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A business model for rating agencies:
learning from the CRISIL experience
Roopa KudvaManaging Director and Chief Executive Officer
CRISIL
June 16, 2010
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Key Messages
Measures of effectiveness of business model for credit ratings
High-quality and accurate credit ratings
Widespread availability of credit ratings
Three possible models
Each has advantages
Each also has potential risks
The issuer-pays model has worked well in India The market lacks organized large bond investors
As in any model, strong safeguards and processes are needed to manage
conflicts of interest
India benefited from its strong regulatory framework
Other lessons from CRISILs experience
Bond rating revenues may need to be supplemented through complementary
businesses
Ratings not being the sole source of revenues or profits helps rating agencies to
maintain their independence
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3.
Presentation Flow
Background: what credit ratings are
The framework for evaluation An evaluation of the business models
The issuer-pays model
The investor-pays model
The government-pays model and its variants
How CRISILs model evolved
The challenges of being a pioneer
The need for revenue diversity
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Background: What Credit Ratings Are
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What Credit Ratings Are
Alphanumeric symbols indicating a scale of creditworthiness for
a security, issuer, or borrower
AAA, AA, B, etc.
Usually indicate probability of default or expected loss
Not recommendations to buy, sell, or hold rated securities
Other considerations would enter into the decision, e.g. price, investors
preferred risk profile
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6.
Why Markets Need Credit Ratings
Not all investors have the ability or resources to carry out a
thorough credit analysis of all available debt securities
Broadens the investable universe for the average bond investor
Allows large numbers of issuers to competitively access
funding at a low transaction cost
A rating is an easy-to-understand opinion from an independentparty
Establishes a common currency across market participants
Allows specification and measurement of capital adequacy and capital
allocation in a transparent manner
Publicly available credit ratings add to the information and
research available about companies and securities
Allow market participants to make better-informed decisions
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The Framework for Evaluation
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What to Look for in a Business Model
Credit ratings should be of high quality, and should be accurate
Should accurately measure creditworthiness
Should be the product of a strong and independent process
Ratings should be widely available to all market participants
The principal benefit of ratings today is that they are freely available to
the market as a whole
This benefit would be lost if ratings were available by subscription only
Smaller investors would be hit the hardest
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The Models Examined
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The Issuer-pays Model
Benefits:
Free availability of ratings. Investors can compare the credit quality of
a wide array of instruments, choose the ones that best fit their risk
preferences, and continuously monitor the credit quality of their
investments
Access for rating agencies to high-quality information
Keeping the cost to the system low
Potential risks:
Potential for conflicts of interest. Strong mechanisms are needed for
managing these, including
Multilevel rating processes
Strict separation of the analytical and marketing functions
Delinking compensation from level of ratings
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The Investor-pays Model
Benefits:
Freedom from possibility of issuer pressure
Potential risks:
Conflicts of interest in the opposite direction. Rating agencies could
face pressure from investors to give lower-than-warranted ratings so that
yields can be higher, and to not downgrade once rated so that mark-to-
market losses can be avoided
Dependence on public information for ratings, given the absence of
a relationship with the entity being rated
Taking ratings out of the public domain, since ratings would be
available only to investors who agree to pay for them
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The Government-pays Model (and its variants)
Benefits:
No structural incentive for bias in either direction
Potential risks:
Moral hazard. Ratings that are paid for by government or regulators can
be seen to have an official approval or even amount to a payment
guarantee
Guaranteed business for rating agencies. Since government cannot
be seen to be favoring any party, all empanelled agencies will be
guaranteed business, removing any incentive to demonstrate analytical
rigor or to update and improve criteria and processes
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Which Model Works Best?
Modern financial markets have overwhelmingly used the issuer-
pays model
The investor-pays model fell out of favor during the 1970s,
although there have been efforts to revive it
The government-pays model variants have so far not been tried
except in pockets; too early to say if it works Each model has its strengths and weaknesses, and there is
room for all three to coexist
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The CRISIL Story: How It All Happened
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CRISILs Growth from 1994 to 2009
#Up to 2005 CRISILs reporting year was April to March
^2005 was a nine month year from April to December 2005
*Majority stake in Gas Strategies sold on 10th Dec 2008
Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005# 2005^ 2006 2007 2008* 2009
Headcount 141 161 191 182 205 197 202 368 370 394 496 638 1155 1484 1750 1956 2164
1 4 1 1 1 1 1 1 42005(9M)*
Total Rev 90 126 183 238 323 364 340 441 685 714 854 1,193 1,405 2,873 4,043 5,146 5,603
Int Rev 1 0 3 2 3 1 2 4 2 0 4 0 3 7 14 3 36 5 66 0 1 ,70 5 2 ,62 9 2, 82 3 2, 91 1
PBT 54 86 120 127 154 208 192 127 272 268 281 314 355 802 1,106 1,875 2,075
5486 120 127
154 208 192 127272 268 281
314355
802
1,106
1,875
2,075
0
500
1,000
1,500
2,000
2,500
-
1,000
2,000
3,000
4,000
5,000
6,000
Rev INR Mn
Total Rev Int Rev PBT
PBT INR Mn
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The Beginning: Credit Rating? Wont Work in India!
No bond market
Directed lending Absence of market-determined interest rates
Zero interest from global rating agencies
Grudging acceptance from domestic issuers and investors
What CRISIL Did
Built credibility
Ensured that opinions put out were independent, objective, and reliable
Developed awareness
Outreach with regulators, borrowers, users, intermediaries
Entrenched itself to benefit from the growth that it anticipated
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1991 2001: Building a Robust Business
Rapid economic growth post liberalization, followed by a slowdown
Deterioration in corporate credit quality
Collapse of many nonbank lenders
These were anticipated by a spate of downgrades from CRISIL
Credit Rating agencies in India were regulated starting 1999
What CRISIL Did
Refused to dilute standards despite loss of business
Market share in ratings plummeted below 40%
CRISIL believed that business would eventually come back if it continued to put out credible ratings, focusedon criteria and processes
Focused on key intermediaries and investors, to address the move to private placements
Incubated and built up infrastructure policy consulting business
Growing competition, shallow market in ratings
Moved strongly into research Acquired Indias leading industry and company research provider
Initiated global tie-up to access best practices, attain scale
MoU with S&P (later evolved, through an equity investment, into a majority holding)
Went public
CRISIL has never borrowed
Comfortable with transparency and exposure that a public listing entails
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Timely Rating Changes: Rating Actions and Market Share
Rating changes and market share
1.1 1.1
0.9
0.7
0.91.0
0.91.0
1.1
0.6
65
72 7071
48
69
50
59
0.0
0.2
0.4
0.6
0.8
1.0
1.2
FY 1995 FY 1996 FY 1997 FY 1998 FY 1999 FY 2000 FY 2001 FY 2002 FY 2003 FY 2004
MarketSh
are(%)
0
10
20
30
40
50
60
70
80
ModifiedC
reditRatio
Modified Credit Ratio Market Share in ratings business (%)
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2002 Today: More Diversification, Explosive Growth
Rating actions in the 1990s built up CRISILs credibility in the credit ratings
space
CRISIL today is the unquestioned leader in the Indian market Opportunities: application of Basel II guidelines, growing sophistication of SMEs
Opened up a huge market for ratings
Indias rating agencies and its CRA regulations have served the market well
Subprime crisis and its fallout have had relatively little effect on the industry in India
Rapid evolution of Indias markets and capabilities have opened up myriadbusiness opportunities
What CRISIL Did
Adhered strongly to values, reinforced processes
Focused on outreach and transparency in ratings business
To maintain franchise with investors, regulators a key source of competitive advantage
Stayed hungry for growth
Acquired and built up Irevna, now the leading knowledge process outsourcing player in the
financial space
Set up research and analytics offshoring for Standard & Poors
Aggressively created market for independent equity research and funds research
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www.crisil.comwww.standardandpoors.com