* Run on not-for-profit basisBy Rachel ArmstrongSINGAPORE, Oct 14 (Reuters) - In a small lab, tucked away in
the depths of a Singapore university campus, a team of
researchers and their computers calculate the credit ratings of
about 50,000 companies.Relying just on public data and stock price movements for
their analysis, the project’s founder, professor Jin-Chuan Duan,
is confident their system can provide a more reliable guide to a
company’s credit risks than the commercial rating agencies.A confident claim, but a growing number of the system’s 800
users are banks and fund managers, utilizing it to help guide
their own internal credit risk systems.”It offers a very transparent and objective approach to
estimating the credit rating of companies,” said Benjamin Wong,
a senior risk analyst at a UK bank.”I’m not sure a single bank could do what they’ve done in
terms of collecting the data, assembling the research
capabilities, and having the technology to do the calculations
on such a large volume of companies.”BORN OUT OF FRUSTRATIONThe idea was born in March 2009, out of frustration at the
debate surrounding credit rating agencies in the wake of the
financial crisis.”It occurred to me that just criticizing the rating industry
and going about the conventional way of regulatory reform is
never going to go anywhere, so I was asking myself is there
something more constructive I could do?,” said Duan, the
director of the National University of Singapore’s Risk
Management Institute.An evangelist for revolutionising the way credit rating
agencies operate, Duan believes the private sector model, where
agencies are paid by the issuers to rate their products, is
flawed.”Credit ratings should be viewed as a public good and part
of infrastructure,” he said.”The natural way to achieve this is for a knowledge
enterprise to do it.”So that’s what Duan did, allocating S$7 million ($5.5
million), part of a grant provided to his institute by
Singapore’s central bank, to fund a free-to-use credit rating
service for four years.He and his team of around 30 researchers built the system
using data from Reuters and Bloomberg terminals on companies
listed across Asia, Europe and America.They designed models to calculate the probability of a
company reneging on its debts, shaped by analysis of previous
corporate defaults.NO MORE AAAsRather than issuing the well known alphabetic ratings like
AAA, the system produces a numerical probability instead. For
example it estimates that the recently rescued Franco-Belgian
lender Dexia SA has a 3.4 percent probability of
defaulting in the next two years — low but still five times the
European financial sector’s average probability of 0.7 percent.The big-three credit rating agencies — Moody’s ,
Standard & Poor’s and Fitch Ratings — have defended their
lettering system as a useful shorthand understood across the
finance industry.But Duan is among the many critics who believe debt should
be assigned a more precise credit rating.”In the political polling sphere during election time we
tell people the points and margin of error in a poll and TV
viewers don’t have a problem understanding, so it should be
possible in the financial sphere,” he said.COMPETITIONIt’s not the first time someone has tried to give the big
three agencies and several local players a run for their money.
Following the financial crisis, Wall Street analyst Meredith
Whitney, entrepreneur Jules Kroll and research firm Morningstar
Inc are among those who have ventured into the ratings
space.What distinguishes the university’s offering is it’s not out
to make money and welcomes outside contributions that will
improve its model.”As we are not for profit, we are happy to invite people to
participate with us in a Wikipedia-type spirit of development,”
said Duan, adding that they don’t register intellectual property
rights for the project, nor do they take corporate donations.It’s this approach that is one of the big winners with the
industry. With banks under more pressure than ever from the
regulators to provide a thorough explanation of their approach
to risk management, they need a credit rating system with a
public methodology they can test for themselves.”They (the institute) are transparent in their methodology
and in disclosing the performance of their ratings,” said Wong
at the UK bank.”For the credit rating agencies, a rating decision is made
based on a committee approach, so it can be quite subjective.”That’s not to say the system’s not got its limitations —
it can only rate publicly listed companies and lacks the access
to issuers that the big rating agencies have.But Duan believes their system, based as it is on
quantitative analysis of previous defaults, will provide a
scientific benchmark for banks and regulators to test other
credit rating systems against.Asked what the commercial players have made of their
offering, he says they have initially been rather defensive but
come round once they realise they are not facing financial
competitors.”Once we’ve made it clear we’re here to create scientific
competition, we’re not here to create business competition they
start to feel a bit more comfortable with it,” said Duan.
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