7 Va. L. & Bus. Rev. 1, Spring 2012
Authors: Nan S. Ellis, Lisa M. Fairchild and Frank D'Souza
SINCE their inception, credit rating agencies (CRAs)
have been important to the efficient functioning of debt markets. Their
assessments of the creditworthiness of issuers are captured by the ratings
assigned and act as certification of an issuer's capacity and willingness to
repay its debt obligations. Hence, investors with different risk preferences
use ratings to determine the appropriateness of debt instruments for their
portfolios. For institutional investors, such as commercial banks, there are
regulatory requirements stipulating that only debt with "investment
grade" ratings can be purchased for the banks' investment portfolios.
It is, therefore, crucial that the ratings assigned are accurate and are
provided by impartial third parties.
CRAs assign credit ratings based on information provided to them by the
issuers. Their analysts then use sophisticated statistical models that consider
the issuer provided information along with information from other sources, such
as economic data, to determine an appropriate rating for the issuer. CRAs
charge the debt issuers a fee for this service and make the ratings available
to investors at no charge. This so-called issuer-pays business model has
allowed CRAs to generate significant revenues, has allowed CRAs to grow in size
and influence in the financial markets, and has significantly
called into question their impartiality in assigning these ratings. It has been
argued that the conflicts of interest inherent in this model affect the
accuracy of the credit ratings assigned. Debate surrounding these questions has
grown in intensity in the aftermath of ...
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