the status quo and does not seek to advance the position of the countries in question. In that light, the question needs to be ‘what can be done?’, but also ‘should it be done?’   The African Union, via its African Peer Review Mechanism (APRM), has developed a report entitled the ‘ African Sovereign Credit Rating Review ’, which was published recently and is available here . The report, which the APRM’s CEO is the f...

Today’s post reacts to an article in the Financial Times from Monday, entitled ‘ Oil and Gas Lobby moves to embrace green investors ’. There are some really concerning elements to the article (what it reports, not how it reports them) and the thought occurred that ESG rating agencies (aka Sustainability Rating Agencies, like Sustainalytics or MSCI) will have a massive role to play in guarding against so-called ‘ greenwashing ’ – where an entity would dress up their operations solely to look good to ESG investors, rather than actually committing to the principles – and, more importantly, whether they have the fortitude, capability, and authority to take on that vital role.   The article focuses on the development of a ‘ ESG Centre ’, a new initiative put together by the Independent Petroleum Association of America . The IPAA has enlisted the help of FTI Consulting, who as a business advisory and public relations firm, are now advising the trade body and its members of how to be...

The connection between the concept of ESG (Environmental, Social, and Governance) principles and the process of providing ‘ratings’ has been a common theme recently, for a number of reasons. On a number of occasions over the past few months, we looked at issues ranging from disclosure standards to sustainability rating agencies’ methodologies . This week, interestingly, the rating universe – that consisting of the credit rating and sustainability rating organisations – have been targeted, but for different reasons. However, both issues are concerned with the concept of ESG, which itself has been the centre of debate for a number of years. As the geopolitical landscape moves in different directions regarding the concept of sustainable finance , the rating universe is seeking to carve out its own place in the arena. However, there are a number of issues being revealed.   The first is one that was advanced by the head of Polymetal, the biggest London-listed producer of Gold. Vit...

In May of this year, Morningstar settled with the SEC for $3.5 million for violating regulations designed to protect against internal conflicts of interest . On Tuesday, the SEC announced that Kroll Bond Rating Agency (KBRA) had agreed to pay more than $2 million to settle charges relating to the ratings of commercial mortgage-backed securities (CMBS) and collateralised loan obligation combination notes (CLO Combo Notes) . In this short post, we will discuss the reality that transgressive behaviour is being witnessed across the industry, not just in the Big Three, and why that may be.   The settlement has been reported widely in the business press ( here and here for good examples). In relation to the actual charges that were put forward by the SEC, it argued that Kroll had permitted its analysts to make adjustments which went on to have material effects to the final rating, although those adjustments were not made on any analytical basis. Furthermore, it was alleged that the...

Since January 2019, the European Securities and Markets Authority (ESMA) has been conducting a public consultation on the issue of internal controls within credit rating agencies operating within the jurisdiction. Based on observations between 2017 and 2018 that identified a number of shortcomings in this area of the CRAs practices, ESMA has been working at providing clear guidelines to help the industry move forward. Today, that report was released.   Based on the CRA Regulation (CRAR) , ESMA are required to ensure that regulations are developed and implemented relating to the internal control systems of the CRAs, which they must have in place ‘ in order to prevent or mitigate any possible conflicts of interest and ensure the integrity of its credit rating activities ’. As we know, this is a common, but no less important objective of rating agency regulators, and it is interesting to note that, more than a decade after the Financial Crisis, regulators are still attempting to ...