Moody’s bought a major African rating agency: why it’s bad news

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Moody’s Investors Service, one of the world’s three largest credit rating agencies, is acquiring a majority stake in Global Credit Rating (GCR), a leading credit rating agency in Africa.

This decision is based on Moody’s anticipation that there will be a surge in demand for credit rating services in Africa. Moody’s also has a significant stake in the Egypt-based Middle East Rating and Investors Service or MERIS.

Credit rating agencies are key players in financial markets. They provide a quantified assessment of a borrower’s creditworthiness. In Africa, demand for capital market borrowing is growing exponentially as traditional sources of finance dry up

GCR is the largest rating agency based in Africa. It represents most of the ratings issued on the continent. It was established in 1996 and is based in Mauritius, with offices in South Africa, Nigeria, Kenya and Senegal.

The “big three” rating agencies – Moody’s, S&P Global Ratings and Fitch – control more than 95% of the global credit rating business. They have been accused of monopolizing the credit rating market by implementing anti-competitive tactics to maintain market dominance. In the United States and Europe, they have been fined for anti-competitive practices.

Other shortcomings include a lack of understanding of the internal context of African economies. Indeed, their top analysts barely make field visits to rated countries. Moody’s has only one office in South Africa which covers all 28 African countries to which it assigns ratings.

An increased presence in Africa will certainly improve Moody’s understanding of the local context in rated countries. Nonetheless, its acquisitions are a huge setback to the development of alternative rating agencies to compete with the “big three” monopoly.

Local capabilities

GCR has pioneered domestic instrument ratings aligned with Africa’s long-term strategy to promote access to affordable capital and promote the development of domestic financial markets. One example is an innovative finance initiative that helps governments mobilize domestic resources through domestic capital markets. It was supported by the African Union and the United Nations Economic Commission for Africa.

Africa-based rating agencies primarily assign ratings to domestic issues. Their ratings are more detailed and significantly higher than the two international ratings issued by the “big three”. This is because they understand local contexts and domestic borrowing is not exposed to currency risk.

The danger is that Moody’s entry into the domestic ratings market poses the challenge of negative analyst biases against African countries. This trend was visible in the international ratings market.

There is also a regulatory issue with regard to international rating agencies operating on the continent. They are largely unregulated. Most rated African countries have domestic bond markets. But they lack legislation for credit scoring services. Moreover, they do not have competent authorities to oversee the regulation and licensing of international rating agencies.

The exception is South Africa which has laws comparable to the G20 requiring international rating agencies to be registered and licensed locally. They are also required to comply with national regulations regarding credit rating services.

Without competent authorities that apply the regulations in each country, there is no central coordination to control the work of international rating agencies.

This is also true when it comes to the issue of anti-competitive behavior. In a well-regulated environment, the acquisition of GCR by Moody’s would have been assessed on the basis of anti-competitive considerations.

Moody’s Chess

Moody’s was called out for issuing unsolicited credit ratings. These are sovereign ratings assigned without the rated country or its agents requesting them. Indeed, the rated country has no formal contractual relationship with the rating agency. It is therefore not chargeable.

Of the “Big Three”, Moody’s has the most countries to which it has assigned unsolicited ratings.

There are a number of downsides to unsolicited reviews. First, the rating agency does not consult sufficiently with government officials during the review process. This means that it does not understand sovereign risk exposures and the government’s strategy to deal with downside risk factors.

Second, the absence of an agreement with the rated country opens the door for rating agencies to use adverse unsolicited ratings as a credible “threat”, forcing countries into contracts.

Beyond the issue of unsolicited ratings, a number of African countries have expressed their dissatisfaction with credit ratings, notably from Moody’s. Press releases have been issued informing stakeholders that the ratings do not reflect the creditworthiness of countries. In some cases, countries have appealed the ratings.

Examples include:

No country has successfully appealed a decision. This is for a number of reasons. First, there is no appeal authority on the continent that can conduct a fair hearing of the country’s submissions and issue a decision. Instead, the calls follow the agency’s own rules set out in the procedures and methodologies used to determine credit scores.

Second, rating agencies are both ‘the player and the arbiter in Africa’. This is not the case in other territories.

Solutions

There is a growing appetite for financial instruments issued in Africa. An indication of this is that bond issues are at least three times oversubscribed. This has allowed rating agencies to position themselves for more business on the continent.

As their dominance and influence continue to expand through mergers and takeovers, African countries should consider taking the following steps.

First, enact legislation on credit rating services to ensure that regulation of international credit rating agencies is at least up to international standards. They should comply with the G20 requirement of globally regulated and accountable credit rating agencies.

Second, competent authorities responsible for the enforcement of credit rating services legislation should be mandated to issue rules and guidelines to provide additional guidance and ensure uniform implementation of the laws.

In addition, the African Union and its agencies should coordinate relevant national authorities to institute a continental regulatory body as a platform of appeal for countries seeking redress against unfair practices by rating agencies. This should be the equivalent of the European Securities and Markets Authority and the United States Securities and Exchange Commission.

Without this, African countries will continue to face the challenges of unsustainable borrowing in domestic and international markets.

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