WHO ARE THE smartest operators in global capital markets? Hedge funds? Private equity firms? Investment bankers?
Guess again. There’s only one sector in financial services able to offer a return on equity in excess of 50% while putting zero capital at risk: the rating agency industry. But all is not well in the rating industry: the decline of the US sub-prime sector has thrown into sharp relief the inherent conflict of interest at its heart.
Rating agencies such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings should be perceived as independent third parties; increasingly they are not. The conflict of interest is obvious: those that they theoretically serve – investors – do not pay directly for the service received. These conflicts of interest cast a shadow over credit ratings, and there are fears that fixed-income capital markets are less efficient because of them. And the problem is only going to get worse: the position of the raters will become even more entrenched as the Basle II regulations come into force.
"The old adage that one cannot serve two masters extends to the financial services industry, including fixed-income ratings," says Sean Egan, CEO of EganJones, one of a small band of independent firms that is paid directly by investors for its research.