The Mechanism Behind Rating Assignment

Rating Assignment Procedures

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Introduction
The process of assigning the Rating takes place according to a time schedule with phases apparently identical for all the Agencies. The substantial differences mainly concern the mere formal expression of judgment.
The process of Rating can start via different procedures:
Stimulus by an entity requesting the assignment of a credit Rating for its own issuance of a liability or its overall reliability;
Stimulus from investors who ask for a Rating for liabilities believed to be interesting;
The Rating Agency that spontaneously activates to assign a credit Rating to certain liabilities or to a certain economic entity.
In most cases, the assignment process is activated through the first procedure.
If it is the issuer who requests the opinion, they will enter into a contract with the Agency in which the obligations of the counterparties are explained. In the case of an unsolicited Rating (case C), the Agency spontaneously proposes itself to the subject, who may agree to enter into the contract or refuse. Refusal by the issuer does not interrupt the allotment procedure but obliges the Agencies to base their analyses solely on publicly available information.
Once the information has been gathered, the process of formulating the Rating in the strict sense of the term begins. This purely analytical phase is based on complex systems of qualitative and quantitative variables, aimed at synthesizing a lot of information under an alphanumeric value.
At the end of this phase, the Agency will give its opinion, as we shall see below. The issue does not entail termination of the relationship between the issuer and the Agency. Often, in fact, the latter is called upon to provide a monitoring service, aimed at maintaining the reliability of the Rating.
In a simplistic manner, the procedure that leads an Agency to carry out the analysis and subsequent evaluation of a given issuer is described in the following figure:

Allocation procedure in the strict sense
The most important peculiarity of the agencies is that they are able to synthesize a vast quantity of information under a simple alphanumeric value.
The three main Agencies (Standard & Poor’s, Moody’s and Fitch) express their opinions with a slightly different symbolism, but with the same informative contribution.

Figure 2: Rating classes for the three main Agencies.
Source: Unicredit Corporate & Investment Banking.
The results shown in the table (Fig. 2) are the result of a process that starts from the acquisition of a considerable amount of information on the issuer by the Agency.
The assignment of the Rating is based on a complex system of quantitative, qualitative and qualitative-quantitative variables.
These include financial statement data, managerial qualities and the market position within the company’s reference sector.
The most critical aspect of the allocation process is precisely that of the acquisition of information relevant to the subsequent analysis.
Agencies have often been accused of taking too little information into account.
In order to carry out a correct evaluation, it is necessary to carefully analyze the quantitative and qualitative factors of the issuer. The latter, however, are not taken into account in their entirety, as they would greatly increase the amount of data to be examined, leading to increased costs.
The formulation procedure starts from the constitution of a group of analysts (the analytical team), required to carry out research and analysis activities; the results are then examined by the Rating committee, which assigns a preliminary Rating, that serves as a starting point for the subsequent elaborations.
Before the final assignment, the team conducts a series of meetings with the management of the issuer, which are intended to evaluate the operational and financial plans and strategies of senior management, but also allow analysts to live in contact with the operational reality of the company, so as to perceive the culture, the corporate climate, the value of management and other quality variables, which are of great importance to achieve the final Rating. While the Agencies are able to process a large amount of information through this process, they are often criticized for their ability to predict the probability of default.
It has often been argued to the Agencies that they themselves, as the main promoters of transparency, are not really transparent to the public [Casey 2009].
In fact, making their methodologies and practices known in the assignment of the Rating is a practice that they have only recently been working with, following a more rigorous regulation.

Conclusions
The second chapter of this paper is intended to explore the methods of analysis and representation of data followed by the Rating Agencies through alphanumeric values.
Also, the question has been raised as to whether these assessments are not always true.
The three main world Rating Agencies and the differences in assignment and symbology used in the analysis of capital in the short, medium and long-term are mentioned.
Lastly, the problem has arisen as to how the Rating Agencies seem more interested in their own reputation than in the real solidity of the capital of the institutions under examination.
Marco Barchetti
Fintech Review

The Mechanism Behind Rating Assignment
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