Mumbai: The credit crisis that erupted in the West in the summer of 2007 has scorched both portfolios and reputations. Credit rating agencies such as Standard and Poor’s (S&P) have been in the line of fire as well, as complex financial instruments they rated proved to be more risky than their initial ratings suggested.
In an interview, S&P president Deven Sharma, who joined the company in September 2007 after a long career in manufacturing and consulting, spoke on the credit crisis, what credit ratings agencies can learn from it, the state of the global economy and S&P’s plans in India.
Sharma also stressed how greater transparency in ratings is one way forward for his company. Edited excerpts.
Do you think the credit crisis is easing?
I don’t think so. Credit spreads have widened again and there is still a lot of skittishness in the market. There were $3.5 trillion (Rs147 trillion today) of structured products sold between 2005 and 2007. Only 1.5% of them have defaulted; but a fifth have had their ratings downgraded. Credit losses will go up. But we are also seeing a pricing correction, which is a reflection of demand, supply and confidence levels. The current pricing fluctuations suggest that there is still a lack of confidence in the market. Till confidence returns, it is going to be tough.
Investor-friendly: S&P’s Sharma is for putting out more information. (Abhijit Bhatlekar/ Mint)
That said, a lot of quality paper is still being issued, including structured products. But overall, there is a flight to simple and quality products.
What are the implications for a country such as India?
Some emerging markets such as Brazil are in a strong position because they have commodity dollars. On the other hand, countries such as China and India are more dependent on exports and domestic demand. They will face pressure.
Most financial crises lead to tighter regulation. Do you think that this credit crisis will lead to stricter oversight and more restrictions on the financial sector?
We think that there will be more regulation of the financial sector. But a lot depends on how this is done. If each country begins to do its own regulation, it will be disruptive and messy. So, global consistency in regulations is going to be important. Regulators need to discuss this with each other. We already see this happening in the International Organization of Securities Commissions and the Financial Stability Forum of central banks.
There have also been calls for more regulation of the ratings business.
There is a view that rating agencies need more regulation and we appreciate that. But we should be left alone as far as our analytical process goes.
A lot of people tell us that we did not know that the products we bought were that risky. But who is responsible for product suitability? Some of the data that went into the rating of residential mortgage securities was not good. Banks and originators, too, have a role to play.
But surely the buck should stop with the credit rating agencies?
We cannot take on the role of the auditors. We need to have standards to ensure that issuers and originators are doing due diligence and then we have to incorporate that into our ratings. Due diligence and auditing has to be done by a third party.
Has there been any soul-searching at Standard and Poor’s after the credit crisis?
When I took on this role in September 2007, I decided we should have no historical boundaries and start with a clean sheet. I asked: “What is it that we could have done to avoid such as crisis?” I asked our teams to think about it and also had discussions with outside agencies.
It became clear that more transparency is needed. Take residential mortgage-backed securities. We did consider the possibilities that housing prices in the US would decline, but the market thought we had only assumed that housing prices would keep going up. We have decided that any stress tests we do, or assumptions we make will be transparently revealed. Or if someone comes to us and then chooses not to be rated by us, we will make that public. The basic idea is to put more information in the hands of investors.
But some assumptions did not work out.
It was almost impossible for us to predict a national housing recession in the US. This is the first time since the Great Depression that we have had a national housing recession. We have decided to give out our “what if” scenarios, so that investors can gauge what may happen under different conditions. We cannot predict a tsunami, but we can give early warning signals.
How does Standard and Poor’s see its role in India?
India is a growing economy and the demand for ratings will be strong. But there are other ways India is important for us. We leverage the talent here. We have a company called Capital IQ that already employs 2,500 people in Hyderabad and Gurgaon for analytics. Then there is the case of Irevna, which does investment research. We have taken it to Buenos Aires and are looking at East Europe.
The business model was developed in India and we are taking it global. And finally we are using India to develop our regional connections, by using talented managers such as R. Ravimohan (who, as a managing director and region head for Standard and Poor’s, oversees markets from the Philippines to Pakistan: P2P as he calls it).