Dual Rating Regime Is the Model Selection of New International Rating System Speech on the Forum on International Rating System Reform
25 June, 2013
What type of international credit rating system should be established so that another global credit crisis can be prevented from happening and the world's economic recovery and healthy development can be promoted? This “Rating Problem” was highlighted by the crisis and requires urgent resolution.
I. Solutions Proposed by the International Community for Tackling Rating Problem after the Crisis
Over the last 5 years, the international community has been undertaking practical and theoretical explorations on how to resolve the rating problem on a global scale because it is closely linked with the vital interests of humanity. At the same time as criticizing the existing international credit rating system, various sources have proposed or implemented a total of nine solutions schemes:
1. Strengthening the regulation of credit rating. A consensus on strengthening regulation of credit rating was achieved in the G20 London Summit in April 2009, and many countries and regions have moved forward substantially on reforming the regulation of credit rating. A drawback with this solution scheme is that regulation is focused on rating management, but it is difficult to reduce global rating risks that arise due to the errors in the rating techniques inherent in the current international rating system.
2. Reforming the payment model. The conflict of interests in the issuer-pay model is deemed by some people as the root cause of unfair ratings and it is proposed to change the issuer-pay model into an investor-pay model, and thereby remove the inherent problem of the existing rating system. The drawback with this solution scheme is that while the issuer-pay model may result in “one-to-one” exchange of interests, the investor-pay model may well lead to a situation in which brokers have the ability to take even more value from the true creditors than is the current situation because brokers can exploit their control over ratings.
3. Reducing reliance on external ratings. Some people are trying to resolve the international rating problem by strengthening internal ratings and reducing the reliance of investors on external ratings. The drawback with this solution scheme arises when companies borrow money from the public. If there is no rating information that is recognized by the market, information which can reveal the solvency of debtors, then it would be very difficult to facilitate the flow of capital through the establishment of socialized credit relations because the public as creditors lack of reliable investment risk information on which to base their decisions. It follows, therefore, that third party rating is a necessary condition in a modern economy based on credit relations. The provision of credit rating information came about irreversibly as a result of the development of the credit economy. It is inadvisable and utterly impracticable to reduce reliance on external ratings.
4. Making ratings legally accountable. Making credit rating agencies （CRAs）legally accountable for the negative consequences triggered by their improper ratings is another solution scheme for international rating problem. The drawback with this solution is that a credit rating is a prediction of credit risks, and there are very complicated uncertain factors affecting the reliability of prediction. A credit rating is relatively accurate only when applied to revealing the laws governing the movement of credit risks and it should only be used as reference for investment decision. Making credit ratings legally accountable moves the responsibilities for making credit decisions and thus the positioning of ratings. It is likely that changing the legal position of ratings will be a failure in practice.
5. Encouraging rating competition. This is a common perception and the focus of practical reform. The drawback with this solution scheme is that the quality of rating information directly affects the quality of credit relations, which in turn affect the way society evolves as a result of capital flows; this chain of consequences means that being responsible to the public is a primary responsibility of credit ratings. Competition implies that market suppliers respond to consumers. Since credit rating grades are products of CRAs, credit rating competition implies there should be many CRAs providing the market with a variety of credit rating grades for specific credit instruments so that consumers may choose among them. Survival will be impossible if market demand is not met. Encouraging rating competition could easily result in CRAs straying from their responsibilities to the public. We would argue that the root cause for the failure of the current international rating system is no other than the competitive rating system and model. An attempt to solve the rating problem by encouraging rating competition will result in encouraging competition amongst rating grades, and thus setting the conditions for the next global credit crisis.
6. Transforming the current rating system. The immediate reactions to this sort of solution include questions such as: what exactly is to be transformed? and who will be doing the transformation? First, it seems that the competitive rating system model, which needs transforming, will not be transformed; second, rating criteria are not included which do reflect the link between the factors governing credit risks and guided by scientific rating theories; third, the rating regulatory model remains sovereign based and not internationally based. The international credit rating system should involve governments, CRAs and creditors; whilst what appears to be occurring is that governments are proceeding without much theoretical support and so the direction of rating system reform is not systematic; CRAs are struggling for survival whilst competition is increasingly fierce, nor is there any internal or external motivation for transforming their rating techniques; creditors are helpless and at a loss as more rating information is released with the special approval of the government, and so they can only reduce investment in order to be involved in the transformation of the current rating system.
It is unrealistic to try to overthrow the flawed international rating system overnight, because the high reliance on rating information for human economic and social activities makes the current rating system an inseparable component of human society, with its deep foundation in the economic, political, and social system. A simple shock therapy will not meet the expectation for international rating system reform.
7. Promoting mutual cross-border recognition of rating results. The problem with this solution scheme is that the external condition for mutual recognition is missing. Credit rating is both an instrument for capital combination and a means for wealth transfer, and the precondition for mutual cross-border recognition of rating results is unified investment policies and capital market regulations are implemented in relevant countries; meanwhile, precautions must be taken to prevent one sovereign country from taking value from another country or transferring investment risks through credit ratings. It is very difficult for countries to achieve consensus and mutual trust. Materially different rating methodologies make the comparison of rating results assigned by CRAs from different countries lack of unified measurement standard, and it would be even more difficult for CRAs from various countries to reach a common understanding about rating standards. Therefore, this solution is not feasible either.
8. Establishing regional credit rating agencies. The problem with this solution is that regional ratings can only meet the needs for rating information for capital flows within the region, but it cannot meet the needs for consistent trans-national and trans-regional rating information that will be needed given a substantial increase of global liquidity of capital. The problem confronting regional CRAs is the same with the solution of mutual cross-border recognition of rating results, and we argue it is impracticable.
9. Creating a global non-sovereign-owned CRA. There is a four-fold justification for this solution:
(1) Credit rating information is a public good and therefore providers of credit crediting have a clear public responsibility so a CRA that provides credit ratings for the world should have regard for the common interests of humanity;
(2) There is an irreversible dynamic underlying the world's economic development relating liquidity to the way capital is generated via credit relations; only an international CRA that uses a set of unified international credit rating standards can provide the world with consistent and comparable rating information;
(3) Only a globally unified regulatory system applying to CRAs that provide global ratings can resolve the contradiction between separated regulations and globalized ratings;
(4) The current international rating system is the provider of global rating information, and its rating errors were the cause of the international credit crisis; to resolve this international rating problem, attention must to focused on the overall situation and top-level institutional design must be conducted from the global perspective.
To sum up, an optimal solution can only be selected by thinking about and exploring each of the solution schemes proposed for the international rating problem and each solution scheme has been significant in the evolution of thought about ratings; the contribution of every participant makes him or her a driver of the advancement of history.
II. Dual Rating Regime Model is the Optimal Choice to Resolve International Rating Problem
The current international rating system that has sovereign feature has both internal and external defects that are difficult to overcome, which are shown in the following aspects:
1. The sovereign property makes it vulnerable to the influence of national interests.
2. The competitive system in credit rating grades deprives ratings of the capability to reveal risks as rating techniques lack of motivation of technical advancement.
3. The rating technique risks brought about by a mono rating system can not be resolved by strengthening regulation and supervision.
4. The inconsistent rating standards make rating information difficult to meet the demand for consistent rating information to promote the universal flow of capital.
The new international rating system that has no sovereign feature has strong advantages that are incomparable by the old system, and they are shown in the following aspects:
1. The non-sovereign nature entitles it to be the representative of the common interests of humanity, not to be interfered by any group interests.
2. There is no competition within the system, which enables it to enjoy the environmental advantage of developing rating technology in order to fulfill its public duty;
3. The competition with the current rating system in rating technology can effectively balance systematic rating risks.
4. Adopting a unified international rating standard can realize the transnational circulation of rating information in order to improve the universal flow of capital.
Global rating problems exposed by the global credit crisis are immanent in the existing rating system, which cannot be fixed by sectional repair or stopgap measures. Only by following the essential requirements of the development laws of credit economy, fundamentally reforming global rating system and creating a brand-new rating system can we thoroughly solve the international rating problems faced by humanity. Therefore, a new (non-sovereign-owned) and an old (sovereign-owned) rating system will form a pattern of two co-existing international rating systems, namely dual rating system. Dual rating system is a new international rating system to resolve the systematic contradictions of global rating system, a new regime of international rating that is historically necessary.
Dual rating means to add a new rating system apart from the ratings assigned by the existing rating system, and it should be regarded as the design and promotion of a new international rating system that cannot be realized through market competition.
III. Conditions of Realizing Dual Rating System
Making dual rating system the model of solving international rating problem is the choice made by human society after it has paid an extremely dear price for the unreasonable rating system. UCRG is exactly the undertaker of this historical mission.
Dual rating system is a worldwide revolution of rating system driven by human's pursuit of justified rating information to ensure the safe development of economic society. Its success needs the support and participation of the entire international community; so to form an extensive international consensus is the prerequisite for realizing this goal.
1. To theoretically summarize the relationship between global credit crisis and the international rating system, discover the development laws of credit economy and rating, and accordingly deliberate and judge over the rationality of the solution to international rating problems.
2. To intensively study the theory and practice of dual rating system, carry out design in implementation level, select a breakthrough, and produce global demonstration effect.
3. Every national government is the designer and promoter of the rating system, and government support is the key to the success of dual rating system. To accomplish this is in itself the performance of government’s supervision over rating, which is to establish and improve rating supervision through a system that is more in line with rating laws. Governments should adopt a new way of thinking to understand the significance of this system reform to its own country and to the world.
The global credit revolution has driven human society to a credit-based economy period by two pairs of contradictions: production vs. credit and credit vs. rating. Production vs. credit, as the driving force of economic pro-cyclicity, is too strong while credit vs. rating, as the force of economic counter-cyclicity, is missing for a long time, which has resulted in an unprecedented credit crisis in human society and the existing theoretic results cannot explain the cause of this crisis, even less to provide guidance for the prevention of the revival of crisis. Therefore, human society needs to muster up undaunted innovative courage to establish a credit economy counter-cyclical system by reforming the international rating system, to make rating the patron saint of the safe development human society,N which requires us to consider dual rating system as the courage and creation of the world’s greatest engineering construction in the current era.