Rating the Law

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Rating the Law: How Financial Rating Agencies are Assessing the Legal Risks of Financial Transactions

BERTRAND DU MARAIS
University of Paris X at Nanterre
PIERRE-HENRI CONAC
University of Luxembourg - Faculty of Law, Economics and Finance; European Corporate Governance Institute (ECGI)
ALAIN PIQUEMAL
affiliation not provided to SSRN
PHILIPPE FROUTÉ
Université Paris X Nanterre
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June 2007

U. of St. Gallen Law & Economics Working Paper No. 2008-12


Abstract:
Financial rating agencies are key actors of financial markets. Their different ratings are usually pre-conditions for issuing securities or bonds. If they assess the financial viability of the financial instruments issued, they also assess the soundness of the legal arrangements used. Thus, taking the law into account is a key element of their assessment. At a macro level, their ratings may express an opinion of the economic attractiveness of a territory. The same may apply to the legal framework used by issuers. Surprisingly, the literature on this topic reveals to be scarce. This paper aims at fulfilling this gap.

It studies, in particular thanks to interviews, how rating agencies consider the law while rating a country, an enterprise or a financial structured instrument. One of the hypotheses we wanted to test was whether financial rating agencies use synthetic indicators of law and institutions effectiveness such as those of IFC (World Bank Group) Doing Business annual reports and if there are biases for or against certain legal traditions. Firstly, this study assesses the relatively informal methodology used by the rating agencies to assess the quality of the legal framework of instruments issued on markets. Secondly, the study reveals in particular the existence of several biases: a general prejudice against Case law and a specific bias in favour of Common Law jurisdiction. This study reveals that, on average, due to the limitations of the ranking used by rating agencies, all other things being equal, corporations or bonds issued from countries unduly ranked should suffer from this prejudice. The paper tries to quantify the sensitivity of rating models to the assessment of the quality of the legal environment. Finally, this paper considers what regulation framework would help to cope with the exhibited drawbacks and to improve the fairness and the effectiveness of the rating process.

papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1139014_code720524.pdf?abstractid=1137896&mirid=3

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Comment on B. du Marais et al.: Rating the Law - How Financial Agencies are Assessing the Legal Risks of Financial Transactions

ALAN SCHWARTZ
Yale Law School
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June 2007

U. of St. Gallen Law & Economics Working Paper No. 2008-13


Abstract:
Professor du Marais and his colleagues analyze the way CRAs condition their ratings on the effectiveness of debt collection. Three such agencies are studied: Standard and Poor, Moody's and Fitch. The method used was to conduct interviews of stakeholders, the CRAs, top managers of all kinds of issuers, and staff of the regulators. All of these interviews were conducted in France.

This paper is in the line of papers that make serious studies of private institutions that affect the law and markets. These institutions have not received sufficient scrutiny, so this paper is welcome. In my view, the paper's positive findings are valuable but its normative critique needs more work. Thus, this Comment should be taken as a request for further research. My remarks are in three categories: market responses; ratings criteria; and data issues.

papers.ssrn.com/sol3/Delivery.cfm....1137923&mirid=2