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Home > Blogs > Anthony Harrington > Abu Dhabi Commercial Bank blows the lid off ratings agency "independence"- Part One

Abu Dhabi Commercial Bank blows the lid off ratings agency "independence"- Part One

Abu Dhabi Commercial Bank blows the lid off ratings agency Anthony Harrington

The scandal of the mis-rating of asset backed securities looks like coming back to haunt the ratings agencies in a major way. Up until July this year companies and institutions trying to sue the major ratings agencies for awarding Triple A status to toxic sub-prime mortgage backed securitisation vehicles, had not been having a lot of joy. Case after case was dismissed by the courts, with the judges arguing that it was pointless letting the cases proceed since it would be next to impossible to tell how much of the damage that plaintiffs claim to have suffered as a result of the mis-rating was due specifically to the mis-rating, versus how much of it was due to the general downturn in the global economy.

As a result of these actions being dismissed, the ratings agencies were spared the ignominy of having to hand over their internal staff emails. There was a widespread belief that if those emails were to come to light it would make it blindingly clear what the agencies' own traders really thought of these securitized packages, but no one knew for sure, since the actions were failing before the point at which a handover would be compelled by legal due process.

In July, however, as reported by Reuters, the New York State judge Shira Scheindlin turned down applications to dismiss by ratings agencies Moody's and Standard & Poor's in an action being brought by Abu Dhabi Commercial Bank and other investors. The action alleges negligent misrepresentation with respect to two structured investment vehicles, Cheyne and Rhinebridge. The ratings agency Fitch is also a defendant in the latter case.

According to the statement set before the court by the plaintiffs, they had invested some $980 million in Cheyne. The case has yet to come to court but the allegation does the ratings agencies no favors:

"The evidence establishes that the ratings had materially false components and defendants had no reasonable basis to believe the assigned ratings were justified. Each defendant knew of or recklessly disregarded the falsity of the alleged misstatments. All defendants knew that the data and assumptions used to rate the Cheyne SIV notes were unreliable and insufficient to support the ratings. They knew that the assets the Cheyne SIV held were not accurately rated and that the ratings were not commensurate with the risk. The defendants ignored these facts and issued top ratings without a basis in fact for doing so."

The matter could not be put more plainly. The ratings agencies have, of course, already been tried and found guilty in the court of public opinion but that verdict, seemingly, left them unscathed and free to continue. Their response has been to swing to the other extreme and to spook the markets again and again by leaping in with endless downgrades of banks and sovereign states, to the point where their pronouncements have begun to have very little impact on the markets. A recent downgrade of bank stocks actually saw bank share values going up the following day.

However, the court of public opinion is one thing, an action for damages is quite another. Apart from the potentially huge damages the agencies could face if the case goes to court and they lose, which looks a racing certainty (though nothing is certain in litigation), the hit to their reputation, or what is left of it, is enormous.

The court document cites S&P's "most senior quantitative analyst in Europe" at the time of the Cheyne SIV launch as saying:

"So it is a factual statement that the ratings of those (SIVs) were inappropriate because the ratings of the underlying assets were not appropriate. So it leads to the conclusion that they should not have been rated, but that is not necessarily my belief. It is just a factual statement."

Abu Dhabi Bank and its fellow plaintiffs argue that the complexity of the Cheyne SIV was such as to leave them "with no choice but to rely on the ratings to assess the credit risk of these investments". Of course, with hindsight, the maxim of not investing in things one does not understand, regardless of the shine put upon those things by ratings agencies or anyone else, looks golden.

While this is on one level simply being wise after the event, it does cast some doubt over the solidity of the phrase "had no choice" in the bank's position. It had every choice and chose to invest in something that, by its own account, it didn't begin to understand, simply because the SIV carried the promise of a mouth watering return - and a Triple A rating.  Henceforward, for a few short years at least, the world i.e. institutional investors and banks, will be a lot more wary about investing in things they do not understand. But what will be interesting is whether or not court action finds serious wrong doing as it unpicks the ratings mechanism. We will probably never know since this case looks odds on to be settled out of court. However, what we do have are the emails from the agencies and that genie simply cannot be put back in the bottle. Part two looks at some choice examples.

Further reading on securitization and the US sub-prime debacle:

Tags: Cheyne SIV , credit rating agencies , Fitch , Moody's , ratings agencies , sovereign downgrades , Special Investment Vehicle , Standard & Poor's , Triple A , Triple A credit rating
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