Report on the Activities of Credit Rating Agencies

REPORT ON THE ACTIVITIES OF CREDIT RATING AGENCIES THE TECHNICAL COMMITTEE OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS SEPTEMBER 2003 REPORT ON THE ACTIVITIES OF CREDIT RATING AGENCIES I. INTRODUCTION Credit rating agencies (CRAs) can play an important role in many domestic and cross-border transactions. CRAs assess the credit risk of corporate or government borrowers and issuers of fixed-income securities. CRAs attempt to make sense of the vast amount of information available regarding an issuer or borrower, its market and its economic circumstances in order to give investors and lenders a better understanding of the risks they face when lending to a particular borrower or when purchasing an issuer’s fixed-income securities.1 A credit rating, typically, is a CRA’s opinion of how likely an issuer is to repay, in a timely fashion, a particular debt or financial obligation, or its debts generally. Issuers, lenders, fixed-income investors, and government regulators use credit risk assessments for a variety of purposes. Issuers and corporate borrowers rely on (and, in many cases, pay for) opinions issued by CRAs to help them raise capital. Investors and lenders typically insist on being compensated for uncertainty and, when taking on debt, issuers pay for this uncertainty through higher interest rates.2 CRA opinions that help reduce uncertainty for investors also help reduce the cost of capital for issuers. Lenders and investors in fixed-income securities, by contrast, use CRA ratings in assessing the likely risks they face when lending money to or investing in the securities of a particular issuer. Institutional investors and fiduciary investors (i.e., those with independent authority to invest on behalf of others, such as the managers of trust funds or pensions), likewise, use CRA ratings to help them allocate investments in a diversified risk portfolio. Government regulators also may use CRA ratings for a variety of purposes, including setting capital charges for financial institutions according to the risks attendant to the institutions’ various investments. The IOSCO Technical Committee formed a Task Force to examine certain key issues regarding the role CRAs play in securities markets.3 In particular, the Technical Committee charged the Task Force with assessing: 1 Fixed-income securities are a particular form of financial obligation that may be publicly traded. CRAs may provide credit ratings for different types of debts and financial obligations — including, for example, private loans and debt securities that are not publicly tradable, as well as zero-coupon bonds, preferred shares and other securities that offer a fixed rate of return. This Report focuses on CRA activities as they relate to ratings of publicly traded debt securities and financial obligations and, for simplicity’s sake, uses the term “fixed-income securities” to refer to bonds, debt securities, preferred shares, and other financial obligations of this sort that CRAs rate. 2 Occasionally this report uses the terms “lender” and “investors in fixed-income securities” in a similar fashion. Although not all lenders are investors in fixed-income securities, both lenders and investors in such securities provide capital to a borrower/issuer in exchange for a pre-determined rate of return. This contrasts with investors in equity securities, who, in exchange for their capital, purchase ownership in the issuer and have a right to share in the issuer’s profits after all other financial obligations are settled. 3 The Task Force was chaired by Commissioner Roel C. Campos of the US Securities and Exchange Commission, and its members included representatives from: the Australian Securities and Investment Commission (Australia); the Comissão de Valores Mobiliários (Brazil); the Commission des opérations de bourse (France); the Bundesanstalt für Finanzdienstleistungsaufsicht (Germany); the Securities and Futures Commission (Hong Kong); the Commissione Nazionale per le Società e la Borsa (Italy); the Financial Services Agency (Japan); the Comisión Nacional Bancaria y de Valores (Mexico); the Ontario Securities Commission (Ontario, Canada); the Comissão do Mercado de Valores Mobiliários (Portugal); the Comisión Nacional del 2— Whether CRAs disclose information about their decisions and rating criteria and whether the amount and quality of the information disclosed is sufficient for making investment decisions; — How, when and to whom CRAs disseminat