Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1120 - 1139)



  Q1120  Jim Cousins: In that case, how can you tell us it is reflected in your ratings?

  Mr Madelain: The rating reflects information that is made available to us.

  Q1121  Chairman: Let us move on. As a general rule, can we say that rating agencies do not change a rating until something happens? In other words, you use historical data.

  Mr Hancock: I am sorry, could you repeat that? We could not hear.

  Q1122  Chairman: Rating agencies do not change a rating until something happens; in other words you use historical data to assess the ratings.

  Mr Hancock: No, not necessarily so. We certainly have our opinions about the future and we incorporate our opinions for the future into our ratings. They are forward-looking instruments.

  Q1123  Chairman: Some submissions have indicated to us that the credit ratings side of your business has quite a high margin, something like 50%. What margins does the credit rating side of your business have?

  Mr Taylor: I do not actually have—. It is a disclosed number in our public accounts. I am more than willing to provide it to you.

  Q1124  Chairman: Roughly.

  Mr Taylor: It is certainly less than 50%. We have a different business model, perhaps, to our competitors.

  Mr Drevon: Approximately 50%.

  Mr Bell: Unfortunately, different from the other ratings agencies. Standard and Poor's is part of McGraw Hill, which is a listed US corporation, and unfortunately McGraw Hill does not break out that number, so under US securities laws I am informed that I am not at liberty to disclose that information.

  Q1125  Chairman: So if I wrote to you, could I get that information: the credit business side of your business?

  Mr Bell: The McGraw Hill Corporation, if it were to disclose that number, would have to do it in accordance with the regulation FD on selective disclosures. I am not an expert in American securities law.

  Q1126  Chairman: Moody's you are 50%? That is the only answer we have got.

  Mr Drevon: Approximately, yes.

  Q1127  Chairman: Okay. On Basle II you heard Professor Buiter saying that no-one any longer trusts the rating agencies' judgment of the creditworthiness of complex structured instruments and, therefore, that puts a huge hole in Pillar 1. Do you agree with that?

  Mr Drevon: No, we do not. There is no, I think, proof that investors have lost confidence in rating agencies. In fact, over the summer we have done a number of outreaches to investors, including very large conference call conferences, and there is still a large degree of interest from the investor community on our opinion about credit risk. On Basle II, perhaps I can refer to our earlier comment, which is that we are not in favour of using ratings in regulations.

  Q1128  Chairman: You are all aggressively now related with downgrading mortgage-linked securities. I think it is because of that that Professor Buiter has made his comment. It seems that it is a legitimate comment that he has made.

  Mr Bell: I think it is a legitimate comment, but I would echo the words of my friends from Moody's, which is that during our interaction in Europe with investors, what we have found is that there is a sense that, yes, the ratings in the US sub-prime did not go the way they were expected to go, but that has not led them to lack confidence in all our work in structured finance. Equally, with Basle I, as Moody's have always said, we were not in favour of being incorporated in Basle I, we did not think it was appropriate.

  Q1129  Chairman: At the moment, in terms of complex structured products and the downgrading you have, do you think you still have the confidence of the market in terms of your judgment of creditworthiness of these structured instruments?

  Mr Bell: I think that the market, quite legitimately, is asking questions which I think it is incumbent upon us to answer.

  Q1130  Chairman: So it does not have full confidence in you?

  Mr Bell: I think the market is diverse. I think some people continue to have trust in us.

  Q1131  Chairman: Largely speaking—we are addressing the generalities—you think that the market does not have full confidence in you at the moment?

  Mr Bell: The market is not one single entity; therefore it is not a binary answer.

  Q1132  Chairman: But a large part of the market does not have full confidence in you. Is that right, Moody's?

  Mr Drevon: No, in fact if the market did not have confidence or was not interested in ratings, it would ignore completely our downgrades. It has been the opposite. The downgrades have a significant impact on the market and therefore—

  Q1133  Chairman: You are keeping this whole confidence in the market. You are coming here and telling us that?

  Mr Drevon: Again, I think the proof will be in the future.

  Q1134  Chairman: I am really asking you for the present. We get lots of submissions into the Committee, and the reason I am putting that comment to you is that most people put that to me, and that is why I am putting it to you. Fitch, do you have the confidence of the market?

  Mr Taylor: Actually I think we do. A comment I made earlier was that investors had not been focused on credit over the last couple of years. Sub-prime is a very specific situation. It is about 3% of the credit market, to keep it in perspective. Do you want me to answer the question?

  Q1135  Chairman: Of course?

  Mr Taylor: So investors have not been focused on credit. I think in the last few months they have refocused massively on credit. We have never been busier in terms of dealing with investor inquiries, investor discussions, so I absolutely think they still see value in what we do. It would be completely arrogant to say we cannot learn lessons from what has been going on, but I do think investors continue to value the core product of what a rating is.

  Q1136  Chairman: I would suggest maybe to people in the market that could come across this that there is a hint of arrogance in that answer, but there we are. The Bank of England Financial Stability Report, October 2007, says that it is unclear whether the ultimate bearers of risk have sufficient information of an underlying credit risk in the product, in particular, the more complex instrument in which they invest, and investors may have become over-dependent on rating agencies' assessments of risk and also could have misinterpreted ratings, assuming that they provide information on a range of risk, such as liquidity and market risk in addition to credit risk. Do you agree with the Bank of England's statement there?

  Mr Bell: We have always been very clear as to the nature of our ratings.

  Q1137  Chairman: I am asking the question: do you agree with the Bank of England's statement here?

  Mr Bell: We believe that certainly some investors—. We do not believe that the investors misunderstood the rating, i.e. we do not think that investors actually believe that a rating was trying to encapsulate a price or liquidity component. However, we think that, in the absence of any other indicators, undoubtedly a number of investors used the rating as a proxy for liquidity or pricing components.

  Q1138  Chairman: So the Bank of England are on to something here then.

  Mr Bell: I think, yes, but I do not think it is a misunderstanding of the rating. I think this is "we used the rating for another purpose because we did not have the other tools, so we thought this was as close as we could get".

  Q1139  Chairman: Do you disagree when the Bank of England say that investors may have become over-dependent on the ratings agencies' assessment of risk?

  Mr Bell: That is entirely possible. We have never advocated that investors should buy—

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Prepared 1 February 2008