John works for his local municipality as a senior administration clerk. His wife is a teacher at the local school, they have two kids aged 7 and 11. John and his wife jointly own a home that was financed through a bank, they are still paying the mortgage. But with kids of school going age to look after and living costs increasing exponentially, John has found the going a bit tough of late. Monthly bills are piling up and salaries are not increasing at a rate that can keep up with rising food, electricity, and other costs.
It gets worse. John has been experiencing problems with the once reliable family vehicle that he bought seven years ago. After spending a fortune trying to fix it, he has decided to finally part with the jalopy and acquire a new car. One Thursday morning, John and his wife walk into a car dealership and their attention is immediately fixated on one particular family sedan. An eager salesman shows them all its new features and even takes them on a test drive. This is the car they want.
The excited salesman, sensing a quickfire sale, hands John and his wife forms to fill out. Because they are not buying the car cash, it has to be financed by a financial institution. This is where the tricky bit comes in. For this couple to qualify for the vehicle of their dreams they need to show that they are creditworthy. What this means is they have proof that they will be able to repay with interest and in the agreed period, the loan that the bank will advance them to purchase the vehicle.
Banks prove creditworthiness by using external credit bureaus which record the entire credit history of a consumer and their repayment patterns. If they are found to have defaulted on certain credit obligations or have court judgements against their names, they will be deemed not creditworthy enough to purchase the vehicle. An affordability test will also be done. This process examines their joint monthly income and compares it to expenses. If after expenses have been taken into account, the remaining balance is deemed insufficient for the couple to take on another major debt obligation, the bank will decline their request for finance.
John and his wife could find themselves back at the local mechanic trying to revive the old jalopy.
This is the nature of the financial services industry and almost the same formula is applied to countries when they need to borrow money to plug national expenditure shortfalls or finance infrastructure projects. Unlike individuals, countries can issue fixed income security certificates in the form of a Bond to institutional and private investors in return for a financial injection. This is basically an IOU certificate which guarantees that no matter what happens, the investor will get their entire money back within a specified period, with the pre-agreed interest added.
Countries can also borrow directly from global development finance institutions such as the International Monetary Fund or the World Bank at more favourable terms. But such assistance normally comes with stringent conditions in terms of expenditure.
But before investors can part with their cash, they have to be certain that country A has the ability to repay the loan being advanced, and that is where global credit rating agencies come in. But how did these agencies become so powerful that they can rate an entire country’s credit worthiness just like that?
To arrive at an informed response to this question, let us examine the history of the three top rating agencies – Fitch, Moody’s and Standard & Poor’s. According to Investopedia.com, John Knowels Fitch founded the Fitch publishing company in 1913 with the aim of publishing statistics for the investment industry. Fitch is credited with introducing the AAA to D ratings system that has become the accepted global model of credit rating.
Moody’s story is also traced back to the turn of the 20th century when John Moody and company published statistics and information about stocks and bonds of various industries. In 1914, the agency created the Moody’s Investors Service which would in just ten years provide a service to nearly all government bond markets. It became a fully-fledged rating agency in the 70s.
But the one that traces its history further back is Standard & Poor’s. Back in 1860 Henry Poor published the History of Railroads and Canals in the United States. In 1906, Standard Statistics was formed, publishing corporate bond, sovereign and municipal debt ratings. Standard Statistics merged with Poor’s publishing in 1941 to form Standard & Poor’s Publishing.
With a rich history spanning over 150 years, the three credit rating agencies control 90% of the market. Issuers of debt obligations, or bonds, rely on the assessments made by these agencies to determine the credit risk of that issuer – governments, municipalities, state owned and private companies. A weak credit rating means potential investors will be wary to invest in that entity, or if they do, will provide less than the requested amount of debt funding at much higher interest rates.
Is a BRICS ratings agency the answer?
Developing nations have long complained that the credit rating system is unfair on them. Writing in Business Day in February, Misheck Muitze and Sean Gossel – lecturers specialising in Finance at UCT and its Graduate School of Business – sought to trace the unhappiness of developing nations with these ratings agencies and numerous efforts to form alternative credit rating agencies as answers to the big three.
Critics of the big three, the academics wrote, have specifically attacked the “issuer-pay model” which dictates that credit rating agencies are paid by those seeking money (governments etc.) rather than the investors who use their information to make investment decisions. The criticism here is that such a model entrenches geopolitical biases that result in more established economies potentially buying their way to good ratings to the detriment of the developing and third world.
In a bid to level the playing fields, the developing world has over the past 20 years attempted to form its own credit rating agencies. These include:
- MARC of Malaysia, which has been operational since 1996, but still only covers corporate ratings
- The Hong Kong-based Universal Credit Rating Group, which was launched in 2014
- Russia’s Analytical Credit Rating Agency, which was established in 2015
- The Beijing-based China Chengxin Credit Rating Group, established in 1992
- Dagong Global Credit Rating established in 1994.
Muitze and Gossel point to the failure of the above agencies to take off at a scale similar to that of the big three as the reason why the mooted BRICS rating agency will remain stillborn. Global pension and mutual funds, the biggest lenders to the developing world, would mistrust such an agency especially if it attempted to adopt a different model to the “issuer-pay model”.
“But adopting a new model might not fly given that the main users of the credit rating information are global pension and mutual funds, which currently use at least one of the big three rating agencies. They are, therefore, unlikely to trust any ratings from the new BRICS agency with a yet-to-be-tested rating model. Adopting a new model would also be tricky as the rating agency would need to wield enough influence to attract sufficient subscriptions from international funds,” the duo wrote.
The truth of the matter is that for as long as Africa and the rest of the developing world continue borrowing from western pension and mutual funds, all efforts to dismantle the current global credit access system will yield no results. Institutional investment funds will always use the tried and tested trio of Moody’s, S&P and Fitch because their credit rating system penalises the third world and developing nations for macro and micro economic set ups that would have been overlooked in the first world. That means these funds stand the chance of earning millions of dollars more in interest from outside the first world by setting higher repayment terms for poorer countries, fuelled by weak credit ratings. The question that remains unanswered is whether or not we as a people are ready to move towards supporting the uncertainty that will come with a Rating agency that will directly challenge the monopoly that is almost guaranteed to protect the interest of the existing global elite. The current “issuer- pay model” seems to affirm that age old adage that, “he who pays the piper calls the tune”.
Until such a time that we stand behind the common vision of the unfettered emancipation of our people from the morass of poverty, we will most certainly be stuck with the old jalopy much like John, at that point we shall realise that Africa and the rest of the developing world lose out once more.
Buyile Sangolekhaya Matiwane