For Whom Daogng tolls
Among the many prominent victims of the financial crisis of 2008-09 – which began with the collapse of the housing bubble – were the main ratings agencies. Although the companies themselves did not collapse, their reputations and professional standing were irreparably sullied. In every analysis of the crash, whether academic, governmental or popular, the significant contribution of the ratings agencies – primarily the two biggest American ones, Moody’s and Standard & Poor’s – to the ultimate disaster is highlighted. No-one, it seems, has a kind word to day about them and their performance, and when you read about how they made a mockery of their self-proclaimed objectivity and ignored or debased their professional standards, all in pursuit of loot, it’s easy to understand why.
Indeed, what is surprising is that these ratings agencies are still around, doing the same kind of work – albeit under greater regulatory scrutiny and hopefully in a humbler mind-set. But the sad fact is that nothing fundamental has changed: the agencies’ inherently flawed business model — in which they are paid by the entities they rate, not by the users of their analyses – is still in place, and the markets still seem to be way ahead of them in identifying problematic borrowers, so that their bond prices slump well before their ratings are downgraded.
It is thus hardly surprising that there is a widespread demand for something better. What is very surprising, and is perhaps a remarkable reflection on the way the global financial system is developing, is that one of the most serious offers of ‘something better’ is emerging from China. Given the poor reputation of the Chinese financial markets and the numerous scandals involving Chinese companies that used ‘creative’ accounting techniques – or even cruder methods of fraud – to separate investors permanently from their money, the idea of a Chinese rating company seems inherently problematic.
But there are several strong arguments against this kind of knee-jerk negativism. One is simply to read about the cynical, systemic and deliberate distortions inflicted by the Western paragons of professionalism – the Chinese will have to work hard to be worse than that. The second is that the ‘Wild West’ environment in the Chinese securities markets is an inevitable stage in their development – as is the response to this, in the form of investor protection mechanisms, including government regulators on the one hand, and private sector entities – such as ratings companies – on the other.
Then there is the simple fact that Dagong Global Credit Rating is already a large and experienced entity in this field. It is best-known to Western investors for being the first rating agency to downgrade the USA, in 2010. The following year it repeated the exercise, as the US teetered on the brink of default thanks to the idiotic brinkmanship of both political parties over raising the debt ceiling — prompting the Wall Street Journal to comment:
Could what once looked like a blatant exercise in self-promotion by an obscure firm trying to expand overseas actually be a prescient assessment of America’s debt problems?
In July last year Dagong Global Credit Rating Co., one of the China’s major domestic credit rating agencies, introduced itself to the world when it initiated its sovereign rating research by giving the U.S. a lower rating than China.
Dagong’s move may have been a smart marketing ploy, but the fact remains that it was a year or two ahead of its Western rivals in addressing the realities of America’s fiscal situation. Now, however, Dagong really is seeking to expand overseas and it has set its sights on continental Europe – sensibly avoiding the US and also the UK, Europe’s pre-eminent financial center.
Europe Dagong is a newly-established subsidiary, in which the Chinese parent holds 60% and a mainly Chinese-owned and oriented private equity firm, Mandarin Capital Partners, is the junior partner. In June it received formal approval to function as a ratings agency in all EU countries and it has just completed a Europe-wide road show to introduce itself to the investment community.
According to the company’s CEO, Mauro Alfonso – who, like most of his staff, is European, with a background in the ratings business, mostly with one of the majors – Dagong Europe is aiming to compete on quality rather than price (in other words, it’s more Italian than Chinese). It is aiming to cover in depth the top 100 companies in each of the financial and non-financial sectors – and will limit each of its analysts to 10-15 companies, thereby seeking to avoid what he calls the “mass production” that characterizes the big rating agencies. He defines the company’s initial goal as “to gain a market share of at least 5% in five years”. Dagong Europe is also, very wisely, avoiding the minefield of rating European sovereign borrowers.
However, its business model is the standard one, wherein the company being rated pays the rating agency. It will be fascinating to see whether Dagong is able to deliver improved performance in the ratings business, but in the wider financial services sector, its arrival in Europe is probably a harbinger of a much larger Chinese invasion. For European and American firms, this should be a wake-up call, but for many it will likely prove a death-knell.