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Over the summer Critical Perspectives on Accounting published a paper I co-authored on the role of credit rating agencies in the process of financialising social housing providers in London. In the style of the TV show, Jeopardy!, the paper is the answer to the question – What is the research outcome when a geography, a housing studies and an accounting academic collaborate?
During our initial discussions credit rating agencies (CRAs) barely warranted a mention, we were more focused on the impact that large amounts of debt finance was having on the provision of below market-rents accommodation in a city that has become a location to store excess capital for the global billionaire class. However, two UK-based colleagues – Thomas Wainwright and Graham Manville - beat us to the punch, publishing an excellent article on innovation in the social housing bond market.
Rating agencies hone into view
The innovation Wainwright and Manville explore is the manner in which not-for-profit organisations, often with a charitable heritage, are increasingly turning to the capital debt markets for finance and issuing their own corporate bonds. In England, up to the turn of the century a social housing provider issuing a corporate bond was almost unheard of – by 2017 there was a cumulative total of 84 bond issues by 58 housing providers, worth £17.1 billion.
The increased activity in this form of finance comes from a combination of severe cuts in government grants during the austerity years and a reluctance by the traditional financers of this sector, banks, to fund over the long term (i.e. a 30-year business plan) after the financial crash of 2008.
Of course, every bond issued by a social housing provider requires at least one credit rating and an ongoing relationship with a rating agency afterwards. However, my co-authors and I were aware that credit rating agencies had been implicated in the 2007/08 credit crunch and following financial crash, and we wondered what impact their rating methodologies have had on the operation of social housing providers.
Rating agencies – a history
For much of their history CRAs have been considered peripheral to the operation of business, often having a quasi-academic image. With roots in the commercialisation of emergent business financial information during the nineteenth century, CRAs started to become key actors in capital and financial markets from the 1970s, in the main due to changes in regulation by the SEC and subsequently under the Basel capital adequacy rules for banks.
In that decade CRAs also changed their business model by securing fees from those issuing financial instruments, (rather than those buying them). This change created similar relations to those in the auditing industry with related conflicts, such as being paid by those you are forming an opinion on and the opportunity to sell ancillary services.
However, it is in recent decades, with the increasing financialisation of the world economy, that CRAs’ revenue and power has grown substantially. For example, in the fifteen years to 2015 Moody’s global revenue grew by US$ 602 million to total US$ 3.5 billion. Further, Moody’s describes themselves as “… an essential component of the global capital markets” which contributes to transparent and integrated financial markets.
Yet, CRAs have been criticised not just in relation to the 2008 global financial crisis but also for not being able to predict the 1997 Asian currency crisis or the collapse of Enron. For example, in the wake of the Enron bankruptcy, Senator Joe Liberman said,
The credit-rating agencies were dismally lax in their coverage of Enron. They didn’t ask probing questions and generally accepted at face value whatever Enron’s officials chose to tell them. And while they claim to rely primarily on public filings with the SEC, analysts from Standard and Poor’s not only did not read Enron’s proxy statement, they didn’t even know what information it might contain.
Not only gatekeepers …
Despite this history and the central role now afforded to CRAs in the operation of the capital markets we know very little about their operation in general and specifically with regards to the impact their work has on the operation of those they rate. Much of the research completed to date places CRAs in a principle-agent relationship, where they act as a reputational intermediary to reassure financial investors.
In this way CRAs are seen as gatekeepers for those entering the capital markets to secure bond (or other) finance.
In our paper we seek to understand the role of CRAs by drawing on the smaller stream of work that utilises a political economy understanding. In this understanding credit ratings are, as Timothy Sinclair has argued, a surveillance system for secure capital mobility across geographical and cultural space.
This idea of capital’s mobility across cultural space is particularly relevant in our case study with ratings being provided for not-for-profit organisations delivering a public service. The idea of movement also allowed us to flip the gatekeeper metaphor round and look at the rating activity from the perspective of the finance providers.
… but gateway constructors
Hence, we were able to theorise, and show empirically in the paper, that credit rating agencies also construct gateways that enable private capital’s movement into a new space, i.e. social housing.
The gateway construction occurs through a number of activities but a central one is that through the process of securing a rating the debt issuer learns to speak the same language as the finance provider. As one of our interviewees stated,
I mean it does educate us when we go out to investors ... [to] do a road show. So, we would have had the experience of a credit rating before one of them and when you go into the investors you’re talking the same language.
Alongside, the new language we show how the social housing providers internalise the priorities of finance capital, through the rating process by changing their internal reporting and decision-making activities. For example, taking key accounting ratios that are preferred by the CRAs into their new build and development decisions.
The financialisation of everything
Since the turn of the century, research on financialisation has tended towards either macro studies of changes in the global processes of capital accumulation or a micro-level focus on individual companies where the short-termism of the shareholder value revolution pre-dominates. Our study focuses on a fine-grained analysis of financialisation processes at a meso-level (i.e. the social housing sector), where credit rating agencies play a crucial, even decisive role.
The members of this sector have been described as hybrid organisations – as the 2014 front cover of one social housing provider’s annual report proclaimed “Socially hearted, commercially minded”. The policy and funding environment over the past ten-years has increased the commercially-minded activities of the social housing providers by securing finance from the capital markets and is enabled by credit rating agencies.
Ultimately this leads us to conclude that credit rating agencies do not play a neutral or independent role in verifying accounting and commercial information but are active participants in the extension of financial logics and practices to ever more areas of human activity; in other words, CRAs facilitate the financialisation of everything.
STEWART SMYTH
Dr Stewart Smyth works at the University of Sheffield, UK where he is director of the Centre for Research into Accounting and Finance in Context (CRAFiC). Stewart is also the chairperson of the Interdisciplinary Perspectives Special Interest Group, of the British Accounting and Finance Association (BAFA).
The paper this blog is based on is freely available under open access rules at the following link:
Smyth, S.; Cole, I. and Fields, D. (2019/forthcoming), “From gatekeepers to gateway constructors: Credit rating agencies and the financialisation of housing associations”, Critical Perspectives on Accounting