Rating agencies are obliged to act with utmost responsibility

On June 1, the European Union’s market regulator fined Moody’s German branch €750,000 ($844,900) and British branch €490,000 for failing to abide by the EU’s rating regulatory rules. The EU move, together with Beijing’s rebuttal of Moody’s downgrading of China’s credit rating, reflects the controversial role rating agencies play in the global economy.

The European Securities and Markets Authority said in a public notice that Moody’s German and British branches “negligently committed two infringements of the Credit Rating Agencies Regulation regarding their public announcement of certain ratings and their public disclosure of methodologies used to determine those ratings”.

Late last month, Moody’s downgraded China’s credit rating for the first time in nearly 30 years, citing the country’s expected erosion of financial strength in the coming years following slowing growth and debt pile-up. In response, the Ministry of Finance said Moody’s overestimated the risks to the Chinese economy and the downgrading was based on “inappropriate methodology”.

The two cases show rating agencies have become increasingly controversial thanks to the inapt methodologies they use and are facing more challenges from their rating targets.

In fact, this is not the first time a major rating agency such as Moody’s has been questioned. Before the 1997-98 Asian financial crisis erupted, the three major rating agencies — Moody’s, Standard and Poor’s, and Fitch — failed to sound alarm by downgrading the ratings of the concerned economies. Instead, after the crisis broke out, they promptly downgraded some Asian economies’ ratings only to intensify the crisis and worsen the situation.

And before the global financial crisis broke out in 2008, the three major rating agencies had issued favorable ratings for securities backed by subprime loans, which in turn exacerbated the crisis.

... and Moody’s can destroy you by downgrading your bonds.