The rapid pace of development of capital markets in Europe over the past decade has meant that the ratings assigned by credit rating agencies play an increasingly important role. The fact that such ratings can be readily understood by investors, and the strong degree of confidence which agencies enjoy within the financial markets, have doubtlessly contributed to this trend.
As a result, requests for the assignment of a rating from an agency, on the part of companies intending to seek financing in the capital markets, have over time become more frequent. The resultant dialogue between the company (or other requester) and the credit rating agency has led to the emergence of the new function of rating advisor, denoting an expert who assists and supports a company through the process of obtaining and maintaining a rating from one (or more) rating agencies.
What Are Rating Advisory Services?
Today, rating advisory services are becoming more widespread and are no longer offered exclusively by investment banks, but also by commercial banks as they increasingly extend their activities in capital markets and the investment banking sector. This prompts a number of questions. What are the functions and activities performed by rating advisors? What is their role within the bank?
The near total absence of bibliographical references means there is no immediate answer to this question. Unlike the extensive body of work devoted to ratings and credit rating agencies, there is no trace in the literature about the topic of ‘rating advisor’ within the investment bank industry. In light of this significant gap and, in particular, given the growing importance of ratings in financial markets, it was decided to conduct a survey.
The aim of the study was to identify the specific functions and activities typically performed by the top global players in rating advisory. The survey was carried out in London in 2007 and consisted of eight direct interviews with rating advisory departments chosen among the 16 top global players listed in the Euromoney ranking.
Main Survey Findings
Role and functions within the bank
The survey found that the main market operators (investment banks) generally offer rating advisory services as an accessory to investment banking services, using them as a means to secure new relationships or consolidate pre-existing ones. As a result, the fees charged tend to be relatively low or even limited to the reimbursement of out-of-pocket expenses incurred during the assignment. According to the respondents, specific functions performed by rating advisors, to a various degree, depending on the economic and market context include:
- Provision of ‘services’ to other departments (i.e. assessment of the debt capacity of specific companies or assessment of the impact of different financing options on the company’s capital structure and on the rating itself, or they might also provide training and education on rating issues to other departments of the bank).
- Searching for and identifying companies (new clients) potentially interested in obtaining a rating.
The size of the rating advisory department was found to vary widely among the survey participants – from very small teams (two people) to large teams (over 20 people). Its employees generally have backgrounds that include experience within rating agencies or credit departments.
Activities carried out for clients
It was found that rating advisors often provide a range of different services simultaneously, although with varying intensity depending on the specific needs or requirements of the company requesting the advisory service through the rating process. Their services include education, assistance and support, and assessment.
In the case of educational activities, it was found that rating advisors offer services aimed at improving the knowledge of the client company. In short, the role of the advisor consists principally of describing and explaining rating topics, such as the meaning of the ratings, the rating process and rating criteria, etc, to the client.
A distinguishing feature of the advisor’s role is the ongoing and specific support and assistance provided throughout the duration of the assignment. This includes everything from organising the collection of the data and information required by the agencies, to helping to write the ‘company presentation’, and supporting the company during the meetings with the rating agency analysts.
With respect to the third group of activities (assessment), the advisor usually helps the client to understand its relative positioning with respect to competitors that already have a rating (peer group analysis), on the basis of their business and financial profiles. The advisor may also be asked to estimate the debt capacity of the company based on the classes of rating which it is likely to obtain from the agency.
The survey also discovered what a rating advisor does not do. First of all, it was found that rating advisors do not review or certify the documentation collected and subsequently submitted to the rating agencies. The rating advisors in fact do not undertake to verify the accuracy of the data received from the company, but merely assume it to be truthful, as is typical for rating agencies too. Second, rating advisors do not conduct due diligence of the company’s operations. Their role is limited to assisting in the data collection and drafting of the presentation (‘book’), which then provides a basis for any further investigation or request for additional information on the part of the rating agencies.
Finally, advisors do not guarantee assignment of a specific rating: they can only indicate the range of ratings likely to be obtained by the client company.
The Rating Advisory Process
After determining the general areas of activity typically engaged in by rating advisors, we proceeded to study the manner in which these various activities are combined in a specific situation. In particular, we chose to examine the various steps in the rating advisory process at a key juncture in the life of a company, i.e. when an unrated company decides to request a first-time rating. In this case, according to the respondents, the work of the rating advisor typically progresses along a sequence of six steps. During each of these steps, the advisor engages in the specific activities described in more detail below.
1. Rating pitch
The first (formal) contact between the advisor and the company is normally the presentation of the rating pitch, i.e. the offer of rating advisory services to the company, generally after it has expressed an interest to the bank’s relationship manager. If the rating advisory pitch is accepted, the engagement is usually confirmed in writing.
2. Planning
The second step involves scheduling the various activities and identifying the company team that will be involved in the project. The choice of rating agency (or agencies, in the case of a ‘double’ or even ‘triple’ rating request) is also made at this stage.
3. Data collection
In the third step, the advisor’s activities generally consist of gathering the information and data needed for writing the presentation report (also called the ‘book’) that will be used to ‘introduce’ the issuer to the agency, though in some cases the company may produce this ‘book’ on its own account. In gathering this information, the advisor expects the company to provide the agency with data that is as accurate as possible and realistic economic/financial projections.
4. Presentation/Book
During the fourth step, the advisor writes the ‘presentation’ working closely in conjunction with the client company. As we have said, this ‘book’ is the document that will be used to present the company to the rating agency. The report, which is strictly confidential, contains the information gathered in the previous step of the process, organised in a manner designed to facilitate its interpretation and analysis by the rating agency. When the report is completed, it is sent to the rating agency for review by its analysts prior to their meeting with the management of the company.
5. Management/Rating meetings
The meetings with the agency are of the utmost importance for the issuer. It is during these meetings that the rating analysts discuss the information received, request any further details they consider necessary, and gauge the quality of the company’s management. Given the crucial importance of these meetings, the rating advisor provides the management with extensive support in preparation for them. The aim is to prepare the management to give clear and comprehensive answers to any requests for explanations or further details that the agency might make.
6. Rating of issuer
The sixth and final step of the rating process is the point at which the rating agency concludes its analysis with a rating decision and writes its press release. After arriving at the rating, as it were through a collective and confidential decision of its rating committee, the rating agency draws up a document (typically, a draft press release) summarising the principal factors for the rating. This document is then sent to the company.
The management must then decide whether or not to make the press release public as it is or – if any new events have intervened, or there is important new information not previously submitted – whether to appeal the assigned rating. These are clearly decisions of the utmost importance, in light of their implications for the future of the company.
As the decision relating to the press release is so critical for the company, it is usually preceded by a certain amount of dialogue with the agency, to help ensure management makes a fully informed choice. The company may also communicate with the agency to point out inaccurate information in the press release, or the inclusion of confidential details that the company does not wish to divulge.
Conclusion
The survey conducted among the top global players made it possible to outline a general model for the activities, functions and roles of rating advisors. There was a near unanimous consensus, among the players interviewed, in interpreting the role of the rating advisor along the general lines set out in this article. The few divergences from this model related mainly to the service intensity devoted by certain banks to specific functions, as compared with other banks.
The reference model that emerges from the survey depicts the role of the rating advisor as differing substantially from certain other professional functions that are often, but incorrectly, deemed to be comparable. These include, in particular, the roles that are found in the ‘research’ departments of investment banks, such as equity analysts and fixed income analysts, as well as the analysts of the rating agencies themselves.
The aim of this article has been to present the first results emerging from the survey, in order to contribute to opening a line of study in this area. Future research on this topic will involve not just surveying a larger number of respondents, but also the investigation of other aspect such as, how the role of the rating advisor (or rating advisory in general) should be interpreted under the Investment Services Directive, as this is not clearly defined in the light of the current regulatory framework and the results of the present article.