Faculty of law blogs / UNIVERSITY OF OXFORD

Analysis of the International Non-Profit Credit Rating Agency Project


Daniel Cash


Time to read

3 Minutes

In my article, I endeavour to introduce the International Non-Profit Credit Rating Agency (INCRA) project, and then to discuss the potential for success of the model as it is currently being proposed. I conclude by suggesting ways in which this project may ultimately become a reality.

The INCRA project is the brainchild of Annette Heuser at the Bertelsmann Foundation. Its aim, essentially, is to develop a non-profit rating agency that will conduct ratings of sovereign debt in a forward-thinking and socio-economic manner by utilising ‘forward looking indicators’. In providing such ratings, the Foundation hopes to provide a genuine challenge to the Big Three (Standard & Poor’s, Moody’s, and Fitch Ratings) in response to their poor performance surrounding the recent Financial Crisis.

There are at least two issues which need to be considered when assessing the potential for the INCRA project to be realised. To start with, the issue of funding must be assessed because the way an agency is funded is one of the key concerns for onlookers. The Foundation proposes that the initial investment would have to be $400 million, which it envisages would come from contributions from the G20, the IMF, and the World Bank. However, the performance of these institutions in the lead-up to the Crisis might demonstrate that the INCRA project should look for funding elsewhere, in order to protect their vision against influential parties who may not share the same ideals. In this vein, I suggest that the Foundation should focus on private endowments to meet the funding requirements, potentially in the form of philanthropic contributions, in order for the influence of these supra-national institutions to be removed from the equation. Indeed, looking for charitable contributions or grants could potentially reduce the conflict of different interests. Moreover, there is a specific sequence of events that would have to occur in order for the project to become a reality and to actually pose a credible threat to the dominance of the Big Three rating agencies. Specifically, INCRA needs to be recognised by regulators, as well as by investors.

Be that as it may, the following two propositions may assist the realisation of the project. Firstly, the INCRA project should consider merging with the Credit Rating Initiative (CRI) that is being developed in the National University of Singapore. The CRI, headed by Professor Duan, rates thousands of firms on a non-profit basis. The merging of these two entities would form a sum that is greater than the parts; the resulting agency would have the capability to rate both corporate and sovereign bonds in a forward-thinking, cyclically-responsible, and ethical manner, thus providing investors with a counterbalance to the ratings they see from the Big Three.

However, although this counterbalancing role is arguably already taken up by smaller rating agencies, such as Egan-Jones Rating Services (who operate on a subscriber-pays basis, rather than the issuer-pays basis of the Big Three), even the subscriber-pays basis entails that the smaller agencies are still beholden to somebody, which potentially taints their output (although not necessarily, and certainly to a lesser extent than the issuer-pays model). In this respect, there is a small gap in the regulatory framework that the proposed INCRA-CRI agency could fill. The ‘Rule 17g-5 Program’, created under the Exchange Act, allows for a Nationally Recognised Statistical Rating Organisation (NRSRO) that is not hired by the issuer to obtain the same information that the hired NRSRO would receive, in order for it to offer an unsolicited and tracked rating. The objective here is to enable the investors to have a comparison between the paid-for agency and an agency that has nothing to gain from issuing inflated ratings. As this would essentially result in no financial benefit for the non-hired NRSRO, it is the perfect fit for a non-profit agency. Furthermore, this would increase the reputation of the merged agency in the eyes of investors (ie investors would soon recognise the accuracy that comes with their unique approach), and it would also reveal to them the effects of issuer influence upon the Big Three, because of the potential divergence between the ratings of the for-profit and non-profit agencies.

Needless to say, for the INCRA project to come to fruition, it will be essential for it to secure both the grant of proper funding and the regulatory recognition of non-profit agencies. Only then will there be a potential for forward-thinking and ethical research, which could in turn lessen the destructive effects of the rating industry upon society.

Daniel Cash is a Doctoral Candidate at Durham University and a Lecturer in Law at Aston University.


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