19 January 2019
Moody's biggest shareholder is Berkshire Hathaway, the flagship company of billionaire investor Warren Buffett.
Moody's biggest shareholder is Berkshire Hathaway, the flagship company of billionaire investor Warren Buffett.

Why credit ratings business is still very lucrative

Financial markets keep a close eye on actions of major credit rating agencies, but their reactions to sudden announcements from the global firms can be varied and unpredictable.

Last week, we saw muted reaction on the markets to Moody’s downgrades of the ratings of China and Hong Kong.

Given the many cases we’ve had in the past when the firms were proved to be off the mark, this is not that surprising.

On August 6, 2011, Standard & Poor’s cut US sovereign rating by one notch to AA+, marking the first downgrade of the country in its history. S&P cited political risks and a rising debt burden for its decision.

The news shocked global markets, and the Dow Jones index slumped over 5 percent the next day. Yet the stock market recouped all the losses within one week.

In fact, soon after, President Barack Obama’s fiscal reform and economic stimulus measures started to work.

GDP growth in the world’s biggest economy accelerated between 2012 and 2015 and the government debt situation was also brought under control.

Right now, the Dow Jones index is almost double its level six years ago.

Japan is a similar case. Moody’s cut Japan’s sovereign rating from AA3 to AA1 on December 1, 2014 citing lack of confidence in the so-called “Abenomics”.

However, Abe’s third arrow of structural reform started to take effect shortly after the downgrade. And the nation’s GDP growth rose by 0.5 percent in 2015 and one percent last year. Japan eventually walked out of persistent deflation, and most workers got pay rises.

By contrast, South Korea’s credit rating was increased one level by Standard & Poor’s from AA- to AA last August. Embarrassingly, the country soon witnessed a slew of negative developments.

Within a month, the nation’s top business conglomerate, Samsung, was engulfed in a crisis involving exploding Galaxy Note 7 devices. Then, South Korea’s largest shipping firm, Hanjin Shipping, went bankrupt. In March, former president Park Geun-hye was accused of abusing her power and colluding with her longtime friend, Choi Soon-sil, and was dismissed from office.

All these cases highlight the fact that rating agencies don’t always get their actions correct.

That said, we should acknowledge that the credit ratings business is still very lucrative. Many large institutional investors, such as pension funds, rely on credit rating agencies before deciding where to put their money.

Without a proper rating, borrowers may be hard pressed to find investors. Hence, bond issuers, for instance, need to hire agencies and secure credit ratings so that they will be able to access capital in the market.

Moody’s is the only listed one among the world’s top three credit rating agencies. It has a market value of US$22 billion. Last year, its revenue and adjusted profit stood at US$3.6 billion and US$1.6 billion respectively.

China is keen to groom its home-grown credit rating agencies in order to break the monopoly held by Western firms.

For instance, Dagong Global Credit Rating was founded in Hong Kong three years ago. However, Chinese players have so far had limited recognition in the global market.

This article appeared in the Hong Kong Economic Journal on May 26

Translation by Julie Zhu with additional reporting

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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