Kroll Bond Rating

Case: Kroll Bond Rating Agency

1. Jules Kroll is planning to enter the credit rating business, Is this a good idea? Is this a good time?         

Jules Kroll planned to enter the credit rating business following the financial crisis in 2008. This could potentially be a good time to enter for Kroll because the big three credit rating agencies received criticism for playing a role in the crisis. Many people believed that the agencies facilitated a bubble in the securities by rating them higher than they should have been. Because of this criticism, it would provide Kroll with an opportunity to enter the credit rating business as a new agency that was not involved in the crisis. Investors might be skeptical to use the big three agencies and decide to use Kroll’s new agency in the future if it is more credible and trustworthy.

Even though the timing is right for Kroll to start his own credit rating agency, it is not a good idea. It would be extremely difficult to start an agency in the credit rating market. Kroll would need to gain the trust of the investors that his agency is accurate enough to rate their securities correctly. If he could not rate them correctly, it could ruin his reputation in the industry and greatly affect the investor's securities. There are also a lot of regulations needed to start an agency that would make it difficult for Kroll. He would need a team of experts to accomplish this in an efficient manner. Although the big three agencies were heavily criticized, which would benefit Kroll, it would still be challenging for his new agency to compete with large well-known agencies that can bounce back from the crisis when they regain the trust of investors down the road.  

1. How did the incumbent credit raters fail in the financial crisis? How does this affect Kroll’s opportunity?

The big three credit rating agencies, Fitch, Moody’s, and S&P, took a lot of the heat for the financial crisis in 2008. During this time these agencies were giving very high ratings to mortgage-backed securities who in the summer of 2007 began to default more frequently. Investors faced large losses and began to criticize these agencies for their conflict of interest distorting their judgment in rating certain securities. These agencies relied heavily on  the “issuers pay” model where firms seeking a rating would pay for such, which led to ratings that were higher than what would be acceptable by investors, especially for complex financial products. The backlash faced by credit rating agencies after the financial crisis led Congress to implement new rules meant to more strictly enforce the SEC’s requirements for NRSROs by late 2010.

Because Kroll wanted to enter the credit rating agency market in such a turbulent time, the firm would have a hard time gaining the trust of investors. There were many established requirements for entering this market along with new emerging rules that would affect Kroll’s agency. It’s hard to say what an appropriate business model is for these types of agencies who are seeking profits but also want to relay accurate information to the public. Making information private and only available for subscribers would result in less profits and also lack of information available to the public. Using the “issuers pay” model results in higher profits for these agencies but also a conflict of interest and possible inaccurate ratings. Kroll’s firm would have to prove their integrity and accuracy to compete with or succeed over the already-established big three agencies.