Competition for lucrative business puts pressure on agency staff to downplay risk and to collude with issuers, particularly when rating elaborate packages of structured debt. Evidence from within agencies bears this out. A 2008 survey of finance professionals by the CFA Institute found that 11pc of respondents had witnessed agencies altering ratings under pressure or influence from outside parties.
Furthermore, in internal correspondence published by US Congressional investigations, agency staff joked that "[a deal] could be structured by cows and we would rate it" and discussed "adjusting", "spinning" and "massaging" ratings methodologies in order to preserve market share.
The fact that around 95pc of the ratings market is controlled by just three agencies (Moody's, S&P and Fitch) does little to promote alternative business models. Indeed, the FCIC report explicitly cites "a lack of market competition due to [agencies'] government-induced oligopoly" in connection with inaccurate risk analyses.
New regulations, in the form of the 2009-10 European reforms and the 2010 Dodd-Frank Act in the US, go some way to improving accountability and transparency. But what is clear from the investigations conducted into the ratings business is that more drastic change is needed.
Without reform of agencies' incentives, greater competition will simply fuel what the US Senate report calls a "race to the bottom" in standards. In November, the European Commission floated a number of options for change, including the creation of a European agency, support for investor-owned agencies, an independent clearing board to allocate ratings business, a network of small and medium-sized agencies and an obligation on institutional investors to obtain their own ratings before purchasing a product. These ideas deserve serious consideration.
As others have said, a publicly funded agency could go some way to mitigate the risks of the issuer-pays system, while in the US the case for a clearing board has already been approved by Senate amendment. Yet the response paper issued in January by the Treasury, the Bank of England and the Financial Services Authority largely rejects these proposals, placing great confidence in the modest, pre-existing EU reforms and calling for a "more narrowly focused" approach to further reform. It asserts that there is "no hard evidence that conflicts of interest in the 'issuer-pays' model lead to ratings inflation", a position inconsistent with the de Larosi�re, US Senate and FCIC reports and above all the massive collapse of AAA-rated securities during the financial crisis.
It is also inconsistent with a recent Bank of England paper that not only argues that "apparent conflicts of interest" need to be addressed, but goes further; exploring options to eliminate them through structural reform of agencies. The paper says the challenges of moving towards an "investor-pays" model "may not be insurmountable", adding the small number of agencies that currently operate this model "seem to have been able to both attract a subscriber base, and to keep ratings information 'private' to subscribers".
In protest at the moves by the Commission, in particular the proposal to make them legally liable for flawed downgrades, the agencies have reportedly threatened a "ratings blackout" of certain countries' sovereign debt. Nonetheless, policymakers must hold firm in their determination to push through reform. The 1997 Asian crash and the 2001 Enron collapse both exposed flaws in the way the agencies operate, yet their power remained unchecked and their failings went unaddressed then. We are well aware what followed in 2008 ? we cannot afford a repeat of that mistake in 2011 and beyond.
? Chuka Umunna is the Member of Parliament for Streatham. He is a member of the House of Commons Treasury Select Committee
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