IFR: How many ratings would an issuer realistically be willing to pay for?
Ged Hawley (HBOS Treasury Services): It is quite difficult. Competition is a good thing, but the reality is, as an issuer, we look very hard at what our investor base wants from us and the reality is that S&P and Moody's stand out, with Fitch third. If somebody is putting together a transaction, they are obviously trying to provide a ratings sweep that is familiar to the investor base. Would we be prepared to pay more? Probably not, we regard it as an expensive necessary evil, as Dagmar put it. The question is that we are paying for a rating as a company and then paying on top for each transaction that comes along, so it is not an insubstantial amount.
IFR: But is it possible that the costs could come down as a result of increased competition?
Ernst Liehr (SG): Personally I think so, yes. But I also think the whole discussion comes back to the same thing and that is ‘what is the worth of a rating’? Which agency really does have the reputation, which ones do not have the status and what is this worth.
IFR: So it is not a question of going to the agency from whom you are likely to get the best rating then?
Theodore: I think, regarding competition, DBRS is in a position where you have this uphill struggle to get into the competitive game. We started in Europe, where I was employee number one, and of course on my first day on the job my main concern was: what am I going to do now? The market, based on the feedback that we get, appreciates seeing more competition. Again, as I said earlier, the rating industry is now in the maturity stage, it is no longer in its infancy. I do not know of any business which is so important, so essential, in capital markets where there are only two plus one players.
So clearly we need competition at least for two key reasons. One, so we have a wider range of opinion in the market. If one player has some controversial opinions, at least there are others that can offset and mitigate and rebut, and this is very important. The market would not then feel the prisoner of a couple of players.
The second important reason why we should see more competition is for business practices. Again, we mentioned rating fees: I know of no business in the world where more competition does not bring lower fees and lower prices, so I think to have more competition will bring added value for investors, issuers and the market in general.
Hawley: But I think competition is as much about understanding that you have a different methodology and that that methodology is accepted by investors, and I think that is one of the concerns for issuers. We need to get comfortable that our investor base is prepared to accept a DBRS rating and understand what that means.
Kent Kershaw: DBRS is in a very difficult position because, as a newer rating agency, if its methodology produces a better rating than you want, investors are not going to believe it. But, if it comes out worse, you are not going to pay for it.
Aucutt: But, is there not a way of changing the status quo? Perhaps, investors could be encouraged to take up more of the payment. At the moment, I can pick and choose, obviously with a limited choice, and if I do not like Fitch's rating, or DBRS's, I can wipe them off the rating without anyone knowing that. But, if you can try and get investors to stump up more on the pricing, or take up more of the slack and request to see the rating that Fitch or DBRS has, then that adds to the competition and it takes away the problem of the issuer paying for pretty much 90% of the rating costs.
IFR: Do you think that that is something that investors would be willing to do?
Aucutt: Probably not.
IFR: Is it a realistic goal, do you think? If historically they have not had to pay, what would be likely to change their minds? Do we perhaps need some sort of credit event?
Hunter: Ratings were originally paid for by investors. But, the business could not be commercially supported by subscriptions anymore.
I think one interesting point that comes out of this is we are discussing why it is important that different opinions should make it into the public domain and in other forums we hear criticism of things like unsolicited ratings on the corporate side, whereas that is an avenue through which an agency, that does not have a lot of coverage in a sector, can get its ratings established in the minds of the issuers themselves. You have to see a range of transactions to understand the context of an agency's ratings.
In the last three or four years it has come up as a topic more often, and we are seeing increasingly different constituencies, like investors and regulators saying it is a necessary part of the market. If there is an opinion out there that would otherwise be suppressed, it is a way that that opinion can get out into the marketplace.
Kent Kershaw: There is one area of the market where investors do pay for ratings. As a structured credit issuer, where we have pools of underlying leveraged loans where we buy assets which are unrated by one or more of the agencies, we do have to pay for a shadow rating, and it has actually become quite a significant market, quite a significant source of revenue for the agencies in doing these shadow ratings. So the option is always there for an investor to get a shadow rating.
But frequently, for ABS transactions for example, if we approach the agencies for a shadow rating on a public deal, we will find that they have actually already rated that deal but the rating was suppressed because parts of it were lower than the one which ultimately came out.
So there is the opportunity for investors to pay for ratings and see those suppressed ratings and get their own private shadow ratings.
Theodore: But I do not think the question should be who is paying for the ratings, because most investors and issuers are paying for the ratings. The question really should be: are they paying too much? This is probably the fitting question, because nobody in the market expects to get something for free. An investor uses ratings and wants to pay not so much just for the rating but for the analysis, for the opinions behind the work. For the issuer, the point is that this rating is going to facilitate access to the capital markets, so of course it has to be paid for.
But the question is, how much, and to the extent that you do not have competition in this industry, the fees are in the stratosphere. It is a very simple business for them.
IFR: As far as a reduction of fees is concerned, will we see one and when?
Kent Kershaw: I do not necessarily think that a fee war is the way to go in the structured world, because Fitch has been beginning to build up a market share and has been more flexible on fees, but I do not see that that has necessarily led to a direct increase in business. So I doubt that people necessarily buy ratings on the basis of who has the lowest fees.
Madelain: I would agree with that. If you look at what is really shaping the industry, fee levels are not and have never been the driving force. The barriers to entry that effectively exist for new agencies are well known, and they include the fact that you need a track record to get recognition in the marketplace, you need broad coverage, and the more you are in the marketplace, the more difficult it is for others to come in. You also have the fact that for a company to invest in an investor relationship is an expensive process in terms of the time and commitment and, therefore, that is not something that can be easily done for five, 10 or 15 different providers.
So that is really what has led to this industry structure: pricing has not.
Click here for Part two of the Roundtable.