When it comes to evaluating counterparty risk, more and more CFOs and their chief risk officers are having what might be called their Groucho moment.
Having for years paid large rating agencies to help investors evaluate the risks of buying their company’s bonds, and having diligently lobbied the agencies for their company’s debt to receive the best possible rating, CFOs appear hesitant to trust the big agency ratings — at least when it comes to evaluating the risks associated with their different partners.
“I wouldn’t want to belong to any club that would accept me as a member,” is the legendary Groucho Marx punch line that seems to best sum up the mind-set of CFOs as fears surrounding counterparty risk spike.
Perhaps CFOs hesitate because the Big Three agencies — Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings Ltd. — are known to be slow when it comes to changing a bond’s rating. In other words, their ratings aren’t always actionable because they tend to lag behind. Or maybe CFOs have suddenly spotted a 30-year-old conflict of interest, where the ratings supplied by the Big Three have become suspect since the agencies garner fees not from subscribers, but from the companies they rate. No matter what the reason may be, it would appear that when it comes to rating counterparty risk, the ratings that investors rely on are not up to CFO snuff.
“Let’s be very clear: The long-standing, deeply entrenched incumbents in this space, which have some of the highest margins in the U.S. — or anywhere in the world, for that matter — have not retained their outsized market share by virtue of issuing high-quality ratings. In the past, quality has never been necessary,” said SEC Commissioner Kathleen Casey during a speech earlier this month that issued an impressive thumping to the big rating agencies.
Just how insiders at the large agencies misled investors when it came to subprime securities is now documented through internal memos and e-mail exchanges introduced before the House Committee on Oversight and Government Reform last fall. Meanwhile, the SEC has already made known its intent to help newer rating agencies gain their competitive footing.
One up-and-coming entrant eager to distinguish itself is Rapid Ratings International, an independent research and analytics firm that provides ratings of companies using a purely quantitative ratings system. James Gellert, Rapid Ratings chairman and CEO, believes that fear surrounding counterparty risk is now leading more CFOs to seek out additional rating inputs.
“This is already the biggest area of growth for us. Companies want to know that the people they are selling to and the people they rely on for the production of their products are going to survive,” says Gellert, who illustrates the sizable challenge certain companies face by citing Boeing, a company with more than 20,000 supply partners.
“The level of insight that corporations are starting to want, even if they haven’t had a product or service to provide them insight before, is massive. And from the board on down, corporate governance and fiduciary responsibility are now requiring that people have greater insight,” says Gellert, whose company today uses a subscriber-pay model, allowing Rapid Ratings to escape a conflict of interest stigma.
The notion that a Groucho moment may now be helping newer rating agencies to enlist subscribers is in some ways ironic, given everything that the big agencies did to help drive the counterparty risk opportunity. For certain, when it comes to the world’s present economic condition, we couldn’t have done it without them.