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Foreign Ownership and the Credibility of National Rating Agencies: Evidence from Korea

Foreign Ownership and the Credibility of National Rating Agencies: Evidence from Korea. by G. Ferri (U. Bari), T.S. Kang (Bank of Korea) , Punziana Lacitignola (U. Bari) and J.Y. Lee (Yonsei U.)

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Foreign Ownership and the Credibility of National Rating Agencies: Evidence from Korea

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  1. Foreign Ownership and the Credibility of National Rating Agencies: Evidence from Korea by G. Ferri (U. Bari), T.S. Kang (Bank of Korea), Punziana Lacitignola (U. Bari) and J.Y. Lee (Yonsei U.) Workshop “Curbing Volatility? Financial Markets, Credit Rating Agencies and Sovereign Investments Funds” Bocconi University, Milan17 November 2011 Bank of Korea University of Bari Aldo Moro

  2. Outline of the presentation • The role of rating agencies as institutions helping investors to evaluate issuer/issue’s creditworthiness • Global Rating Agencies (GRAs) versus National Rating Agencies (NRAs) • The Korean rating agencies experience • Analysis of the effects of rating activity of GRAs and NRAs on local markets • Our event study (downgrading) • Conclusions

  3. Main criticisms of Global rating agencies (GRAs) 1. Low degree of competition among GRAs due to NRSRO recognition by SEC (Partnoy, 1999; White, 2002) and reputation matters  difficulties for NRAs to gain access to international markets 2. Lagging (IMF, 1999; Bongini, Laeven and Majnoni 2002) and procyclical ratings (Ferri, Liu & Stiglitz, 1999; Bhatia, 2002) 3. GRAs’ ratings in developing countries: - less accurate than in developed countries (Ferri, 2004; Ferri & Liu, 2003 - 2005), but still no specific evidence on this about NRAs; - excessively tied to sovereign ratings (Ferri, Liu and Majnoni, 2001)

  4. Main criticisms of Global rating agencies (GRAs) (cont’d): 4. Little price competition 5. Entry restrictions due to regulatory requirements to obtain a rating from an NRSRO rating agency, to date the NRAs officially recognized as NRSROs are JCR and R&I (regulatory franchise; Partnoy, 1999) 6. Unsolicited ratings practice to gain market share by GRAs 7. Sub-prime: poor performance in the evaluation of structured finance product (complexity and conflicts of interest)

  5. A sip of recent criticisms: subprime & structured finance Perilous reliance on structured finance Race to revise

  6. A potential trade-off GRAs versus NRAs • GRAs (established since 1909): • reputation, indep’nce & int’l recognition … but • apply a “standardized” rating methodology across countries (regardless the environment in which firms operate) • NRAs (established since mid 1980s): • comparative advantage accessing more appropriate knowledge of local environment • originated with the support of nat’l regulation • lower fees than GRAs’ … but • less independent (mostly owned by domestic financial institutions)

  7. Trade-off between higher reputation/indep’nce of GRAs and in-depth knowledge of NRAs on local basis Complementarity between GRAs (larger, internationalized companies) and NRAs (small-sized/domestic focused companies)(Ferri, Kang, Lee, 2006; Ferri & Lacitignola, 2007) Markets seem to take into account both NRA and GRA ratings when pricing securities; bothmay activelycontributetofinancial market development(Ferri & Lacitignola, 2007) In Japanese local markets, NRA rating changes influential more than GRA rating changes (Lacitignola, 2007) (less for Li et al., 2006) Market impact of GRAs and NRAs

  8. Specifically for Japanese financial markets: A combination of NRA and GRA ratings predicts spreads on securities’ secondary market trading more accurately than any of the two classes taken separately (Packer, 2000) NRA ratings are more related to rated companies’ financial ratios than GRA ratings (Packer, 2000) In the opinion of Japanese corporations, NRAs do not differ from GRAs in terms of market influence and recognition (JCIF, 2001) Market impact of GRAs and NRAs (cont’d)

  9. Ratings Across the Emerging World • More ratings in Asia, where most NRAs belong Figure 1 Source: Our calculations on Financial Times Interactive data for Winter 1998-99 and Winter 2004.

  10. Only Asia features a significant presence of NRAs, elsewhere (e.g. EU) NRAs have been acquired by GRAs Figure 2 Source: Our calculations on Financial Times Interactive data for Winter 2004

  11. In some Asian countries NRAs issue numerous ratings compared to GRAs Figure 3 Source: Our calculations on Bloomberg data for 2004.

  12. Who are the GRAs and the NRAs? • GRAs: • Moody’s, S&P and Fitch • NRAs (example in 4 Asian countries): • Japan: JCR, R&I, Mikuni • South Korea: KIS, KR, NICE and SCI • Malaysia: MARC and RAM • India: ICRA, CRISIL and CARE GRA’s usually operate world-wide through affiliates subsidiaries and branches

  13. NRAs: rating less internationalized (listed) companies Fig. 5 Source: Our calculations on Bloomberg data between 1990 and may 2005

  14. Relative (Average) Size of Companies With National Ratings Only 0,300 0,259 0,250 0,200 0,150 0,128 0,097 0,100 0,055 0,050 0,000 India Japan Korea Malaysia NRAs: rating smaller-sized (listed) companies Fig. 6 Source: Our calculations on Bloomberg data between 1990 and may 2005

  15. The Korean rating industry • GRAs due to regulatory burden do not directly operate in the Korean rating market • KIS is affiliated to Moody’s which controls “50%+1 Stock” of it since 2001 • KR is affiliated to Fitch: Fitch Ratings Ltd. had 9.01% of KR shares since 2001 and increased its shareholding to 54.4% in April 2007, and again to 64.2% in September 2008 • NICE is wholly domestically owned

  16. The event study set-up Hypothesis: KIS and KR due to their affiliation with GRAs benefit of its reputation capital and are perceived as higher information providers than NICE (domestically owned) We expect larger effects of rating changes by KIS and KR on daily bond prices with respect to rating changes from NICE (Korean issuers) • Estimation window: 90 trading days; • Event window 21 trading days (t-10, t+10; where t is the event date) • Bond prices & rating changes over 2001-2007

  17. The event study set-up (cont’d) • To calculate the normal returns we use the Market model • Rit = i + iRmt + it • E(it = 0) var (it ) = i2 As market portfolio we use the KOSPI index Bond returns are assumed jointly multivariate normal and independently and identically distributed through time Normal return is estimated by OLS

  18. The event study set-up (cont’d) • Abnormal return (AR) is calculated as deviation of the predicted return from the observed return: • To construct tests, ARs are aggregated both • across bonds and across time: To test the persistence of the effects of rating changes AARt are aggregated through time:

  19. Because of previous evidence we focus on Downgradings: • rating upgrades have no impact on the bond and stock markets and downgradings are Associated with significant negative returns in Equity and bond prices (Griffin and Sanvicente, 1982;Holthausen and Leftwich, 1986; Impson et al.,1992; Barron et al., 1997; Ederington and Goh, 1998; Goh and Ederington, 1993, 1999; Liu et al., 1999; Matolcsy and Lianto, 1995; Wansley et al.,1992; Zaima and McCarthy, 1988).

  20. Our sample

  21. Results: • Effect of downgrading on AARt: on the event date is significant only for KIS and NICE with similar impact (AARs are -0.0076 and -0.0080, respectively; Table 3). In the day after the event date the downgrading is significant for all NRAs, but the effect is larger for NICE (AAR= -0.020), with respect to KR (AAR= -0.012) and KIS (AAR= -0.009). Downgrading effects are persistent over time.

  22. Results - from Table 3:

  23. Results (cont’d): • Effects of 1-notch downgrading on AARt: AARt are significant the day after the event occurs for all NRAs but with different magnitude (Table 5); effects slightly bigger for NICE (-0.01276), then follow KIS (-0.01141) & KR (-0.00676); effects on bond prices are persistent in time; they are anticipated more days before by markets for KIS and KR, the same is not true for NICE. The effects (CAARs) of NICE’s downgradings after the event date are persistently larger than for the other two NRAs (Figure 1).

  24. Results (cont’d) - from Table 5:

  25. Fig. 1: Effects of 1-notch downgrading on bond prices

  26. Conclusions: University of Bari • We confirm the evidence about downgrading effects on bond markets • Our results cast some doubts on the superiority of GRAs as perceived by a financial market as important as the Korean one. NRAs affiliated to GRAs don’t seem to benefit of their reputational capital • A policy implication is that developing NRAs may be beneficial to the development of domestic financial markets

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