The global credit rating industry has witnessed a shift in fortunes. From being the revered gatekeeper of capital markets, the industry has over the past two years become an institutional villain for its role in the subprime crises. However, in most emerging markets such as Malaysia, credit rating agencies are valued and considered an integral part of capital markets. Asymmetric information and lack of independent opinion in emerging markets have necessitated and often enlarged the role of credit rating agencies in comparison to the developed markets.

Independent risk assessments and credit opinions provided by rating agencies have not only helped to link debt issuers with investors, but have also enabled easy comparison of credit risk among various instruments and issuers. However, the independence of credit rating agencies has often been questioned as credit ratings are paid for by the debt issuers and not the investors who are the eventual users of the rating.

Due to the lack of a workable alternative solution, the issuer-pays model is still globally prevalent, but continues to attract controversy. With the very foundation of the credit rating industry premised on its analytical independence and objectivity in its rating activities, most credit rating agencies have managed to fight off the pressure from issuers and debt arrangers who seek “inflated ratings”.

In Malaysia, which has one of the largest private debt securities markets in the region, the focus is unfortunately centred on getting the highest possible rating, thus resulting in the practice of “rating shopping”. To an extent, everyone — issuers, arrangers, investors, rating agencies and the regulator — has to share the blame for this practice.

Inevitably, over-rating or under-rating of risk does happen at times as a result of differing analytical interpretations and methodological errors. However, to persistently over-rate or under-rate a risk would invariably raise serious questions on the rating agency’s motives and analytical objectivity. When such practices are widespread, it will eventually diminish stakeholder confidence in the credit rating industry and threaten its very existence!

What makes credit ratings, which are a mere assortment of letters and suffixes, valued and trusted? Undoubtedly it is the confidence that investors, issuers, arrangers, regulators and other stakeholders place on the credit rating industry for its analytical independence and objectivity. Thus, it is of utmost importance that credit rating agencies adhere to the highest standards of professional conduct. Unlike in other businesses, commercial considerations should never dictate the priorities of a credit rating agency.

The credit rating actions taken by rating agencies are based on their rating methodologies, which are expected to be realistic and robust.  Although some guidance is obtained by way of comparison with major global rating agencies, in the Malaysian context, the two domestic rating agencies are mostly free to determine their own methodologies. While methodological changes are essential for enhancing the relevance and applicability of ratings, industry best practices warrant any such changes to be well researched and backed by justifiable facts and interpretations.

When methodological changes are driven by commercial motives or rating actions are not backed by transparent methodologies open to public scrutiny, it would undermine a rating agency’s analytical independence and objectivity — the very foundations of the credit rating industry.

This would not only be a worrying development for the regulator, which may eventually witness credit ratings evolve into a meaningless alpha-numeric soup, but also for issuers whose credit ratings may not contain the informational value it would otherwise be expected to contain.

If everything can be rated at AAA by changing assumptions at the push of a button, why do we need credit rating analysts?

Anandakumar Jegarasasingam s vice-president of ratings at Malaysian Rating Corp Bhd (MARC). The views expressed are the writer’s personal opinion.

This article appeared in Forum page, The Edge Malaysia, Issue 796, Mar 8-14, 2010