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Building Up Constructing a Correct Rating Outlook On Rating

May 18, 2015 05:17 PM Author dagong Font:TTT

Guan Jianzhong


The reason why constructing an accurate ratings outlook has been proposed is that cognitive limitations are currently preventing us from scientifically drawing lessons from the global credit crisis that was triggered by Western credit ratings. We must curb our rectification of flawed credit ratings; it is urgent that we sort out ideas related to credit ratings and reach consensus in an effort to guide our ratings practice with an accurate ratings outlook.

Where does an accurate ratings outlook originate? It is by no means a subjective conjecture, even less does it possess an ideological outcome; rather, it is a cognitive result of the practice of a credit-based economic society. In particular, it is a result of reflections upon the lessons we are able to draw from the global credit crisis; it is also the logical representation of objective rules. Hence, it can withstand the tests of practice and time.

Then, the question is: what is an accurate rating outlook? In my opinion, the correct rating outlook should include the following ideas:

1. Credit Rating is Closely Linked with Society's Sound Advancement

The logic behind this idea is as follows: The credit relationships established between creditors and debtors have already been pervasive and globalized, and the credit system that has been constructed on credit relationships as a form of capital combination  serves as the main artery for social fund circulation. Therefore, credit relationships have become the economic base for singular countries and for the world; the status of credit ratings, as the medium through which credit relationships are established, directly determines the stability of credit relationships and the economic base.  Flawed credit ratings lead to bubbles in credit relationships. The bursting of credit relationship bubbles that are not underpinned by repayment capacities will definitely lead to breaks in the social credit system chain, thus triggering a credit crisis and sabotaging the economic base.

The absence of such an idea makes it very difficult for people to consciously consider credit ratings as an indispensable governance mechanism for contemporary economic and social development. It also makes it difficult for us prevent credit crises through effective credit rating risk control. Including this idea into the ratings outlook would enable us to scientifically summarize the lessons from the global credit crisis and safeguard mankind’s sound advancement, starting with institutional credit rating design.

2. Credit Ratingsare a Driving Force for the Counter-Cyclicality of Credit-Based Economies 

The logic behind this idea is as follows: The pervasiveness of credit relationships results in two pairs of contradictions, namely, the contradiction between production and credit and the contradiction between credit and rating. The contradiction between production and credit in essence demands an infinite expansion of credit to satisfy the growth of production, making it a driving force for the pro-cyclicality of credit-based economies. The contradiction between credit and ratings demands control of excessive credit expansion by providing quantitative boundaries for debts through credit ratings, making it a driving force for the counter-cyclicality of credit-based economies.

The absence of such an idea would make it very difficult for us to accurately define the role of credit ratings in credit-based economic societies, to meet the objective requirements for building a driving force for counter-cyclicality, and to effectively restrict excessive credit expansion. Including this idea into the ratings outlook would enable us to accurately locate the position of credit ratings in credit-based economic societies and have a clear understanding of the public responsibility that credit ratings should undertake.

3. Creditors Should Have a Say in Credit Ratings

The logic behind this idea is as follows: Creditors are capital owners, while debtors are capital users. Having an accurate estimation ond ebtors' repayment capabilities is a precondition for safeguarding creditors' interests. The stand of credit ratings is fundamental: only when creditors have a say in credit ratings can the stability of credit relationships be maintained through effectively disclosing debtors' risks and controlling debts' quantitative boundaries. When debtors have control over the say in credit ratings, it is inevitable that creditors’iinterests would be transferred to debtors through mismatching credit rating grades and credit risks, triggering the break-up of credit relationships. Therefore, decided by the basic norms of creditor-debtor relationships,  the final say in credit ratings should naturally go to the creditors.

The absence of such an idea would make it very difficult for us to escape the cognitive bewilderment surrounding the question of who should have the final say in credit ratings, and also make it difficult to resolutely correct the mistakes that occurred from the wrong parties having the final say in the practice of credit ratings. Including this idea into the ratings outlook would enable us to be fully aware that only by unifying the final say in credit ratings and capital ownership can the debt risks be truly disclosed so as to safeguard the soundness of credit relationships.

4. The Current International Credit Rating System is the Creator of the Credit Crisis

The logic behind this idea is as follows:

 (1) The final say in credit ratings, controlled by the incumbent players, decides where the global capital flows. This in turn decides the status of the international credit rating system;

 (2) The credit rating standings of the current rating system are to meet the needs of the host country's credit expansion, which in turn decides the orientation of the credit rating criteria;

 (3) The credit rating criteria of the current rating system serve the interest of the host country, violating the inherent logic behind the underlying credit risk factors, which in turn heralds credit rating failure;

 (4) Rating supervision over the incumbent players is missing; the host country's government has failed to implement effective supervision and regulation, while the international community is not entitled to supervise the rating behavior of a sovereign country's major credit rating agencies that provide the world with credit rating information.

The absence of such an idea would make it very difficult for us to spot the root cause of the credit crisis, and also make it difficult to come up with a final solution to avoid a reoccurrence of the crisis. Including this idea in the ratings outlook would enable us to get a clear understanding of the essence of the existing international credit rating system, reach consensus on reform, and find an accurate roadmap to address the problem of world-wide credit rating unfairness.

5. Constructing a New Type of International Credit Rating System is a Historic Choice

The logic behind this idea is as follows:

 (1) It is impossible for us to enable the current international credit rating system to take responsibility for providing independent and impartial ratings for entities across the world simply by attempting to patch it up, and it is even less likely for us to be able to uproot an institutionalized credit rating system that has been woven into the very fabric of our society;

 (2) The only correct choice of the institutional credit rating model is to set up a new international credit rating system that represents society's common interests and assumes the responsibility of assigning impartial and independent ratings to entities across the world in order to create a situation where the new and old credit rating systems co-exist to evolve;

 (3) The essence of constructing a new international credit rating system is to reconstruct a world-wide rating regime, for it would be altogether impossible to try to rectify the flaws of the current rating regime with a market approach. It will definitely be the result of reforming the credit rating regime through governments in an effort to effectively manage credit-based economies, since governments are the makers of regulations and regimes.

The absence of such an idea would make it very difficult for us to throw off the yoke of the traditional way of thinking, and also difficult to get out of the cycle that the world economy is still relying on flawed credit ratings in the post-crisis era. Including this idea into the ratings outlook would enable us to find the right direction for international credit rating system reform, stay steadfast in our beliefs of the reform, and identify who would bear the responsibility of the reform.  

6. Competition-Based Credit Rating RegimesNaturally Lead to theBetrayal of Ratings' Public Responsibilities

The logic behind this idea is as follows: As providers of credit ratings, CRAs embody their value through the credit ratings that they provide to creditors that are able to adequately disclose debtors' repayment risks. Credit ratings are the CRAs' finished products, and creditors make investment decisions based on this credit rating information. Objectively, CRAs are market players that are characterized by the social responsibility they take. As demanders of credit ratings, what debt issuers need is credit rating grades that will satisfy their own interests; the competition of multiple credit rating providers is actually creating an environment for debtors to select a higher credit rating grade. The competition-based credit rating regime directly promotes credit rating grade commercialization. If CRAs cannot meet the needs of debtors for higher rating grades, it would be difficult for them to survive and maintain their status in the market. The inevitable result of supply being dominated by demand is the mismatch between credit rating grades and credit risks, which leads to the accumulation of social credit risks while debtors are encroaching on creditors' interests. Consequently, credit ratings ultimately deviate from the due public responsibility.

The absence of such an idea would make it very difficult for us to locate the institutional cause for the failure of Western credit ratings, and would also make it difficult to make a breakthrough in the paradigm of introducing the generic market competition principle into credit ratings. Including this idea into the ratings outlook would enable us to explore the institutional mechanisms for credit ratings that would allow for a balance between responsibility and development.

7. Rating Criteria Decides the Rating Capabilities of a Credit Rating Agency

The logic behind this idea is as follows: Credit ratings interpret the internal links of real credit risk factors through cognitive methods, and accurate rating methodology is based on rating theories that reveal the rules governing credit risk formation. After all, rating capabilities are a credit rating agency's abilities to create rating theories and cognitive approaches, to unveil objective credit risks through rating theories and cognitive approaches, and shoulder the social responsibility of exposing credit risks. Hence, the only yardstick to measure the “rating”aof a credit rating agency is whether it is able to create original rating theories and criteria, and whether its rating theories and criteria reflect the objective rules of credit risks. Any subjective conjecture and plagiarism of ratings criteria will definitely lead to a credit rating agency's rating incapability, and the usage of ratings assigned by these CRAs will inevitably harm public interest.

The absence of such an idea would make it very difficult for us to differentiate a competent CRA from its incompetent peers, and also make it difficult to conduct professional rating practice management. Including this idea into the ratings outlook would enable us to find the rating rules in the intricate credit rating world and build an institutional environment that facilitates the sound development of the rating sector.

8.The Only Correct Supervisory Idea is to Prohibit Credit Rating Competition while Encouraging Rating Technology Competition

The logic behind this idea is as follows: A government is the maker of institutional models for a rating regime, and the regulator of rating practices and regulatory ideas plays a decisive role in the government’s activities. The regulatory idea that generic market competition is introduced into the credit rating sector and that the credit rating sector develops better in a fully competitive environment will unavoidably cause institutional credit rating rivalries. Consequently, ratings will become a tool used to cover up risks for debtors' interests. The regulatory idea of prohibiting credit rating competition and encouraging rating technology competition reflects the essential requirements for credit rating agencies to fulfill their social responsibilities. By acting on this concept to design an institutional model for rating regime and regulate credit rating agencies, it is possible to stimulate technological advancement and enable credit ratings to unveil credit risks while safeguarding creditors’cinterests.

The absence of such an idea would make it very difficult for us to learn a hard lesson from the failure of the ratings assigned by Western credit rating agencies and to identify an institutional approach for the scientific regulation of credit ratings. As a result, it would be inevitable that we would repeat the same mistakes. Including this idea into the ratings outlook would enable us to avoid the situation where the intended strengthening of credit rating regulation is transformed into exacerbating credit rating competition, and avoid turning back the wheel of history.

9. Reducing Dependence on Credit Ratings is a Fantasy that Goes Against the Rules of Credit-Based Economic Development

The logic behind this idea is as follows: Credit relationships established between creditors as capital owners and debtors as capital users are, in essence, a type of capital combination. This type of capital combination has become a mainstream form of capital supply amid the socio-economic development in modern times. The establishment of credit relationships is a prerequisite of capital supply and, in order to make capital supply work, creditors' accurate judgment of debtors is crucial. Hence, amidst the pervasiveness of credit relationships, credit ratings that reveal the credit risks of debtors are selected as the medium through which to forge credit relationships, and are endowed with the role of deciding credit capital flow. Credit ratings determine credit relationships, while credit relationships decide the supply of social funds. This is sound logic that naturally came into being in the development phase of credit-based economy. Cutting reliance on ratings is a makeshift measure that has been taken to prevent a credit catastrophe from happening again, which suggests people’s incapability of understanding the rules governing the development phase of credit-based economies. Moreover, this option will result in credit disorder and crisis as it intensifies the asymmetry of information about social credit risks, impedes free capital circulation, and mismatches creditors and debtors.

The absence of such an idea would make it very difficult for us to shun blindness in rating governance and to actualize the desired results of the rating practice. Including this idea in the ratings outlook would enable us to make correct choices and reasonably contemplate the development model of the credit ratings sector.

10. It Makes no Sense for Credit Rating Agencies to be Legally Accountable

The logic behind this idea is as follows: Credit ratings are a kind of scientific prediction in the scope of economics. They are projections of possible future scenarios made by analyzing and processing accurate and relevant information through logical reasoning. Whether the prediction is sensible or not depends on two major factors. One is an institutional guarantee: whether such an institutional environment is available to secure fair ratings, such as rating system models and credit information support systems. The other is ratings criteria: whether there are rating theories and criteria that reflect the intrinsic links between credit risk factors. Essentially, institutional arrangements carry much weight with the latter factor. In a distorted credit rating environment, the idea that credit rating agencies are simply held legally accountable for the consequences that ratings may cause does not have a legal basis. At the same time, different from other intermediary services, credit ratings are not conducted to identify what has happened, but area conclusion of subjective judgment that serve as reference for investors in consultation. If credit ratings were held legally accountable, no one would risk assigning credit ratings.

The absence of such an idea would make it very difficult for us to get a clear picture of the root causes of problems in the credit ratings sector and formulate laws and policies in light of the rules governing credit rating. Including this idea into the ratings outlook would enable us to carry out professional credit rating agency management and prevent institutional failure from distorting the development of the entire rating sector.

11. Charging ModesareNot the Root Cause of Partial Ratings

The logic behind this idea is as follows: Credit rating agencies are market players responsible for their own losses and profits, and they realize the value of their services by charging fees from rating users. Rating users can be divided into two groups: bond issuers on one hand, and investors on the other. Furthermore, investors can be segmented into end investors and intermediary investors, who live on bond trading. If rating fees are directly collected from bond issuers (debtors), conflicts of interest will happen in credit rating, and thus affect the impartiality of credit ratings. If end investors (creditors) are charged a rating fee, no conflicts of interest will happen. That being said, it is not feasible to charge numerous investors rating fees under the current institutional setting. When intermediary bond investors- instead of bond issuers- are charged rating fees, stronger conflicts of interest will occur. The reasons behind this scenario is that intermediary bond investors are brokers in bond markets. If these brokers control have a say in the credit ratings, ratings would turn into a tool for them to directly manipulate the bond market and rake in more profit. The attempt to charge investors instead of issuers in a bid to address the problems facing credit rating agencies only scratches the surface of the conflict of interest between the charging mode and credit ratings. It is assumed that this effort would remove conflicts of interest, but it couldn’t eliminate the detriment brought out by credit rating competitions that are ignited by a credit rating system with adequate competition, which is the underlying cause of partial ratings.

The absence of such an idea would make it very difficult for us to clearly see the nature of the problems facing credit rating agencies and truly tackle the fundamental problems of credit rating. Including this idea in the ratings outlook would enable us to discard a metaphysical mentality and hammer out management methods in line with the rules governing credit rating development.

12. Credit Rating Problems Addressed by Encouraging Competition Will Only Exacerbatingthe Rating Crisis

The logic behind this idea is as follows: Responsibility and development is the inner core of the intrinsic rules governing credit rating. This requires CRAs to achieve self-development on the premise that they perform public responsibilities through technological progress in an effort to enhance their risk-disclosing abilities. After the global credit crisis, in an effort to prevent flawed ratings from impairing the social economy, competition in the rating industry has been universally encouraged for the purpose of reinforcing regulation and supervision. Nevertheless, without knowing what kind of encouraged competition would be beneficial to the soundness of the credit system, increasing the number of competitors in the game will result in competing CRA's luring talent with higher remuneration, which will drive up the cost of human resource in the rating industry, hence inflicting a new round of impairment to the rules governing talent maturation through accumulation of hands-on experience in the credit rating sector. Blindly firing up competition will also make CRAs scramble for clients by assigning higher rating grades, which will abet rating grade commercialization, hence inflicting a new round of sabotage to the credibility of the entire rating sector, and showing not the slightest sense of progress. Therefore, ill-intentioned competition that goes against the core rules of credit rating is nothing short of drinking poison to quench  one's thirst.

The absence of such an idea would deprive people of the courage and wisdom to challenge formidable traditions, leaving people unable to voluntarily rectify the incompetent credit rating management regime. Including this idea into the ratings outlook would enable us to reflect deeply on the existing competition mode of the rating industry and therefore lay an ideological foundation for the reconstruction of the rating regime.

13. It Is Utterly Impractical to Promote Mutual Rating Results RecognitionBetweenCountries

The logic behind this idea is as follows: The aspiration to attain cross-border rating information flow by promoting mutual rating result recognition between countries is against the rule of rating information formation. The domestic political and economic environment of a country is the key objective credit risk factor for local debtors, while their own profitability the key subjective one. The aforementioned two categories of risk factors essentially shape the particularity of what makes a country’s credit risks; hence demonstrating the fact that countries are distinctive in credit risk formation mechanisms. Local domestic CRAs adopt certain rating criteria that is only suitable for disclosing the credit risks of local debtors, and accordingly generate very different rating results. It is simply impossible to quantify and have mutual recognition of such a great variety of rating opinions that represent the features of different countries' credit risks. Meanwhile, the cross-border mutual recognition of rating results will inevitably give debtors complete freedom to choose a CRA they prefer when there is no guarantee of a regulatory system for cross-border ratings. Given the stance of debtors, the reliability of rating information will be adversely affected. Consequently, mutual recognition will evolve into cross-border transference of credit risks with severe repercussions.

The absence of this idea would make it very difficult for us to explore the mode of the transnational flow of rating information from the view of the globalization of credit relationships, reach consensus on reform, and take action. Including this idea into the outlook on rating would enable us to cast away illusions and proactively seek the correct development path for the credit ratings sector.

14. It Deviates from the Time Neededto Establish Regional CRAs in the Context of Credit Globalization 

The logic behind this idea is as follows: Global economic integration requires an international capital flow system to underpin the economic integration options; the capital form featuring credit relationship combinations is the artery of this system. Credit relationship globalization is an unavoidable trend; cross-border and cross-region combinations of credit relationships call for globally consistent, comparable, and transferable rating information as an intermediary. Credit ratings present their value by catering to the need for capital flow. Because there is almost no absolutely closed regional economy, regional rating information cannot facilitate capital flow across regions for local capital; neither can it be accepted as an intermediary for capital flow for capital from other regions. Therefore, it is impracticable to attempt to address the problems in the current international rating system by resorting to regional ratings.

The absence of such an idea would make it very difficult for us to have a good understanding of the objective environment for credit ratings, and also difficult to find the correct path to reform. Including this idea into the outlook on rating would enable us to comply with the time needed and devote ourselves to creating a global CRA.

15. The Dual-Rating Model is the Best Option to Address Credit Ratings' Global Problems

The logic behind this idea is as follows: The post-crisis era has witnessed mankind’s enormous efforts to redress the current international rating system. Proposals, such as reinforcing the regulatory regime in the rating sector, reducing reliance on ratings, CRAs being legally accountable for the ratings they provide, changing fee collection modes, encouraging competition between CRAs, promoting mutual rating result recognition, and creating regional CRAs are among the endeavors to reform the global credit rating system. However, those endeavors would never shake the foundation of the current international rating system that has been highly institutionally incorporated with credit-based economic activities, let alone prevent flawed ratings from being circulated in the future. We must base ourselves on the fundamental requirements of the globalization of credit relationships for the credit rating system and build up a new global rating system that represents the common interests of mankind-a system that provides consistent, comparable, and transferable rating information to facilitate international capital flow and offer an alternative credit rating. Only through a new system can we reshape the current global credit rating landscape. In other words, what we endeavor to establish is a new, non-sovereign-owned global credit rating system that will coexist with its functioning sovereign-owned counterpart for the purpose of forming a new global rating architecture boasting co-existence, openness, inclusiveness, complementariness, and counterbalance between the two systems. This is the optimum option for society to reform the global credit rating system.

The absence of such an idea would make it very difficult for us to grasp the historic opportunity to reshape the global credit rating order, and also make it difficult to prevent flawed credit ratings from crippling the world economy. Including this idea into the ratings outlook would enable us to precisely depict the blueprint of the global rating system and to reduce the reform costs.

16. Governments are the Primary Undertakers of Rating Responsibilities

The logic behind this idea is as follows:

(1) Credit rating is a management system in a credit-based economic society, and governments are the undertakers of this top-level institutional design. It is an important means for the government to regulate the macro-economy and ensure sustainable socio-economic development through constantly expanding the scale of direct financing so as to generate additional consumption capability, thus creating a major relationship in national economy in terms of the proportion between the social debt scale and the sources of repayment. This objective rule requires that the government should not only have in place regulations that guarantee the increase of the credit scale, but should also scientifically formulate a credit rating regime that discloses sources of repayment risks. Only in this way can we avoid the ultimate destruction to national economies through excessive debt scale expansion due to the absence or irrationality of the credit rating regime.

(2) Credit rating puts national credit systems and economic bases at stake, and governments are the undertakers of this responsibility. The pervasiveness of credit relationships established between creditors and debtors not only constitute the social credit system on which social reproduction relies for its normal operation, but also has become the economic base of society as a whole. As the medium through which credit relationships are established, credit rating directly determines the status of the national credit system and economic bases; what is decisive to credit rating in performing this significant social responsibility is the rating regime developed by the government. Only by developing a management system that encourages those CRAs capable of undertaking rating responsibilities in light of the essential requirements of credit rating  through the development of a credit-based economic society can we prevent incorrect ratings from becoming a destructive force that may overthrow national credit systems and economic bases.

The absence of such an idea would make it very difficult for us to find the primary undertaker of rating responsibility fundamentally, and also make it difficult to assign the due role of credit rating in the management of a credit-based economic society institutionally. Including this idea into the ratings outlook would enable us to understand the government's administrative responsibility in supervising credit ratings. Social debts can be effectively controlled with a scientific rating regime in place, making it a positive forcein driving the development of a national economy.

The global credit crisis, triggered by flawed credit ratings assigned by Western CRAs, is far from over. Among the most practical needs of this era is changing the status quo of global credit ratings, guiding capital flow with impartial rating information, and expediting the process of the global economic recovery. In order to extricate ourselves from the misunderstandings of credit ratings and carry out accurate rating practices, we need an ideological transformation. Building up an accurate outlook on ratings complies with this historic need.