Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 943 - 959)

TUESDAY 13 NOVEMBER 2007

MR PAUL TAYLOR, MR CHARLES PRESCOTT, MR MICHEL MADELAIN, MR FRÉDÉRIC DREVON, MR IAN BELL AND MR BARRY HANCOCK


  Q943  Chairman: Good morning and welcome to the Committee's inquiry into financial stability and transparency. Can you introduce yourselves for the shorthand writer, please, starting at this end?

  Mr Prescott: Charles Prescott, Financial Institutions, Fitch Ratings.

  Mr Taylor: Paul Taylor, Fitch Ratings.

  Mr Madelain: Michel Madelain, Executive Vice President of Moody's. I am responsible for bank ratings.

  Mr Drevon: Frédéric Drevon, I am Moody's for Europe. I am also co-head for securitisation business. I am London-based.

  Mr Bell: Ian Bell, I head the securitisation business of Standard and Poor's in Europe.

  Mr Hancock: Barry Hancock, Head of European Corporate Ratings for S&P in Europe.

  Q944  Chairman: Maybe I can start by asking a simple question. What do rating agencies do and what do your ratings mean? All your ratings mean different things in different companies. Is that correct? Maybe you can tell us, starting with Fitch, what your ratings mean, and Moody's, what your ratings mean and then yourselves?

  Mr Prescott: Our ratings are measuring the likelihood of interest and capital being repaid in terms of the conditions of the issue.

  Mr Madelain: Our ratings speak to the risk of default and recovery on securities issued in the capital markets.

  Mr Bell: Similarly to Fitch, our ratings are opinions as to the likely default, either on interest or principle in a timely basis.

  Q945  Chairman: So really your ratings reflect credit risks—that is the ability or willingness of a party to repay a debt—but they do not imply anything in terms of liquidity, potential for appreciation or volatility. Is that correct?

  Mr Bell: That is correct.

  Q946  Chairman: So they do not do that for liquidity. Therefore, an investment decision based only on ratings can be misguided.

  Mr Bell: We have always been very clear that no investor should base a decision to invest or not invest in any debt solely on the rating; this is one component of all the risks that that investor should take into account.

  Q947  Chairman: So the decision could be misguided?

  Mr Bell: If based only on a rating, almost certainly, yes.

  Q948  Chairman: At the end of the day, you have different quantitative models to rate the credit risk, but you usually almost always agree in terms of the rating, triple-A or whatever else. Some of you use triple-A, some of you use lower case "a", but you always usually agree. How do you agree at the end of the day when you start off with a different base?

  Mr Taylor: Actually we do not always agree; quite the contrary in fact. There are two levels to this. One level is what you do not see in the public markets. So each of the agencies has situations where they do not rate something because they disagree with the risk assessment that appears in the public market, but we also have differences in the ratings themselves. If you look at the specific ratings assigned to different issuers, different transactions, different companies, banks, there are differences between the levels assigned. There is a lot of similarity as well simply because of the fact—

  Q949  Chairman: I am pointing out that Arturo Cifuentes, who is the Managing Director of RW Pressprich says, "In practice, however, the degree of agreement category by category is extraordinarily high. This degree of agreement seems strange."

  Mr Taylor: I am not sure it is extraordinarily high. First of all, it is based on facts. The facts we all get are the same. How we interpret those facts is down to our individual decisions and analysis. The facts are the same. So you would not expect massive differences on a frequent basis, but there are differences.

  Mr Drevon: I should also add in the specific context of securitisation, arrangers who create these transactions have a goal to achieve a higher rating, typically a triple-A rating, so they will structure a transaction in a way that achieves the highest rating possible; so it is not unlikely that different rating agencies rating the same instrument will achieve the same highest rating.

  Mr Bell: In addition, in structured finance you also have the fact that, even if there are differences in our analysis of a particular transaction because the people structuring the transaction wish to have the highest rating, they will simply take the most conservative position of the two or three agencies, so enabling each agency to give a triple-A.

  Q950  Chairman: Do you agree with Mr Cifuentes that the rating agencies enjoy a power that goes beyond what regulators probably intended and, maybe even worse, understand?

  Mr Madelain: I think that is an understatement. I think we are a provider of opinions on credit risk. There are many other providers, many different ways to form opinions, and we are one of such providers.

  Q951  Chairman: I will go on with what he is saying. He says whether a bond gets an investment grade rating or not is critical—in some cases it prevents certain investors from buying the bond, in others it forces the holders of the bond to sell it—but what is frightening, he says, is not only that the agencies determine whether the bond meets the BBA standard or not is the fact that you define that standard. Is that not frightening?

  Mr Madelain: There are two things. There are certain situations where ratings are embedded in regulations. This is clearly the case in the United States; much less so in Europe. Second, we have rating criteria that, indeed, lead to assigning certain rating levels, but those are fully transparent and available to every user of ratings and actually may default from one agency to the other.

  Q952  Chairman: In terms of the practice of the rating agencies, the appraiser in the rating process is paid by the seller rather than the buyer. Is that correct?

  Mr Madelain: That is correct.

  Q953  Chairman: The rating agencies provide technical assistance and advice on how to design structures that could attract the best possible rating—

  Mr Drevon: That is incorrect.

  Q954  Chairman: —to the very issuers whose structures they will subsequently rate?

  Mr Bell: That is absolutely incorrect.

  Q955  Chairman: So, you agree completely with Professor Buiter?

  Mr Drevon: No, we disagree completely.

  Q956  Chairman: You disagree with Professor Buiter?

  Mr Bell: Yes, absolutely.

  Q957  Chairman: Okay; that is fine. The rating agencies provide other financial services and products than ratings or ratings advice?

  Mr Madelain: We do not provide advice, as we have said.

  Q958  Chairman: Other financial services that you provide.

  Mr Drevon: We can speak for Moody's. We do provide some additional tools to the market but those are done separately, they will be done separately from the rating agency.

  Q959  Chairman: But you provide those services.

  Mr Hancock: Exactly the same at Standard and Poor's.


 
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