The announcement last month that Dubai World would seek to restructure US$26 billion (Dh95.45bn) in debt threw investors and analysts into a tizzy. Yet perhaps most significant among the hand-wringers in the uncertain weeks leading up to Abu Dhabi's $10bn aid package for the government-owned Dubai World last week were the credit ratings agencies. Those firms, which have rightly come under fire for giving their best marks to the exotic securities that touched off the global financial crisis, showed their fickle stripes following the Dubai World debt standstill announcement.
All the majors - Fitch Ratings, Standard & Poor's (S&P) and Moody's Investors Service - downgraded Dubai Government-related companies. S&P was first to act, cutting DP World, Dubai Holding Commercial Operations Group (DHCOG), the Jebel Ali Free Zone Authority, Emaar and DIFC Investments on the day of the standstill announcement. S&P downgraded the Jebel Ali port and DP World before Dubai had time to announce that those two firms, both owned by Dubai World, would not be part of the restructuring. That did not seem to matter, as S&P cut all of the government-owned firms it rates in Dubai.
Then came Fitch Ratings on November 26, the day after the S&P moves, with a downgrade of DHCOG, a property and hospitality subsidiary of Dubai Holding, and the Dubai Electricity and Water Authority (DEWA). Moody's chimed in as well, relegating DP World, Jebel Ali, DIFC Investments, Emaar, DHCOG and DEWA to junk status. A few days later came more reduced ratings and negative outlooks. Among the victims were Dubai Bank, Tamweel, TAIB Bank, Commercial Bank of Dubai, Emirates NBD, Mashreqbank, HSBC Middle East, the Hamriyah Free Zone Authority in Sharjah and Dubai Islamic Bank.
The carnage was in some ways understandable. Abdulrahman al Saleh, the head of the Dubai Financial Support Fund, said in the days after the standstill that Dubai World was not a direct liability of the Government in the same way that, say, the Department of Finance was. This destroyed an assumption the ratings firms had long been making: that if any of Dubai's three big government conglomerates - Dubai World, Dubai Holding and Investment Corporation of Dubai - ever ran into trouble, a rescue would be in the offing.
It was an assumption not based on evidence let alone a firm legal promise. In fact, the prospectuses for bonds issued by Dubai World and its subsidiaries made it crystal clear that they were not part of the Government and that investors should not expect assistance. When Mr al Saleh said Dubai World was not technically the Government, he was repeating what investors should have known long ago, presuming that they had bothered to do their research. In the end, then, the agencies did the right thing when they removed their presumption of support after the standstill, causing ratings at several UAE firms to take a hit.
There had never been an explicit guarantee made except in the case of the Investment Corporation of Dubai, which is considered a direct liability of the Government. The bigger problem that the uncertainty in Dubai helped expose, though, was that ratings agencies tend to be reactive rather than predictive. The major houses are effectively rating the current risk of default, not the future risk of default.
While knowing current risks is far from useless, it does not address what investors need most: a sense of how likely it is that the company they are putting their cash into will be unable to pay its debts in the long run. "There will be continuing concern about the debt ratings and so forth, but the great thing about these credit rating agencies is they look through the rear-view mirror," Mark Mobius, one of the world's best-known emerging markets investors, said last week.
"Now they downgrade. Thank you very much, but why didn't you tell me before?" Something clearly needs to change about the ratings agencies. It would be foolhardy to argue that they should be made extinct because they can and do perform a useful service. Some have suggested that they be untethered from the issuers that pay them. That would be smart. If borrowers were not paying the agencies to rate their own debt, the agencies would have an added measure of independence. At the same time, investors would have to pay the ratings firms, which would present a significant logistical hurdle.
Whatever difficulties it might present, solving the ratings riddle is important. What the agencies say exerts a real and long-term influence on the interest rates Dubai and its government companies pay when they raise money. @Email:firstname.lastname@example.org