Who Are the Rating Agencies and What Do they Do ?

By FX Empire Analyst - Barry Norman
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Who are the ratings agencies? ‎

The big three agencies are Fitch, Moody's and Standard & Poor’s. 

What they do is assess how likely a borrower is to be able to repay its debts and help those trading ‎debt contracts in the secondary market.‎

That means for those trading debt contracts such as Treasury gilts after they have been issued, ratings ‎agencies help assess a fair price to charge. Ratings agencies have been criticized for having too much ‎clout in jittery markets during the financial crisis. They were widely attacked for failing to warn of the ‎risks posed by certain securities, in particular mortgage-backed securities.‎

Losing your rating or being downgraded can have a fatal effect on your country's ability to borrow ‎money on the markets.‎

Thanks to the three big agencies, we can bring you the ratings of countries around the world as of ‎today. Because each agency's approach is slightly different, we have color-coded them in three broad ‎categories too. ‎

In layman's terms, the 2008 crisis started when thousands of US homeowners stopped paying interest ‎on their mortgage. The crisis spread because thousands of bankers and fund-managers had foolishly ‎backed those mortgages, and so lost a lot of money themselves. They did this partly through their own ‎lack of foresight, but also because of the ratings agencies' failure to warn them of the risks involved. In ‎the run-up to 2008, a staggering proportion of mortgage-based debts were rated AAA, when in fact ‎they were junk. The same goes for groups such as Enron, Lehman Brothers and AIG. Days before they ‎went bust, Moody's, S&P, and Fitch all still rated these failing companies as safe investments. ‎Shockingly, more than half of all corporate debt ever rated AAA by S&P has been downgraded within ‎seven years.‎

Part of the problem is that ratings agencies are funded by the very companies they rate. If you want to ‎be rated, you must pay an agency between $1,500 and $2,500,000 for the privilege, depending on the ‎size of your company. In theory, this creates a conflict of interest, because it gives the agency an ‎incentive to give the companies the rating they want. It could explain why, for much of the past ‎decade, agencies seemed happy not to question either the risks banks were taking, or the accuracy of ‎their accounts. ‎

There are more than 150 ratings agencies worldwide, but in order to have any credibility, companies ‎really need at least one of Moody's, S&P and Fitch on their side, and preferably all three. The first two ‎firms each control around 40% of the market. Fitch has about 15%, and is usually engaged when S&P ‎and Moody's disagree significantly about the creditworthiness of a debt. This generally happens ‎because S&P measures how likely a debtor is to default, whereas Moody's rates how long the default ‎is likely to last.‎

At the beginning of the 20th century, there were no ratings agencies, and very few ways of telling ‎which of the many emerging securities were worth investing in. There was a gap in the market, and ‎the first person to fill it was a Wall St errand boy called John Moody. In 1900, aged 32, he published ‎Moody's Manual of Industrial and Miscellaneous Securities, a compendium of information on ‎thousands of financial institutions. The book sold out in months, and an industry was born. Poor's ‎Publishing Company emerged in 1916, Fitch in 1924.‎

For countries such as Britain, the USA and France, the threat of a downgrade is not as serious as it has ‎been for other European countries. Moody's negative outlook did not hit the pound or government ‎bond prices hard, and the FTSE 100 was affected only slightly. Even if Britain's rating fell to AA1, the ‎state is unlikely to be seriously affected because most other countries are in the same situation.‎

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