Credit rating: what is it?
A credit rating is an independent assessment on a borrower’s ability to meets its financial debts.
Although the word rating is commonly used as abbreviation of Sovereign Credit Rating, which are opinions on the probability of default of a sovereign entity, it could also refer to:
- Rating of Financial Instruments: ratings assigned on financial securities, also known as Issue Rating. They assess the probability that an issue will be fully and timely repaid at the maturity date;
- Corporate Credit Rating: assess the creditworthiness of financial and non-financial corporates. As the assessment is assigned to an entity (like Sovereign Rating), they are also called Issuer Rating.
In Europe, only Credit Rating Agencies (CRA) recognized by ESMA, the European Securities and Markets Authority, may issue ratings. The registration as a CRA is subject to a thorough examination of the rating methodologies and the fulfilment of the requirements of transparency, governance and compliance. Such examination recurs any time the Agency extend its rating activity on new subjects (for example, if, in addition to the issue of Corporate Credit Rating, the Agency want to extend its activity to the issue of ratings on financial instruments).
Solicited and unsolicited
There are two main reasons for requesting a credit rating:
- to get a creditworthiness assessment on the own company;
- to receive an opinion on the counterpart’s reliability.
Ratings requested by the rated entity itself are defined solicited ratings, while ratings requested by a third entity or issued by the Credit Rating Agency without any commission (generally for marketing purpose) are defined unsolicited ratings.
The main difference between solicited and unsolicited rating, other than the claimants, is the availability of information for the evaluation. Unlike solicited ratings, where credit assessment includes also private data and information provided by the issuer itself, unsolicited ratings are based on public data only.
Private or public disclosure?
Credit ratings can be disclosed publicly or conveyed privately.
While public ratings have legal value, private ratings are strictly confidential and can be shared with a limited number of people. They can therefore be used for internal evaluation only and public dissemination is not permitted.
Private ratings can be published on request if solicited. In case of unsolicited ratings, the choice is up to the applicant.
Whether solicited or unsolicited, at the end of the evaluation process the Rating Agency has the duty to notify the rated entity of the rating assigned and to ensure that the notification has been received. The rated entity has three days from delivery to appeal if it finds factual errors in the assessment.
Ratings represent a certification of reliability and can bring numerous advantages to the rated company: from a self-evaluation of the economic and financial health to the diversification of the funding resources.
From the report that follows the assessment, companies can identify, predict and prevent internal and external risks and intervene timely on critical factors. Ratings are also important information for investors and may boost the company’s accreditation on the stock markets. They unfold companies new financing opportunities (from peer-to-peer lending to mini-bonds issuance), allowing them to reduce the dependence from bank credit and reinforcing the perception of reliability towards suppliers and investors.