German rating agency attacks: “We work three years at our own expense”

Two large US agencies have shared the global rating market for decades. The German Creditreform Rating has been working on a plan to change that for years. It will soon become clear whether this plan will work, as agency boss Michael Munsch told in an interview. He is also opposed to badmouthing the entire economic situation in the face of rising inflation, rising energy prices and supply chain problems. So far, the economy has come through the Corona crisis surprisingly lightly. Waves of insolvency, massive payment defaults and government bankruptcies did not materialize. Now, at the end of the pandemic, disillusionment is spreading. The danger of new crises, for example through rising energy prices, is being conjured up again. What do you see when you examine the creditworthiness of companies and states?

Michael Munsch: Payment defaults and bankruptcies have so far remained at an extremely low level. At the beginning of this year, I myself had forecast an increase of 20,000 bankruptcies in 2021. But that did not happen. If we now look to the future, to the coming year, we see two opposing trends. One is the return to normal bankruptcy law after almost two years of exemption. This means that if insolvency or over-indebtedness is expected, more companies will have to file for bankruptcy again. The other trend is simultaneous economic recovery.

Many business representatives are currently very concerned about this recovery. Keywords: energy prices, inflation, delivery bottlenecks, …

It is true there are some problems. The leading economic research institutes recently revised their growth forecast downwards for this year and next. But we shouldn’t become pessimistic about that. More than two percent is still decent growth. In addition, the economy is likely to catch up on the growth rate it has now lost in the coming years. That is still our basic scenario.

How big are the risks for this scenario? At the moment there is a lot of talk about the risk of inflation. If energy prices in particular should continue to rise, there are fears that the European Central Bank will have to raise interest rates and that heavily indebted countries will experience payment difficulties. Do you see this danger?

As a rating agency, we are programmed to see risks: The high debt of the states after the pandemic is currently one of them. But the increased debt level is offset by sound debt management, and the ECB will continue to ensure stable conditions. Issues like inflation, energy prices and problems with supply chains have always existed. That’s why we can’t talk bad about everything now.

You have set yourself ambitious growth targets for Creditreform Rating. They want to break the oligopoly of the dominant US agencies. Why is this oligopoly a problem at all?

In fact, it’s actually just a duopoly between S&P and Moody’s, who share more than 80 percent of the entire rating market. One problem that this poses for many companies is the extremely high price level. The two big agencies have a profit margin of 40 percent. Moody’s has long been considered the most profitable company on Wall Street. In addition, the rating agencies are seen by many critics as contributing to the last global financial crisis. I do not necessarily share this view in this form. But a further look at the problematic financial products from a different perspective would have helped in any case.

This has been discussed for more than ten years. Nevertheless, you and others have not succeeded in penetrating this duopoly. Why can’t you easily undercut Moody’s given the high price level?

There is a chicken and egg problem: I often hear two things from potential customers, i.e. large companies or banks that need a rating for a bond, for example. On the one hand: You are too small and too unknown to investors in Asia, for example, to whom we would like to advertise our bond. On the other hand, it is important for us and our investors that banks can use our bond with the European Central Bank as security for their refinancing. But so far only the ratings of the four largest agencies have been accepted. And then again from the ECB: You are too small for us to take you into account.

How do you intend to solve this chicken and egg problem?

The requirement of the ECB is that an agency must have rated at least ten percent of the relevant securities issuers and 20 percent of the bonds, Pfandbriefe etc. accepted by it for three years in order to be taken into account in its risk management procedure. And that’s what we did. We have rated dozen of companies and stocks. The three years will be over at the beginning of next year and we will present the result to the ECB.

Does that mean you did this work for three years at your own expense?

Yes, we don’t have the orders. So we work with a team of 15 people for three years at our own expense. This is a big investment for us.

How sure are you that the ECB will accept your results?

There is no such thing as security. After all, there is no precedent for this. We are one of the first agencies to go this way. But of course we are in close contact with the ECB and I am very confident.

What exactly do you expect for the development of Creditreform Rating when you receive the ECB “seal”?

With this we can actually solve the chicken and egg problem. If, thanks to ECB acceptance, large corporations in Europe take us on board as a second rating agency alongside one of the big ones, then we would soon be known and accepted in other markets such as Asia. Our goal is to increase our global market share to around three percent by 2030, from the current 0.53 percent.

What’s your long-term goal? Can you catch up with the big agencies?

Beyond that, we don’t have any specific targets. But once we have achieved a three percent market share, that will be a springboard for further development. In the long term, we want to grow worldwide, also with new branches in Asia and Latin America. In the long term, this will change the entire structure of the market.

As you have already mentioned, the reputation of the rating agencies suffered greatly during the financial crisis. Do you still feel that with customers and investors?

No. A lot has actually happened since then. And not only in the form of new laws and regulations, but also in their practical implementation. The control of the agencies by the supervisory authorities is now very intensive in Europe. As a result, trust in the industry has grown. The demand for ratings is increasing – not least because of the increasing importance of climate protection and sustainability.

What significance does sustainability have now in assessing the creditworthiness of a company?

You have to make a distinction. There is still a need to use a rating to assess the credit quality and the probability of default. Sustainability aspects play a role alongside many other criteria. An unsustainable company can still have good credit quality and a low probability of default. But in addition, the assessment of a company’s sustainability strategy is gaining in importance for many investors. More and more banks, for example, increasingly want “clean” companies in their loan portfolios.

How do these topics contribute to your work as a rating agency?

We are just at the beginning. Currently, the topic of ESG [Environmental, Social, and Governance; Umwelt, Soziales und Unternehmensführung] 20 to 25 percent of our work, and in the long term, definitely a third or more.

Everyone in the financial industry is talking about ESG right now. Every company publishes long sustainability reports. But is that more than greenwashing, i.e. simply giving the previous business activity a green coat of paint without any real changes?

Yes, something is really moving in the end. The EU set binding standards this year and the ECB has made it clear that sustainability criteria play a crucial role for them when assessing assets. This means that sustainability strategies are no longer a minor matter for companies, but important financial factors. Our job as a rating agency is to make this transparent for investors.

Max Borowski spoke to Michael Munsch

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