Articles & Speeches

Correct Rating Theory is the Cornerstone for Performing Ratings Responsibility

May 18, 2015 05:11 PM Author dagong Font:TTT

Guan Jianzhong

Distinguished guests and friends from the press,

Good morning!

Today, we are hosting this press conference for the release of the Guiding Principles of Credit Rating. As a credit rating theory, it is of utmost significance for credit rating practice, and is closely related to the sound development of our socio-economic base. The deficiencies and misconceptions of the Western credit rating system have taken a toll on the global financial system; theGuiding Principles of Credit Ratingwas independently created by Dagong to fill in a gap found in the century of rating history. The effective distribution and explanation of the new rating theory is of paramount importance for the healthy development of the global economy.

Credit relationships between creditors and debtors manifest themselves as a form of capital combination. The pervasion of credit relationships contributes to the formation of debt chains, which ultimately form a capital flow system. This system, incorporated into social reproduction, makes credit relationships the economic base of a modern society. The premise of credit relationships is the estimation of the debtor’s default risks made by the creditor. Credit relationships suggest the combination of pervasive credit demand and supply relationships. The debtor’s credit ratings are needed for the creditor’s judgment, and they become a medium through which credit relationships are built. In this context, credit rating undertakes the responsibility of maintaining stable credit relationships and reinforcing the socio-economic base and credit rating results, true or false, which have a stake in sound socio-economic development. That being said, what acting factors decide rating results?

Credit ratings, by looking into the true picture of the debtor’s credit, play a role in revealing existing credit risks. Credit rating demonstrates a comprehensive approach. In other words, credit ratings act as an ideological method to recognize credit risks, and rating methodologies determine the rating information quality. In this sense, what decisively affects rating methodologies?

Factors contributing to credit risks have intrinsic connections between them; the rules of motion present themselves in an intricate and out-of-order form, making it difficult to discover their essence at first sight and truly expose potential risks. Therefore, we need to do in-depth research to look for the intrinsic logic behind credit risks and objective rules in order to developlogic that reflects the rules- that is, a credit rating theory. Credit rating theories are methodologies that follow and unveil the rules governing credit risk formation, setting a general direction for credit rating practices. Rating methodologies that are not underpinned by rating theories are like water without a source or a tree without roots; they will eventually lose their essential value. Rating methodologies that have been misguided by incorrect rating theories violate objective rules, and will naturally lead to rating failure.

The aforementioned analyses tell us that in the era of credit-based economy credit rating theories, rating methodologies, rating information, and credit relationships constitute part of the intrinsic development rules governing the economic base. Only accurate credit rating theories are able to maintain the healthy development of pervasive credit relationships, as well as the economic base.  

I. Historic Background of the Emergence of the Guiding Principles of Credit Rating

The global credit crisis that broke out in 2008 wreaked havoc on international credit relationships established by Western credit ratings. The crisis has exposed the world economy's disguised prosperity, which had been nourished by excessive credit supply, but had not changed the basic rules regarding credit-based socio-economic development. That is to say, credit relationships remain the economic base of a modern society, credit ratings are still an approach to building credit relationships, and rating continues to be the groundwork of stable credit relationships. The credit crisis has testified that Western credit rating systems can no longer be relied to provide impartial global ratings. Under these circumstances, a historic mission emerged: to guide rating practices through accurate credit rating theory.

National brand internationalization, a path taken by Dagong as its international development strategy, will guide Dagong to develop itself into a world-wide influential credit rating agency by contributing Chinese wisdom to the world in the credit rating sector. Therefore, Dagong is strongly motivated to innovate a rating theory, build a competitive edge in rating philosophy, and make it widely recognized by the international community. With this in mind, Dagong has courageously taken on the historic mission of theoretical and ideological innovation.

II. The Framework of the Guiding Principles of Credit Rating

Dagong’s Guiding Principles of Credit Rating represents a methodology unveiling intrinsic connections between the factors contributing to default risks. This theory aims to reveal the general rules governing credit risk formation; it is the foundation for developing rating methodologies for specific debtor communities.

1.The philosophical method behind Dagong’s Guiding Principles of Credit Rating

Dialectical materialism, the thinking method adopted for theGuiding Principles of Credit Rating, tells us that we should start theoretical innovations regarding credit rating by exploring the essence of credit risk formation, study both subjective and objective factors affecting the debtor’s repayment capability as an approach to discover their intrinsic links and rules of motion, and set up a system of cognition to reveal credit risks. The principles guiding the theoretical innovation originate from reality, exceed reality, and are applicable in reality.

2.The theoretical base of Dagong’s Guiding Principles of Credit Rating

The theoretical base for theGuiding Principles of Credit Ratingis the theory of credit rating as a countercyclical element. Two pairs of contradictions, namely the contradiction between production and credit and the contradiction between credit and rating, are the driving force behind the development of a credit-based economy. The first pair of contradictions essentially demand infinite credit expansion to satisfy the growth of production, making it a driving force for the pro-cyclicality of the credit-based economy. The second pair of contradictions demand control of credit expansion risks, making it a driving force behind the counter-cyclicality of the credit-based economy. This significant theoretical attainment, achieved by Dagong, ensures the position and role of credit rating in the credit-based economy. It also provides the objective and purpose for theoretical innovation, that is, credit ratings should aim to prevent the exponential expansion of social credit size through disclosing the risks of repayment sources when covering debts.

3.The ideological system behind Dagong’s Guiding Principles of Credit Rating

This system is a holistic, theoretical description of the developmental rules governing rating practices. It includes nine aspects:

(1) The idea that superstructure impacts solvency;

(2) The idea that economic bases impact solvency;

(3) The idea that wealth creation determines solvency;

(4) The idea that the degree of deviation between the sources of repayment and wealth creation capacity is important;

(5) The idea of the three debt repayment capabilities;

(6) The idea of assigning ratings by a progressive matrix exponent;

(7) The idea of credit risk alerts;

(8) The idea of an analogue simulation of diversified credit risks;

(9) The idea of consistency and comparability.

The ideological system for Dagong's credit rating provides principles and orientation for the implementation of credit rating theory as a counter-cyclical element. It serves as a powerful ideological instrument to excavate and restore the inherent links between credit risk factors.

4. Dagong’s Guiding Principles of Credit Rating

The textGuiding Principles of Credit Ratingis composed of two parts: part one builds analytical logic to determine solvency risk elements, while part two presents the analytical results of part one through rating language. The rating principle consists of the following eight units: repayment environment, wealth creation capabilities, repayment sources, debt repayment capabilities, credit rating determination, credit rating verification, simulation tests, and credit rating symbols.

The Guiding Principles of Credit Rating are shown in the following diagram:

Dagong’s Guiding Principles of Credit Rating boasts it most conspicuous innovation in the idea of the degree of deviation for repayment sources against wealth creation capabilities, with the degree of deviation in direct proportion to solvency risk.  In reality, there are various repayment sources, and each repayment source varies in its impact to the solvency risk. For instance, one debtor may repay their debt with profit, while another debtor may repay their debt by printing more bank notes. In each scenario, the debt is repaid; the decisive factor in differentiating the security degree of their repayment capabilities is the difference between the repayment source and wealth creation capabilities- namely, the degree of deviation.

III. The Historic Position and Significance of Dagong’sGuiding Principles of Credit Rating

The Guiding Principles of Credit Rating establishes its position in global credit rating history through revealing credit rating laws discovered by applying objective laws to credit risk formations.

1.Pinpointing the rating position for the first time

Committed to answering the three questions about debtors’ repayment capabilities and evaluating the security level of repayment capability in an effort  to perform the counter-cyclical function of rating, the Guiding Principles of Credit Ratingaffirms rating's role in preventing credit crises from triggering economic and social turmoil by preventing excess credit expansion. It theoretically unravels the position of credit rating in the social evolution of credit-based economy for the first time.

2.Fully explaining credit rating philosophy for the first time

Aiming to assess repayment capability, the Guiding Principles of Credit Ratingdraws a rating roadmap from elements affecting repayment capabilities to achievements in disclosing credit risks, and develops a full and clear rating philosophy system. This, for the first time, presents the intrinsic credit rating rules in a systematic way.

3.Formulating the degree-of-deviation rating concept for the first time

Dagong’sGuiding Principles of Credit Ratingpersists in taking wealth creation capability as the fundamental source of debt repayment, believing that any source of repayment that deviates from wealth creation capabilities contains uncertainty, and that the further the deviation, the greater the risk. Such an inventive rating philosophy provides the means to prevent debtors' misuse of credit, while their repayment sources substantially deviate from wealth creation capabilities and play the countercyclical role of credit rating. The assure, for the first time, the correct direction for rating development.

The emergence of Dagong’sGuiding Principles of Credit Ratingwill be positive in the following three aspects:

1. It fills in the international theoretical gap in credit rating, taking on epochal significance;

2. It consolidates the role of rating as a countercyclical driver for credit-based economies, taking on practical significance;

It changes people’s awareness and understanding of credit ratings, which is conducive to the wide application of accurate rating concepts, taking on social significance.

The global credit crisis testifies to the failure of Western credit rating at the cost of the entire international financial market suffering the consequences of the crisis. The Western rating theory goes against the rules of credit risk formation, and is the object of questions and denouncements from all over the world. What we can learn from this situation is that only correct rating theories can enable us to discover credit risk formation mechanisms by looking into the very core of the extremely complicated credit risk systems. Credit rating agencies should undertake public responsibility by providing the market with impartial and independent credit rating information. Therefore,N the only criteria that should be used when measuring whether a CRA is able to perform its rating responsibilities is the capability to innovate a theoretical credit rating system and develop rating methodologies. The emergence of Dagong’s Guiding Principles of Credit Ratingplays the role of a cornerstone for Dagong to undertake rating responsibilities in an even bigger market.

Thank you!