Controlling Risk in a World of Risks
The ratings business is at a crossroads. The recent report of the European Securities and Markets Authority (ESMA) has once again pointed to the major defects of the pre-crisis rating organization. The ratings of the Big Three rating agencies, Moody’s, Fitch and Standard& Poor’s are criticized for their potential conflicts of interest, for their lack of confidentiality and for their poor quality. At the same moment, many institutions, in China and the ASEAN region, in India as well as in Africa, raise the question of the necessity to create a new model that could give a better picture of the world economy. These questions are sound reminders of the necessity to reform this sector, because in fact world growth is at stake.
There are two reasons to this. One is the past, the other is the future.
The first reason is the lesson of the past, because the 2007-2008 crisis has taught us the massive impact wrong ratings could have. The rating agencies are not the cause of the crisis, but they have undoubtedly catalyzed it. They have slowed down the awareness of the dangers before the crisis, through underevaluation of the risks on the financial market and the derivate products.
They have accelerated the defaults of companies and states after the breakout of the crisis through rapid downgrading that led in fact to an overevaluation of risk. In a nutshell, they have done exactly the contrary of what they are designed to do. And if we want more stability in finance, we need a reform of credit rating. The solutions are at hand, they are pluralism, objectivity where today we have ideology and monopoly.
The second reason is the future of the world economy. We are entering a more complex, a more diverse, a more global economy in which information and risk assessment will be even more the key of growth and stability as they are today. The existing credit rating system was adapted to an economy of the West or at least dominated by the West. The rise of the emerging countries has changed the game. With the massive unbalance of credit in the world, with all the liquidities in the emerging world, in China with the trade balance surplus, in Russia, Latin America or the Middle East with the mineral resources and all the debts – private, corporate and sovereign- in the Western countries, the monopoly of the West in risk assessment is not only unfair, it’s terribly perilous.
What will be the future of globalization? Let’s face it, it will be a struggle for long term capital on the world scale, because the emerging markets are no more only export-oriented factories but are becoming fast growing domestic markets. They will need more and more infrastructures for urban development, housing, communications and this means massive investments. At the same time, new emerging economies will appear, with their own needs. In the coming decades, Africa will need around a trillion dollars in infrastructure investments for example. But African companies are barely rated now. Africa is still considered in the West as a black hole of risk, when there are methods, there are criteria, there are precedents that can be used to evaluate sovereign and corporate risks on the continent. But for this strong local credit rating agencies, in Western Africa for example, would be needed.
In this struggle, risk assessment will become strategic and to guarantee stability, we have only one choice, diversity. We need a choice in risk assessment. It’s not about replacing the monopoly of the Big Three by a new monopoly. It’s about new voices. And there are several promising projects today in this exciting sector.
In this new world of risk, risk assessment will be even more than they already are a major public good, as important as the freedom of communications, as the security of the seas, as the stability of climate. That’s why we need public and private actions to reform the system.
We need public reforms and this means a new regulatory environment. An exemplary work has been done on this matter by the European Union since 2008, with three different laws, probably because the States of the Union have been major victims of erratic ratings in the past. Since last June, the new regulation is enforced and creates the conditions of a more precise, more objective and more ethical rating. It has promotes confidentiality. It avoids many situations of conflicts of interests, by regulating the simultaneous shareholding of rating and rated companies. It develops legal responsibility in rating, which is crucial and it creates the conditions of diversity by promoting a double rating, one of the two originating from a small agency.
This leads the way but isn’t enough we need worldwide reform, and the G20 hasn’t been at the level of expectations on this issue. In fact, this raises the question of worldwide economic governance as a whole. We need global regulations and global criteria to evaluate the work of Credit Rating Agencies, but also to regulate the banking system. For this we need an economic Security Council of the United Nations, that would directly control the Bretton Woods Institutions. We also need the World Bank to give the impetus to changes in risk assessment by promoting a cultural diversity of ratings.
We also need private changes, because innovation is best bourne by new private entities that put all their energy in a new competition. What should a useful, innovative and solid rating agency be? I think some aspects of a new methodology can be pinpointed.
First, it should provide a “glocal” view on an economy that is becoming at the same time increasingly global and increasingly local.
Secondly, it should provide a contracyclical measure of risk, being more conservative in times of rising tides and more flexible in times of falling tides. In my view, this is a key responsibility for risk assessment, because it’s not the role of rating agencies to promote speculation or to provoke the burst of these bubbles.
Thirdly, it should lead the way and give a good picture of the future. This means giving the public information about sovereign debts, but also about key sectors of the future and working hard on adapting its rating methods to sectors with a bright future, IT sector, energy sector, infrastructure projects.
Now is the time for a new globalization, that can be either multipolar, based on fair development, stability and innovation or confrontational, based on privileges, speculation and inequities. This means making choices and changes in many sectors: let’s begin with credit rating.
12th December 2013, Huffington Post