Credit ratings and its significance

Fitch Ratings said this week it is committed to providing the world's securities markets with independent, timely and forward-looking opinions on credit risk via prospective ratings and in-depth research and analysis.

Over the past few months, discussions with many market participants including investors, issuers and regulators have revealed a broad understanding and support of Fitch's approach to assigning ratings on the 'AAA' scale. However, some market participants have requested further transparency and more detail 'behind the ratings'.

"We get regular questions regarding the different dimensions of risk communicated by our ratings," said report co-author, Richard Hunter, Regional Credit Officer at Fitch. "We wanted to pull these together to help people understand the thought process behind the ratings and the underlying strengths of the rating scale, as well as the limitations built into what the ratings can express."

A new study by Fitch on this issue covers a number of topical issues, including the comparability of ratings across sectors, the degree to which loss severity is incorporated in ratings and the time horizons which apply to 'through-the-cycle' ratings. The report also summarises the impact of event risk on Fitch's credit ratings, from wars to changes in tax law. "We feel it's important for users to understand the assumptions we use when assigning ratings," noted Sharon Raj, Senior Director and Head of Rating Policy.

"Currently, for example, there is a lot of debate about what an 'AAA' rating means to the investor," said Hunter. "Credit ratings have never explicitly spoken to pricing of an instrument, nor to liquidity of the instrument, but the market has generally formed its own expectations regarding these factors based on historical 'AAA'-rated assets. The expectation that a 'AAA'-rated security would always be highly liquid and price at a very fine level - assumptions 'beyond the rating' - worked well for treasury bills and very low risk institutions, but will increasingly be challenged as the universe of very low-default instruments expands."