modefinance,
a Credit Rating Agency

A credit rating is an opinion on the creditworthiness of an economic entity, such as a company, bank, financial instrument or public body.

An useful measure for assessing the ability that the subject has in generating the resources necessary to repay its debts, this judgment is expressed by authorized agencies (the Rating Agencies) in the form of an alphanumeric code (i.e. A2+ or BBB), each of which identifies a class of risk ordered on the basis of a predetermined scale.

At the highest steps of the rating scale there are the categories considered more solid (A1), while the lowest ones correspond to risky subjects (C2), up to the last step (D) which typically corresponds to subjects in default, or those actually defaulting on one or more financial commitments.

To learn more, discover the proprietary MORE methodology page.

With reference to the rating of a company, the procedure for analyzing a credit rating involves the use of both quantitative and qualitative information, taking as reference the economic-financial, managerial and organizational parameters of the individual analyzed, as well as sectorial data, geographical, and macroeconomic.

The former are extrapolated from the company's financial statements, where the practice involves analyzing the last 3 years on which to carry out a financial statement analysis, in order to view the equity, economic and financial situation. The main parameters are liquidity (it expresses the ability to achieve financial equilibrium conditions in the short and medium term), solvency (measures company structures, the consistency of assets and activities and the debt ratio with respect to equity), and profitability (the firm's ability to create value and make a profit by adequately remunerating the capital invested in the firm).

As regards the qualitative aspects, the aspects of the company are taken into consideration, the people who guide it, the strategy and development plans, the sector to which it belongs, the reference markets in which the company operates, any negativity or protests possibly also extended to the reference persons of the company itself (prejudicial acts, insolvency proceedings and insolvencies, in the presence of official data).

To talk about the rating scale, we need to introduce the concept of mapping.

Based on the authorization of ESMA, the European Securities and Markets Authority, modefinance can issue ratings on both non-financial corporations and financial instruments and banking institutions, and make them public or distribute them for a fee or via a subscription service. 

The ratings have the same level of quality both in the case of solicited ratings, or opinions expressly requested by the rated entity, and in the case of unsolicited ratings, or evaluations not requested by the judged entity.

From 15 May 2018, the amendments to the Implementing Regulations (EU) N. 1799/2016 and N. 1800/2016 have also come into force with which the list of regulatory ECAI mappings is updated with the inclusion of five new institutions, including modefinance. These changes make it possible to all intents and purposes the use of ratings issued by modefinance also by insurance companies and banks.

The mapping is the table with which the rating classes used by the agencies are equated with the Credit Quality Steps, the creditworthiness classes defined by European technical standards (Implementing Technical Standards, ITS). This procedure makes it possible to standardize the judgments, establishing unique parameters for everyone. For Agencies that issue both solicited (i.e. requested by the rated entity) and unsolicited (i.e. rated requested by third parties) ratings, it is also required to demonstrate the equal quality of both types. In fact, unlike solicited ratings, which also include private data and documents provided by the subject itself in the evaluation, unsolicited ratings are based only on public data, but this does not mean that they can provide less accurate and in-depth evaluations.

Following the 2008 financial crisis, the Basel Committee, made up of the regulators of the G20 countries, decided to publish a new regulation with the aim of improving the banking sector's ability to absorb financial shocks, making entities' financial activities more transparent, and improve risk forecasting and management capacity. The new agreements (known as Basel III) provided for an increase in the prudential requirements of banks and, for the European Union, tighter regulation of Rating Agencies.

In January 2011, ESMA was founded, the European authority for financial instruments and markets. The body is made up of all the EU market supervisory authorities and has the task of overseeing the European financial system by protecting investors. ESMA is entrusted with the direct supervision of the Rating Agencies and the application of the European regulation N.1060/2009, known as the CRA Regulation.

The introduction of the CRA Regulation constitutes a fundamental turning point: before 2009, in fact, the regulation of the activities of the Rating Agencies was entrusted to the individual States, and only some provided for specific legislation. With regulation 1060/2009 the need for common legislation is recognized and the requirements for operating as a Rating Agency in the European Community are established for the first time.

The basic criteria are summarized as follows: attention to conflicts of interest, quality of ratings, transparency and internal governance of credit rating agencies. ESMA is entrusted with the role of supervising compliance with these requirements.

ESMA's authorization to operate as a CRA, or Credit Rating Agency, is granted only after examining the requirements established by Regulation N.1060/2009. Agencies are therefore required to publish updated information on their independence and on the management of conflicts of interest, as well as on the services they provide, on the policies regarding the publication of ratings and their remuneration, and on the code of conduct adopted.

CRAs are in fact included in the ECAI (External Credit Assessment Institutions), a term used to define all institutions, other than banks and insurance companies, authorized to issue credit ratings. However, two further steps are required to re-enter the ECAI list: publication of the mapping on the European Banking Authority (EBA) website and recognition of the equal quality of solicited and unsolicited ratings.

Obviously, registration alone is not enough. Regularly, the Rating Agencies are required to draw up a transparency report and submit the methodologies used in issuing the rating to a validation process.

ESMA itself, for its part, exercises supervisory activity by monitoring the ratings issued by the Agencies, carrying out documentary investigations and verifying any shortcomings reported by third parties. In the event of a violation of the regulation, ESMA clearly has the power to impose adequate penalties, which can range from the payment of a fine to the revocation of the registration.

The reasons that can lead to the rating request are mainly two:

• to receive a certification of the health status of your company;
• to obtain an opinion on the creditworthiness of the counterparty, be it a potential customer, supplier or partner.

When the rating is requested by the company being evaluated, it is referred to as a solicited rating.
On the other hand, when it is requested by a third party, it is defined as an unsolicited rating.

The main difference is the availability of information for the assessment: it is clear that in the case of a solicited rating it is in the client's own interest to provide all the data and information necessary for an in-depth examination.

In case of unsolicited ratings, the analyzes and the final judgment are based exclusively on public information available (financial statements, corporate structure, sector or country risk, etc.).

Ratings can be public or private.

The difference is apparently obvious, but it should be noted that a private rating can be shared with a limited number of people and can only be used for internal evaluations.

On the contrary, the public rating has a certification value and allows you to obtain loans at lower rates, attract investors, increase the visibility of the company, certify its solidity at an international level, etc.

By whom the Rating Agencies should be paid for the assessments issued, is a complex and often debated issue, as it touches on issues relating to conflict of interest.

Simplifying, we can say that there are three different payment models:

• the issuer-pay model: the rating is paid by the rated entity. Solicited ratings follow this model;
• the investors-pay model: the rating is paid by the investor, or the person who requested the service, and is the model adopted for unsolicited ratings;
• the subscriber-pay model: the ratings are distributed by subscription to the subscribers of the service.

A company that has never requested it, or that is not aware that it is under analysis, cannot in any case be faced with a rating on its company released without its knowledge.

The Rating Agency has the duty to notify the rated entity of the assigned rating and to ascertain that notification has been made. In turn, the assessed entity has three days to appeal in the event that it finds factual errors in the assessment.