International Rating Agencies: Their role and impact

Businesses, many of which use all the liquidity tools at their disposal in order to implement their business plans, need capital that, among other things, will allow them to finance their growth goals. Bank lending – the most widely used financing tool – and bond issues also stand out, although they depend to a large extent on the conditions prevailing in international markets.
Both of these options require a sound credit profile of the businesses seeking funding, so that lenders / investors can trust them. How is this assessed? In the case of bank lending, through credit criteria defined by the relevant European authorities, and in the case of bond issues, by means of a rating by an independent international firm that certifies the ability of businesses to repay their debt.

Ratings are carried out on long-term (bonds) and short-term (bills of exchange) liabilities of companies. Out of several rating agencies active in the global market, three hold a share of more than 90%: Moody's, Standard & Poor's (S&P) and Fitch. Each agency has evaluation models and mechanisms, which focus mainly on the prospects of each business. Specifically, the credit rating, which can be given either on the agency’s initiative or at the company's request, takes into account, among others, the following:

Country risk

A company operating in a country whose economy is fragile faces greater risks of default than one based in a country with a booming economy.

International Rating Agencies: Their role and impact

The features of the sector and the company’s position within it

Some sectors are more prone than others to fluctuations in the economy, a fact that international agencies must consider before making their rating. Also, the position of the company in relation to the competition is always a parameter that is taken into account, since it helps to draw conclusions regarding its current and future economic standing.

Its capital structure

i.e. the mix of long-term liabilities and own funds of an enterprise that indicates the extent to which an enterprise's activities are financed from long-term sources of financing.

On the basis of the above, as well as a host of other data, the agencies issue credit ratings, which take the form of abc grades. For example, Aaa represents the top rating in Moody's ranking system, while AAA is the highest rating in S&P's system. The impact of these ratings is enormous, both for the lender and the borrower. Lenders receive information regarding the credit risk involved in various alternative investment opportunities, while borrowers have the opportunity to adapt their internal procedures and activities so as to be compatible with credit standards.

International agencies’ ratings, however:

Can't predict the future: Although they can outline the credit profile of businesses based on specific data, they can’t foresee with certainty what will happen in the future. Thus, even if the bonds of two companies receive a different rating, this does not mean that the default will occur only in the case of the one with the lowest rating.

Do not constitute investment advice. The decision rests solely with investors, who will have to weigh a number of factors, such as their investment objectives, their risk appetite, their ability to suffer losses and their level of knowledge and/or experience. Investing in financial instruments/ investment products entails risks, including the risk of loss of the initial invested capital, regarding which potential investors should be properly aware on the basis of all the respective product documents.

The evaluation is a valuable tool in the hands of businesses, provided, of course, that the request has been made by them and not on the initiative of the international firm. This is because, in the latter situation, there has not been exchange of inside information, which is necessary in order to draw safe conclusions about the who's who of the business in question and – if necessary – correct any shortcomings in its structure and operation.

Sources: https://euretirio.com/pistoliptiki-ikanotita