Arjoon Harripaul, Contributor
HARRIPAUL
CREDIT RATINGS arose out of the railroad expansion in the United States the capital requirements were too heavy to be met by only bank loans (even cross border bank loans) and equity injections. The solution was to create a large corporate bond market which dwarfed all the then existing sovereign bond markets.
Credit ratings arose in an environment where relationships, merchant bankers' prospectuses and specialised publications were insufficient to meet the investor's demand for independent information.
The fact that credit ratings are first and foremost a response to the market's demand for information is evidenced by the number of entrants to the credit ratings business since the 1970s. In 1973 the Bretton Woods system of fixed exchange rates collapsed giving way to flexible international exchange rates. International capital flows and financial globalisation on a previously unknown scale emerged. There was a manifold increase in the scope for raising global funds and with it came the urgent need for better, more extensive credit information world-wide.
The first expansion of credit rating agencies outside of the U.S. was seen in its northern neighbour, Canada. The Canadian Bond Rating Service was founded in 1972 followed by the Dominion Bond Rating Service which now serves Canada, the U.S., Europe and Japan. The Japanese followed with Mikuni & Co in 1975, the Japan Bond Research Institute in 1979 and the Japan Credit Rating Agency in 1985.
International Bank Credit Analysis was formed in the U.K. in 1979 and was merged with Fitch in 1997 to form Fitch/IBCA.
CRISIL Limited started in India in 1987 and has grown to become the largest rating agency after S&P, Moody's and Fitch. CRISIL is the technical consultant to CariCRIS.
NATIONAL RATING SCALES
There are at least 60 credit rating agencies world-wide and it is an almost impossible task to keep track of them all due to mergers, buyouts, etc. The majority of CRAs are domestic and use national rating scales. A national rating scale allows an investor to compare the creditworthiness of a borrower in respect of a particular debt instrument issued in the domestic financial market relative to all other borrowers issuing paper in the same market.
CariCRIS is proud to be a global innovator in the ratings business by introducing a rating scale where the sphere of comparison is neither global nor national but rather regional.
In order to assess the timeliness and relevance of CariCRIS to the regional financial markets, it is useful to examine how the Caribbean compares with the state of the U.S./world financial markets at the time that credit ratings were birthed and flourished.
Conditions that created the need for credit ratings at the beginning of the 20th century:
Large sums of capital required With the advent of large railroad projects the amount of debt to be raised both domestically and internationally was too much for bank loans and equity injections. This characteristic remains true for several large projects being undertaken in Trinidad & Tobago and the wider region - a single jurisdiction is not able to absorb the full capital requirement of individual large projects. Examples include issues by Trinidad Cement Limited and National Flour Mills.
2. Globalisation. European investors wanted to benefit from on-the-ground knowledge without being present during the US railroad expansion. If the demands of globalization were felt in the 1900s they are felt even more keenly now. In applying this point to the Caribbean region perhaps the term "regionalization" can be used. Regional markets were birthed in the 1990s when governments did not have access to favourable conditions outside of the Caribbean. Caribbean cross-border transactions will only increase. A Trinidadian investor in Jamaican, Antiguan or Barbadian paper increasingly wants verifiable on-the-ground information - word of mouth is insufficient.
3. Expansion of investor base. Before the birth of the US corporate bond market, investors in bonds comprised the very few, very wealthy. As the US corporate bond market was birthed, the investing class expanded rapidly. There was a rising swell of demand for information. The Caribbean region is becoming increasingly more financially sophisticated with lay and other non-institutional investors joining the market. As at June 2004, mutual funds (registered with the Central Bank) nearly matched the global deposits of the banking system in T&T. This is being replicated throughout the Caribbean. But most investors are ignorant of the underlying credit risks of the mutual fund - and most mutual funds have no guarantees. In other words, soon the investing public is going to move beyond the illusion of safety offered by a mutual fund and demand to know the underlying credit risks and the specific diversification benefits.
4. Need for independent information. As the investor class expanded, the reputation of merchant banks was insufficient; investors wanted access to the same information and they wanted it from an independent source. The Caribbean financial markets are at a similar juncture - the demand for independent information is increasing. This was evidenced when CariCRIS performed its feasibility study - all market participants thought the time was ripe for an independent information and rating agency.
5. Need for uniform comparability. Although the US corporate bond market started in the railroad industry, the amount of debt issued by state and local government grew quickly. In addition, public utility and manufacturing companies joined the market. Investors wanted to be able to compare creditworthiness of various kinds of instruments in different industries on the same scale and thus benefit fully from comparability. This is a pressing need in the Caribbean financial markets today.
CariCRIS was formed and launched for operations in 2004 in response to the Caribbean market's need for independent information and analysis, particularly on a regionally comparable and consistent scale. The questions of appropriate pricing and risk diversification demand this information.
CariCRIS is the Caribbean's Regional Credit Rating Agency. This article forms part of a series on issues surrounding capital markets and credit ratings. E-mail: info@caricris.com or call 868-627-8879.
