Kroll buys bond rating firm Lace Financial, but it’s likely not the better mouse trap the market wants.
Love them or hate them, the big guns of the credit ratings world are here to stay. To be sure much has been made of the evils rating agencies rained down upon the markets with their misguidance on CDOs and other dodgy instruments. But they are not going away and companies still need them.
And to the newbies? Good luck. As one banker from UBS told members of The NeuGroup Bank Treasurers’ Peer Group back in May, “there is no answer for the ratings industry business model. The structure, the breadth and depth of S&P, Moody’s, etc., are so deep that it would take a lot of money to replicate” by new challengers.
So will Jules Kroll’s purchase of Lace Financial buck the trend? It remains to be seen. Lace does have the valuable Nationally Recognized Statistical Ratings Organization (NRSRO) designation from the SEC and it has been around for 25 years (which gives it some depth and background, although as one bank treasurer put it, “It’s a guy in a garage with a computer, they don’t do research and they just want to sell you their data—they don’t want your input.”). And Mr. Kroll himself has very deep pockets. But that NRSRO moniker might not last forever, as it’s repeatedly seen as protectionist, despite a 2006 law that opened up the field to a few dozen; and despite the 25 years of experience, it pales by comparison to Moody’s or S&P; and finally, despite the deep pockets, Mr. Kroll might lose interest.
But there are still many other hurdles. “There is a lot of infrastructure surrounding ratings, so any challengers will have a headwind in going against them,” the UBS banker said. Also, there’s a bigger question as to whether issuers will continue paying for ratings. As has been heard at more than one NeuGroup peer group meeting, there are many cases where companies just simply decide not to pay for ratings but seem to receive them anyway.
There is also the issue of rating agency diversification. Two of the big raters, Moody’s and S&P, will continue to offer alternatives to their regular ratings in hopes of hedging against the falling franchise value of NRSRO ratings. (See related story here). These are services that complement DIY ratings, either by providing the tools or having the risk assessments done for you with these same tools. In either case, there remains the question of whether clients will pay for these offerings.
Chances are Mr. Kroll will spend a lot of time and money building Lace’s infrastructure. Whether the market for such service will be the same is the big question.