Moody's proposals for ratings transitions for investment grade issuers subject to event risk have provoked a storm in the treasurer community. The reaction was especially strong considering that Moody’s consulted the market during the dog days of summer.
To take account of transforming events, Moody’s was proposing to transition the ratings via a series of interim rating actions as opposed to a significant, one-off multi-notch rating after the consummation of the event. The progression of these sequential rating actions would be based on the interrelated factors, the expected degree of migration from the current rating to the final potential rating, and Moody’s ongoing assessment of the probability that the transaction would complete.
Treasurers could see no benefit in such a revised approach, especially as there is no evidence that the present system of placing a rating under review and analysing the potential change is no longer sufficient. If Moody’s does decide to adopt the new approach it needs to proceed cautiously, only making a rating change when the event has become highly probable. Moving any faster could be premature and imply more than is warranted. Moody’s does acknowledge the difficulty that this proposal would create: the agency would need to assess the possible credit impact of any rating action on notes that may benefit from a change of control and associated downgrade type of clause.
All this provokes some wider questions about the role of credit ratings. In a sophisticated, global market economy no one can dispute the role of a credit rating as a standardised assessment of the creditworthiness of an entity which investors and analysts can use as a guide for investment decisions. The problem is when credit rating agencies move from being informed onlookers in the securities markets to participants. The agencies dislike their ratings being used for purposes such as triggers in loan agreements for pricing or events of default, or for bank capital purposes, but this is what happens in the market now.
Ideally, treasurers should not allow rating triggers into agreements since the ratings are not within their control. A preferable measure is a specific financial covenant, which gives treasurers and their colleagues much more control over their company’s affairs.
The fear for treasurers wrestling with transforming events is that rating triggers can quickly create a vicious spiral, with a downgrade causing default or increased interest rates, which lead in turn to a further financial deterioration, which causes a ratings downgrade.
A good treasurer is one who spends time maintaining a decent relationship with the rating agencies, conscious that they wield enormous amounts of power. With this power comes responsibility.
Dealing with transforming events is difficult. All stakeholders need to be confident that any change in approach will not disadvantage corporates and investors nor needlessly confuse and disrupt markets.
PETER WILLIAMS
Editor
See Marketwatch, page 05
