In an apparent response to criticism that the three credit rating agencies were slow to downgrade bad actors like Enron Corp. and WorldCom Inc., the Securities and Exchange Commission admitted a fourth company to the exclusive group it regards as qualified to provide corporate bond ratings. The point? To inject a little competition to get debt analysts on their toes about spotting trouble. A noble mission, but how much of a threat does the new entrant, Canada’s Dominion Bond Rating Service Ltd., really pose? In the short run, not very much; any potential will take some time to develop.
Established in 1976, Dominion plays a prominent role in Canada’s debt market, just as market leaders Moody’s Investors Service and Standard & Poor’s Corp. do in the U.S. However, Dominion is much smaller than the major U.S. rating agencies. As a private company, it does not report its revenues, but Dominion has 65 employees. By contrast, Fitch Ratings, the third, smallerU.S. player, says it has more than 1,200, while Moody’s has more than 1,700 and S&P more than 5,000.
Observers say that the disparity in size initially will limit the extent to which Dominion can take on the established market brands of Moody’s and S&P. “David and Goliath looked good in the Bible. It doesn’t always work in finance,” says Glenn Reynolds, CEO of CreditSights, a company that provides credit research and strategy. Kent Baker, a finance professor at American University’s Kogod School of Business, compares the ties between bond issuers and the rating agencies with those between corporations and their auditors. While relationships, post Enron, with both auditors and agencies have been under stress, many companies are sticking with what they know. Clearly, there “has to be a fairly strong reason for someone to change,” Baker notes.
And if history is any guide, achieving the status of a Nationally Recognized Statistical Ratings Organization (NRSRO), the tag applied to the SEC’s chosen rating agencies, is hardly a guarantee of success. All four companies to which the SEC granted NRSRO status between 1982 and 1992 have disappeared, having been absorbed by Fitch.
Still, Dominion is raring to go. Greg Root, its executive vice president, says the agency hopes to capitalize on its expertise in natural resources, securitization and structured finance and leverage its Canadian dominance to build relationships with investors here in the U.S.
There are other would-be NRSROs waiting in the wings: Egan-Jones Ratings Co. of Philadelphia, Lace Financial Corp. of Frederick, Md., and A.M. Best Co. of Oldwick, N.J., have applied. But it’s not clear whether Dominion’s approval–after waiting three years– signals changes in the SEC position or just a bone thrown to critics.
Still, many see it as a needed first step. “Four is better than three,” says Lawrence White, a professor at New York University’s Stern School of Business, although he would prefer the SEC to get out of the business entirely, since it does little to regulate their operations, Reynolds says the process of building a real competitor will take time, money and “a differentiating feature.” But it’s like Lotto: You have to be in it to win it.