Nov
28
Credit Intelligence where Credit is Due
Filed Under B2B, Big Data, Blog, Financial services, Industry Analysis, internet, Search, semantic web, social media, Thomson, Uncategorized, Workflow | 1 Comment
The best network marketplace ideas are simple. And inexpensive in terms of user adoption. And productivity enhancing. And regulator pleasing. And very, very clever. So we need to give Credit Benchmark, the next business created by Mark Faulkner and Donal Smith, who successfully sold DataExplorers to Markit earlier this year, a double starred AAA for ticking all these boxes from the start. And doing so in the white-hot heat of critical market and regulatory attention currently being focused on the three great ratings businesses: S&P, Moodys and Fitch. Here is a sample from the US (taken from BIIA News, the best source of industry summary these days at www.biia.com):
“Without specifying names, the U.S. regulator said on Nov. 15 that ratings agencies in the country experienced problems such as the failure to follow policies, keep records, and disclose conflicts of interest. Moody’s and Standard & Poor’s Corp. accounted for around 83% of all credit ratings, the SEC said. Each of the larger agencies did not appear to follow their policies in determining certain credit ratings, the SEC found, among other things. The regulator also said all the agencies could strengthen their internal supervisory controls.
The SEC noted that Moody’s has 128 credit analyst supervisors and 1,124 credit analysts, in contrast with S&P’s 244 supervisors and 1,172 credit analysts. The regulator also examined the function of board supervision at ratings agencies, and implied in its report that directors should be “generally involved” in oversight, make records of their recommendations to managers, and follow corporate codes of conduct. Source: Seeking Alpha”.
Well, in a global financial crisis, someone had to be to blame. It was the credit rating agencies who let us all down! The French government and the EU have them in their sights. They have a business worth some $5 billion with excellent margins (up to 50% in some instances). They are still growing by some 20% per annum because they are a regulatory necessity. They have become a natural target for disruptive innovation, and small wonder, because this combination of success and embedded market positioning attracts anger and envy in equal parts. Yet no one, least of all the critical regulators, wants disruptive change. It is easy enough to point to the problems of the current system, illustrate the conflicts inherent in the issuer-pays model, bemoan the diminished credibility of the ratings, or criticize the way in which multiple -notch revisions can suddenly bring crisis recognition where steady alerting over a time period would have been more useful, but at present no one has a better mousetrap.
At this point look to Credit Benchmark (http://creditbenchmark.org/about-us). Having successfully persuaded the marketplace, and especially the hedge funds, to contribute data on equity loans to a common market information service at DataExplorers (a prime example of UGC – user generated content – more normally seen in less fevered and more prosaic market contexts) the team there have a prize quality to bring to the marketplace. They have been once, and can be again, a trusted intermediary for handling hugely sensitive content in a common framework which allows value to be released to the contributors, which gives regulators and users better market information, and which does not disadvantage any of the contributors in their trading activities. So what happens when we apply the DataExplorers principle to credit rating? All of a sudden there is the possibility of investment banks and other financial services sharing their own ratings and research via a neutral third party. At present the combined weight of the bank’s own research, in manpower terms, dwarfs the publicly available services – there are perhaps as many as 8000 credit analysts at work in the banks in this sector globally, covering some 74% of the risks. If all members of the data sharing group were able to chart their own position on risks in relationship to the way in which their colleagues elsewhere across a very competitive industry rated the same risk using the same data – in other words show the concensus and show their own position and indicate the outliers – then the misinformation risk is reduced but the emphasis on judgement in investment is increased.
And of course the Big Three credit agencies would still be there, and would still retain their “external” value, though maybe their growth might be dented and the ability to force up prices diminished if there was a greater plurality of information in the marketplace, and if banks and investors were not so wholly reliant upon them .The direction in which Credit Benchmark seem to be going is also markedly one which is very aligned to the networked world of financial services. User generated content; data analytics in a “Big Data” context; the intermediary owning the analysis and the service value, but not the underlying data; the users perpetually refreshing the environment with new information at near real-time update. And these are not just internet business characteristics: they also reflect values that regulators want to see in systems that produce better-informed results. A good conclusion from Credit Benchmark’s contributory data model would be better visibility into thematic trends for investment instrument issuers and their advisors, as well as more perception of and ongoing monitoring of their own, their client’s and their peer’s ratings. In market risk management terms, regulators will be better satisfied if players in the market are seen to be benchmarking effectively, and analysts and researchers who want to track the direction and volatility of ratings at issuer, or instrument, or sector, or regional levels will have a hugely improved resource. And something else will become clear as well: the spread of risk, and where consensus and disagreement lies. Both issuers and owners get a major capital injection of that magic ingredient – risk – reducing information.
None of this will happen overnight. Credit Benchmark are currently working on proof of concept with a group of major investment banks, and the data analytics demand (in a market place which is not short of innovative analytical software at present) is yet to be fully analysed. Yet money markets are the purest exemplars of information theory and practice, and it would be satisfying to be able to report that one outcome of global recession had been vast improvements in the efficacy of risk management and credit rating of investments. Indeed, in this blog in this year alone we have reported on crowd-sourcing and behavioural analysis for small personal loans (Kreditech), open data modelling for corporate credit (Duedil) and now, with Credit Benchmark, UGC and Big Data for investment rating. These are indicators, should we need them, of an industrial revolution in information as a source of certainty and risk reduction. Markets may never (hopefully) be the same again.
Comments
1 Comment so far
David
great article and reminds me of an exchange we had about whether all the data needed to make good credit decisions (in their broadest sense) is available in the network or whether some of the most valuable data is still locked behind the firewalls of individual corporations. Here is an example of another (potential) breach in the firewall that enables better decisions to be made by the sharing, aggregation and analysis of data.
One of the things rarely mentioned outside the circles that people like me with a strange interest in credit information is that Consumer Credit scorecards that were built on shared positive and negative data still performed robustly as a predictor of the relative probability of default for one scorecard band to another.
Put in layman’s terms if a scorecard ranked individuals from 1 to 100 where 1 was the highest probability of default and 100 the lowest, the distribution of scores from 1 to 100 in any given population was still a powerful indicator of probability of default after the credit crunch as it was before.
What changed was individual organisations appetite for risk and the creation of the various financial devices such as Mortgage Backed Securities that allowed the originator of the risk to lay it off through a serious of complex and largely opaque mechanisms for packaging and bundling risk.
Whilst many commentators have deplored the rise of payday lenders in markets such as the UK and USA and the exorbitant interest rates they charge (2000% APR for example) the reality is that they are operating to an old maxim, which is you can accept high risk credit applicants if you can charge high enough interest rates so that those that pay (and not all High Risk consumers default) cover the costs of those that don’t and generate a sufficient return to make it a valid business model.
How does this tie back to this article? Well Experian, Equifax and the multitude of Consumer Credit Bureaus around the world have been executing the model that Credit Benchmark are now trying to bring to the Credit Rating market. They act as neutral parties in the process of collecting, aggregating and analysing consumer credit information so that their customers can make better credit decisions.
As my Mother always said its good to share and in the world of credit risk, be it consumer, SME or corporate credit, the more sharing, the greater the transparency and as a consequence better credit decisions can be made to the benefit of lenders, borrowers and our economies at large.
So lets hope they succeed and hopefully more firewalls will come tumbling down.