The pricing behaviours of credit ratings agencies could come under intense scrutiny from the Australian competition regulator after S&P Global announced further expansion of its local profit margins last year.
According to financial accounts lodged with ASIC, S&P Global Australia Pty Ltd posted a net profit of A$34.7 million in the 12 months to the end of December – up 19 per cent on the 2020 result.
S&P’s bottom line performance was remarkable given that it was distilled from a revenue base of only $107 million.
This means that S&P’s Australian business operates on an after-tax profit margin of 32.4 per cent.
On a pre-tax basis the operating margin is 46.3 per cent.
The disappointing news for financial institutions and other subscribers to the firm’s credit ratings services is that the margin is continuing to swell.
In 2020 the after-tax profit margin was 30 per cent – and in gross terms it was 43.9 per cent.
While S&P’s earnings metrics were impressive, they were bettered last year by the firm’s global rival Moody’s Investors Service, which almost doubled its net profit in Australia to A$33.6 million.
Moody’s net profit margin from its Australian operations now stands at almost 37 per cent.
While the global credit ratings market has been dominated by S&P and Moody’s for more than a century, the emergence of Fitch as a global competitor in the 1990s stoked hopes that the industry’s duopoly would be exposed to serious price competition.
For a period after the Global Financial Crisis, Fitch’s success resulted in the global operating margins of the duopoly falling below 50 per cent.
Whatever impact Fitch’s entry into the global ratings market might have had seems to have dissipated in recent years, with the longstanding incumbents reverting to acting as price-givers to a captive pool of corporate subscribers and governments.
Neither the ACCC nor most other international regulators pay much attention to the credit ratings duopoly, but the industry’s pricing dynamics continue to attract the attention of academic economists.
A substantial body of peer-reviewed research has grown in the last 15 years that highlights the pricing power of the ratings agencies and governance issues concerning their interaction with rated entities, including governments.
The recent surge in the global profitability of Moody’s and S&P indicates that the industry is reverting to another cycle of aggressive pricing.
In 2007 German economist Fabian Dittrich characterised the structure of the global ratings market as a classic duopoly.
“Moody’s and S&P hold a nearly duopolistic position with about 77 percent of worldwide credit rating revenues,” Dittrich observed in a research paper.
“The remaining business is dominated by Fitch holding another 15 percent.
“Despite the enormous growth of the industry – which has multiplied its revenues many times to over $4 billion in 2005 – no significant new player managed to enter the global rating market.
“Meanwhile, Moody’s and S&P are highly profitable with operating margins well above 50 per cent.”
Contemporary research has focused on financial data to show that corporates across the world are captive price takers of the agencies’ services.
However, one study this year has delivered a range of counter-intuitive and ostensibly perverse findings.
An international study led by Professor Mingyi Hung from the Hong Kong University of Science and Technology found that the quality of credit ratings issued by S&P and Moody’s tended to be “stricter” in markets where they each enjoyed dominant market shares.
“Using a global sample across 26 countries from 1994 to 2019, we find that greater market power of global credit rating agencies, measured by their country-level market shares, is associated with stricter corporate ratings,” Hung reported in an article published in the Journal of Accounting and Economics earlier this year.
“Collectively, our findings suggest that global rating agencies' market power leads to stricter rating standards and timelier ratings by strengthening the agencies’ reputation concerns, but at the expense of increased false warnings.”
Professor Hung’s findings could be marshalled as evidence to support the retention of the duopoly because credit ratings are prone to being “inflated” in more competitive markets such as Japan.
Even if Hung’s findings are right, it shouldn’t stop the ACCC from investigating whether the duopoly’s local pricing practices qualify as a rort.