Examination of Witnesses (Questions 943
TUESDAY 13 NOVEMBER 2007
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
Mr Madelain: Michel Madelain,
Executive Vice President of Moody's. I am responsible for bank
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
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 risksthat is the ability or willingness
of a party to repay a debtbut 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
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
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
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,
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 criticalin some cases it prevents certain
investors from buying the bond, in others it forces the holders
of the bond to sell itbut 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
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
Q959 Chairman: But you provide those
Mr Hancock: Exactly the same at
Standard and Poor's.