Trusting the rating agencies - A global problem

 

For debt investors, 2021 is year of nervousness - what don't we know about the debt we hold? More specifically. what are the risks in China fixed income? What is underneath the Evergrande iceberg?

Evergrande was declared in default by S&P on December 16th, a week after Fitch. Moody's gave Evergrande a C rating in September which is typically applied to default firms and is its lowest rating. Chinese rating agencies have kept Evergrande at much higher ratings than the big three international agencies. There really was no choice but the real question is why rating agencies took so long to see the problems of Evergrande 

There is a home bias that works against international bond investors and the bankruptcy process now falls into the political. Two of the most important elements of an efficient capital market are trust and certainty with the rules of the game. 

There needs to be trust in accounting numbers. Auditors have to be a frontline defense for investors. There needs to be trust in those who evaluate firms, yet we know that brokerage firms can have biases withe their evaluations. We look to third party firms to provide unbiased advice, the rating agencies, yet these firms also may have biases. Regulators must ensure that firms follow the rules and push for maximum transparency. Still, we always must ask the simple question, "Cui bono, who benefits?".

Certainty is needed to know that the rules of the game are stable. This applies to contract and bankruptcy law. It is a fluid concept based on the interests of the powerful.

There is no question that every investor should do their own analysis, but rating agencies should provide a useful signal weight of relative credit worthiness versus the set of all possible credits. 

Unfortunately, only under stress do we find out that there are clear biases, and the system has biases. Only under bad times are the flaws of the system evident but by then it is too late.