The Politics of Credit Rating Agencies

China’s Dagong Global Credit Rating Co. rating agency may not be the one you trust most but it has certainly stirred up the sleepy and mostly complacent world long dominated by the three American agencies, Standard & Poor’s, Moody’s and Fitch (now French-owned but of US origin and with headquarters in New York and London).

New blood was certainly needed in this business after the disasters inflicted on the global financial sectors and hence the economies that had to bail them out as a result of the top ratings given by the big three to paper which turned out to be junk. Clearly their desire for business overwhelmed both their judgment and their ability to comprehend the new instruments put before them for rating.

It was easy to assume that those who paid the piper played the tune so that they easily became privileged partners of Wall Street and by extension were prone to view more favorably than deserved the sovereign debts of the United States and other western nations.

So another international contender gaining respect from all major markets would be welcome. But does the China-based Dagong Global Credit Rating Co. have the credibility to be such? It has trodden a deliberately different path from the big three and is keen to market itself outside China, in Europe as well as the developing world, in countries which want a wider variety of views and less perceived US bias. However, no sooner had Dagong gained kudos for its early downgrade of US debt when it sullied its reputation by giving a AAA rating to China’s Railways Ministry despite it many known problems of excessive capital commitments, corruption and money-losing high speed trains.

For sure Dagong’s arrival and its downgrading of US debt have sparked off much soul-searching among and competition between the big three. It is not difficult to surmise that if Dagong had not made a big noise about downgrading the US two days earlier, then S&P would not have shaken the market by doing the same. Fitch, not wanting to be seen as a sheep, then declined to follow and re-affirmed its existing top ratings, citing the very Congressional budget cuts which had caused S&P to downgrade because of the threat of default. So at least different thoughts are now contending.

In fact, Dagong’s latest move was its third downgrade of the US. The first was in June 2010 when it took it from AAA to AA then down to A+ in November and now to a single A. Nor was Dagong alone. The German agency Feri also downgraded the US last year. However, Dagong attracted more notice because it seemed to reflect the views of the US’s largest creditor, China, making a statement of concern that the US was deliberately weakening its currency though its debt issuance and low interest rates.

There was already a strong political element in Dagong’s appearance on the international scene. In June last year it launched a high-profile report in which it went out of its way to claim to “break the mold” and give a different sovereign ratings picture from the big three. In doing so it sought to position itself with countries, mainly developing ones, which felt that the other agencies were culturally biased against them and gave a too easy ride to the old developed world.

In rating 50 countries Dagong went out of its way to emphasize this. It noted that its ratings were “Unanimously higher” than the others for China, Hong Kong, Macau, Russia, Brazil, India, Indonesia, Venezuela, Nigeria and Argentina. It was not difficult to see some political ingredient in some of these gradations. At the same time Dagong’s list of “Unanimously lower” ratings included most major western countries, including Germany, France and the Netherlands as well as UK and US, plus Japan. It also gave lower ratings to Thailand and the Philippines.

There were and are legitimate differences in approach. The established agencies have relied on a past history of creditworthiness as much as current situation. Dagong looked more at growth rates and foreign debt and reserve levels. It also appeared much more favorable to resource exporters, including Australia and New Zealand.

But the political message had been there from the beginning when Hu Jintao implied criticism of the three by calling for “an objective, fair and reasonable standard” for sovereign ratings not “affected by ideology.” Dagong’s chairman, Guan Jianzhong, has been more outspoken, claiming that the US has in effect already defaulted by encouraging the decline in the dollar and hence in the real value of its debt and alleging that the other agencies did not accurately reflect the US debt repayment risk.

Dagong cannot be taken lightly if only because the creditor nations of the world are now mostly developing countries plus the oil producers and some developed Asian ones. All have reason to be wary of the past performance of the big three. However, they may also have cause to doubt Dagong’s motivations for several reasons.

Firstly, though it claims to be private, it has always been favored by Beijing. Set up in 1994 with People’s Bank of China support, it has become the Ministry of Finance’s favored agency for representing China in international meetings concerned with bond ratings and represents a slew of major companies. It is the largest such agency in China with more than 500 employees and six regional offices.

It may also have been happy subtly to emphasize its nationalist credentials by criticizing the western agencies. Two local rivals, Chenxin and China Lianhe, are 49 percent owned by Moody’s and Fitch respectively.

Dagong is also angry with the US Securities and Exchange Commission which last year turned down its request to become a Nationally Recognized Statistical Rating Organization (NRSRO) which would have enabled it to operate in the US domestic market. Dagong said that it would not submit to the required level of supervision demanded by the SEC “at the price of sacrificing national sovereignty.”

The precise demands of the US were not clear. As of now a Canadian and a Japanese firm both have NRSRO status. There was some speculation that the inability of foreign firms to own more than 49 percent of agencies operating in China was a factor in the rejection.

Dagong meanwhile is also probably unfairly tarnished by the performance of some high-profile auditors and other professionals in China regarding the accounts of listed companies. Its bigger hurdle in gaining widespread international recognition will be its ability to be – and be seen to be – free of the influence of superior institutions in Beijing.