So much recent market volatility has been caused by the downgrading of the USA by Standard and Poor from AAA status. But who are these agencies and what does this mean?
Credit rating agencies grade government and companies on how well they have performed against credit worthiness criteria.
There is inevitably a degree of subjectivity within this process as has been seen with this recent downgrade. The figures being banded about by the White House and Standard & Poor (S&P) cannot both be correct, and much is clearly down to interpretation.
The AAA rating that the USA lost recently is the equivalent of an A grade and indicates that the holder is almost certain to pay back its loans. It is the highest possible ‘prime’ rating, and agencies say of that the holder of an AAA rating has ‘extremely strong capacity to meets its financial commitments’.
The USA has been downgraded by one notch to AA* which means in rating agency S&P’s view that the USA government just has a ‘very strong’ capacity to repay all loans.
The USA is now officially classed as a riskier bet that investing in the UK, Australia, Sweden and even the Royal Borough of Kensington and Chelsea which all have AAA ratings.
Having a strong rating is important because it determines how much a country, principality, company or even individual is charged to borrow money.
S&P’s ratings decrease on a sliding scale from AA, AA -, A + and A to BBB. Anything below BBB is described at sub investment grade or junk. The lowest rating is D which shows that a company or country has defaulted on its debts.
Rating agencies can be traced to the 19th Century, and the major rush to build railways across America. Investors wanted to establish which of the many ambitious rail road projects were the safest bets. Henry Varnum Poor (one of the founders of S&P) was one of the first analysts to publish an analysis of the financial health of the various railway companies.
John Moody launched a similar venture called ‘Analysis of Railway Investments’, in the earlier 20th Century. ‘Fitch Ratings’ founded by John Knowles Fitch, says it was the first agency to create an alphabetical rankings for bonds issues by countries, called Sovereign Debts, and corporations in 1924. The ratings apply to both countries and companies.
Today, S&P, Moody’s and Fitch are the world’s biggest and most respected agencies. They are regulated by the Securities and Exchange Commission (SEC) – the USA financial regulator, which has endorsed them as ‘Nationally Recognised Statistical Rating Organisations’.
Recognition as an NRSRO is important because it tells investors that the agency in question has a track record of correctly analysing countries and companies financial health and therefore how likely it is that they will get their money back.
Some investment funds are only allowed to hold bonds that have very high ratings from a credited agency.
There are 10 rating agencies recognised as NRSRO’s – the designation which first came into use in 1975 – including a Canadian and 2 Japanese agencies, but S&P, Moody’s and Fitch remain the standard bearers.
[For further information on Griffin & King Licensed Insolvency Practitioners in Shrewsbury, contact Janet Peacock on 01743 491239.]
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