Portrait: Markus Krall, alone against the Big Three
16 March 2012
The EU daydream of breaking the Standard & Poor’s, Moody’s and Fitch Group monopoly on credit ratings may become a reality if a lone German consultant succeeds in creating a European ratings agency. Excerpts.
Markus Krall is Europe's last hope. He knows that the continent needs a little success. And so the man from the consulting firm of Roland Berger has been crisscrossing Europe in airplanes for a few weeks now, visiting a bank, insurance company or investment fund almost every day. Almost every day, the 49-year-old talks to a CEO, makes a presentation and hands out a sheaf of paper. It’s worth working through it, to explain what’s at stake.
About 60 such visits are scheduled in total, and in the end Krall would like to have about 30 signatures – each worth, on average, ten million euros. Krall's goal is to come up with 300 million euros.
A European ratings agency built from scratch
The money will go towards building a European rating agency from scratch. Many others have failed in the effort to get such an agency off the ground in the past 20 years. Krall's trial is probably the last chance for Europe to put something in place to counteract the three Anglo-Saxon rating agencies, which dominate the credit-rating business globally: Standard & Poor's Ratings Services (S&P), Moody's Investors Service and Fitch Ratings – the Big Three, as they are known.
Markus Krall is buoyed by the feeling that the Big Three have very few friends in Europe these days. But Markus Krall's opponents wield a lot of power. Every company, every bank, every state that wants to get money from investors in the capital market needs a credit rating. The better the rating turns out, the more cheaply it can borrow the money.
And to get such a rating, almost all of them turn to the Big Three. Their power is deeply anchored in the regulations, and their popularity among investors remains undimmed. That makes Markus Krall’s battle an uphill struggle. But Krall wants to take them on.
[His] plan begins with establishing a European Rating Foundation. From 12 to 18 months after that day, Krall hopes to bring the first rating to the market. He wants to start with the ratings of states. Companies and banks will come later. Within three years, he hopes to hire 1,000 employees. After five years, the new rating agency ought to have a 25 percent market share in Europe. After ten years, 25 percent worldwide.
Competition? Yes, there are already other rating agencies. Overall, worldwide, depending on the source, from 70-150 rating agencies are in business, but they are working only regionally or in individual asset classes. Investors with billions in assets, though, like to spread their money around the world and across all asset classes, and so they prefer to get ratings from a single agency. Only the Big Three offer that.
Governments are railing against them, because a downgrade in their rating makes it much more difficult and expensive for them to borrow money on the capital markets. It almost seems paradoxical, but for all that, Athens and Lisbon pay out hundreds of thousands of euros a year – to the rating agencies. In the classical model, which Markus Krall will also have to follow at first, the agencies are paid by those they are called in to give a rating to.
Reducing the importance of the Big Three agencies
The fact that the Big Three are more or less alone in their field, and thus exposed to little competition, is reflected in their operating profits: in 2011 Fitch Ratings had an operating margin of 31 percent, S & P Ratings Services 41 percent, and Moody's Investors Service 44 percent.
Although a management consultant, Markus Krall isn’t taking aim at profits like those. The European rating agency is to be privately funded, for how else could it offer independent ratings of states? The new agency is not meant to be profit-oriented, as the Big Three are, and it will certainly not be listed, as Moody’s is. All together – the large number of 30 investors, its organisational form as a foundation and the absence of a profit motive – should ensure independence, Krall hopes.
In the U.S. and the EU the legislators want to reduce the importance in the regulations of the ratings from the Big Three. But what criteria can replace ratings? Simply doing away with them without bringing in a replacement will create new problems. A fund manager, for example, might be suddenly free to buy any securities he wanted to – and could be tempted to buy possibly more profitable yet riskier securities.
Here’s where the loyalty of investors plays a part. The Big Three are holding onto power today largely because pension funds, money funds, hedge funds, insurance companies and banks have gotten used to them over the decades. Their ratings are simple. They reduce the complexity of the financial world and make securities comparable from nation to nation. “The enormous influence of the Big Three is due simply to the fact that they have already been around as long as Wall Street,” says an experienced banker in New York.
Even if Markus Krall does succeed in creating a European rating agency, he’ll still be faced with the problem of winning over customers. Companies and banks bring in rating agencies only when the investors take those agencies seriously. Investors, however, take rating agencies seriously only when they are called in by a lot of companies and banks. It’s a closed circle.
Agencies rating their shareholders
But Markus Krall is keeping up the fight. For Roland Berger, the project has long been a matter of reputation, and the consultancy wouldn’t mind picking one or another lucrative contract, either. That’s why Krall has another trump card up his sleeve. A trump card that should help to change the rules of the game over the long run. It is a study by Roland Berger that shows that other American fund companies such as Vanguard, Capital World, State Street, Black Rock, to name just a few, own shares in Moody's and McGraw-Hill, the parent company of S & P.
This interdependence raises, firstly, the question of how great the conflicts of interest are, since the agencies are also rating firms that count among their shareholders. On the other hand, in view of the interdependence and the high combined market share, the study diagnoses “monopolistic structures” in the rating market.
Moody's and S & P reject the notion of a ‘harmonised’ American rating complex. “The mere fact that an investor is involved in Moody's and McGraw-Hill at the same time doesn’t mean there’s a conspiracy,” says Daniel Kolter, head of Moody’s German office. His colleague from S & P is even clearer. “Not even my CEO has any influence over the decisions of our analysts,” says Torsten Hinrichs, head of S&P’s German office. “Analysis and business are strictly separated.”
Hinrichs looks on the efforts of Markus Krall and Roland Berger calmly. “We wish them a lot of success. I really mean that.”
Translated from the German by Anton Baer