What caused the downfall of Chinese credit rating agency Dagong?

Dagong was ordered to suspend domestic services for a year. Photo: Reuters

Dagong Global Credit Rating, a Beijing-based credit rating agency with a mission to challenge the domination of the big three Western credit rating firms, has been ordered by the securities regulator and a supervisory group under the central bank to suspend services in the Chinese bond market for a year, after it was found to be selling favorable ratings to bond issuers, facing risk management problems and hiring unqualified assessors.

The punishment marks a rare rebuke that reflects the regulators' rising concerns about irregularities at the country's credit rating agencies.

"It (referring to the punishment) strikes a warning bell to all rating agencies," said a source close to the regulators.

The rule violations were exposed by a Dagong employee, who reported to the regulators that the company provided good credit ratings to bond issuers in exchange for their agreements to buy its costly consulting services, according to Caixin, a leading business news provider in China.

At least 26 bond issuers, some of which are listed companies and state-owned enterprises, are involved in the case, Caixin reported. Among these companies, Tunghsu Group failed to issue bonds even though Dagong gave a favorable credit rating, and SanPower Group has been identified as a problematic company.

"Gaining a higher rating can reduce the financing cost. It is a collusion (between Dagong and bond issuers)," said a market participant.

Following the Dagong case, the National Association of Financial Market Institutional Investors is reportedly planning to make a set of standardized rules to manage conflict of interest, in a move aimed at letting investors fully know about whether a credit rating agency sells other products to a bond issuer, to which it simultaneously provides credit rating service.

Bundle sales

According to Caixin, Dagong has customarily promised to upgrade the credit rating of a private company to AA+ from AA on the condition that the latter agrees to buy Dagong's 9.7 million yuan data management consulting system with an annual service fee of 800,000 yuan.

The data management consulting system, which is officially named the Supply Chain Financial Credit Management System, is developed by the Dagong subsidiary, Dagong Credit Data. According to Dagong, the system helps users improve their credit management and prevent credit risks. Dagong Credit Data calls itself a high technology company dedicated to studying credit rating technology and Internet finance.

Dagong has a marketing list of companies including the 26 bond issuers mentioned above, to which the credit rating agency sells rating service bundled with the consulting product, Caixin reported, citing sources close to the matter.

Dagong's bundle sales have affected the objectiveness and accuracy of its credit rating, and violated the rules on conflict of interest in the credit rating industry, an executive at a credit assessment company told Caixin.

In addition, Dagong cannot make sure whether the data uploaded to the Supply Chain Financial Credit Management System is real, said a bond market participant.

According to statistics from Wind, the number of bond issuers whose credit ratings were ungraded to AAA or AA+ from lower ratings by Dagong reached up to 232 in 2017, accounting for a large part of the total.

In 2017, the companies whose credit ratings were ungraded to AAA from AA+ by Dagong accounted for 18 percent of the total, compared with an average 7 percent, the National Association of Financial Market Institutional Investors said in a statement.

Ungrounded ratings

The punishment to Dagong is expected to deal a blow to the companies, for which Dagong has been developing specially designed Supply Chain Financial Credit Management System, because their rating results would be questioned by institutional investors.

In March last year, Dagong upgraded the credit rating of the bond issued by NeoGlory to AA+ from AA, a move that helped the bond's return rate to 30 percent. However, NeoGlory's bond was widely considered as a rubbish bond by market participants at the time.

In July, Dagong assigned a stable outlook to NeoGlory's bond in a credit rating report, which led to a hike in the bond's return rate.

On the contrary, Dagong downgraded the credit rating of the bond issued by Xiwang Group, which is financially endorsed by Hengfeng Bank and the local government, triggering doubts among market participants, who believed that the move was caused by Xiwang Group's refusal to buy Dagong's Supply Chain Financial Credit Management System.

In 2011, Dagong assigned a AAA rating to China's debt-ridden Ministry of Railways, higher than China's AA sovereign credit rating. Professor Huang Yiping from Peking University was at the time shocked by the rating, casting doubt on the professional credibility of Dagong.

Since January when Dagong downgraded the sovereign credit rating of the United States, the regulators have received many letters reporting on Dagong's irregularities. But Guan Jianzhong, chairman of Dagong, has defended his company's role in "protecting the interest of China on the world stage" and described it as America's conspiracy aimed at bringing down Dagong.

Regulatory improvement

With the regulators seeing rating results as a key factor for the formulation of industry standards, China's credit rating agencies can easily control the issuance pricing of bonds.

Industry insiders say that linking policy making with credit rating cannot meet the needs of the bond market, calling on investors to weaken their dependence on credit rating in order to diminish the bond market bubble.

The National Association of Financial Market Institutional Investors has warned that some credit rating agencies lack capability in credit risk warning and control.

Currently, some mainstream institutional investors have their own credit rating departments and only see credit rating results provided by third-party rating companies as a reference.

Over the recent years, the National Association of Financial Market Institutional Investors has lowered the requirement of bond issuers needing a credit rating assessment report provided by third-party rating agencies before issuing bonds, putting emphasis on the exposure of financial indexes. The move is aimed at preventing bond issuers from spending money to buy a better credit rating.

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