Shame on credit rating agencies

Three domestic credit rating agencies have been notified of heavy penalties for inaccurate ratings to benefit their corporate clients. The Financial Supervisory Service (FSS) discovered they have been “selling” favorable grades and delaying unfavorable ratings to corporate clients in return for their business. In other words, the rating agencies served their clients at the expense of investors and the market, dealing a critical blow to the credibility of our credit rating system.

A credit rating helps investors assess cash flow, business prospects and the potential investment value of underlying securities, bonds and other debt paper. Credit rating agencies assist investors, regulators and others in identifying price discrepancies, security risks, risk management, capital allocation and trading.

The grading system is crucial in the operation of a capital market and serves as a pillar of guarding the reliability of the capital market, which is essential in a free-market system. Therefore, any manipulation, engagement of conflicts of interest, misrepresentation or dishonesty in credit ratings could shake the capital market and free-market order. The FSS may have to consider additional criminal action against the rating agencies on top of heavy administrative penalties so that dubious practices do not recur.

Domestic companies and their ratings have been under scrutiny for a long time. They incurred heavy losses for investors because they maintained the strong investment grade rating on debt issued by Tongyang Cement despite the company’s liquidity woes. They downgraded the securities only after the company went under court receivership.

International rating agencies also faced a series of damage suits for causing losses to investors by not warning them against subprime mortgage loans. Credit misrepresentations can not only disrupt market order, but also lead to a financial crisis.

Along with strong administrative and criminal actions, financial authorities must come up with effective measures to prevent fraudulent rating practices. Regulators should consider designating rating firms for corporate assessment or have them rotate in rating individual corporations in order to avert conflicts of interests. Agencies also should be required to disclose evaluation guidelines and information to support their rating decisions. Domestic credit rating companies could be the first to be shunned by the market unless they can restore their credibility.

JoongAng Ilbo, June 20, Page 30