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China Holds Credit Rating Agency Responsible (translated from deflation com)


The credit rating agencies’ track record of adequately warning lenders has been less than stellar in many cases. The Chinese court forces one of these agencies to pay. Here is an excerpt from a January 4 South China Morning Post article:

A Chinese court ruled that a local rating firm should help pay compensation to some creditors for defaulting on a construction firm’s 1.4 billion yuan ($ 216 million) bonds three years ago, for the first time in the country as Beijing pressure agencies to they improved their financial and legal expertise. Dagong Global Credit Rating is responsible for repaying up to 10 percent of at least 494 million yuan of cumulative debt claims of more than 400 private bondholders of Wuyang Construction Group … The court stated that Wuyang Construction’s legal representative and actual controller Chen Zhizhang, an underwriter at Tebon Securities, as well as an accounting the company and law firm are also collectively liable, citing their failure to conduct due diligence.

Beijing has tightened its surveillance of the country’s bond market following a spike in defaults since November, imposing short-term bans on new business at two other rating agencies and launching investigations against several banks, accounting firms and large brokerage firms for alleged violations related to bond sales. The Hangzhou court ruling also sets a precedent for bond underwriters, accounting and law firms that are financially liable for bondholders’ losses, potentially offering a new roadmap for dealing with such cases in the future.

“This verdict should be the first of its kind in China. It significantly increases the cost of fraud and lack of legal due diligence in the bond market, ”said Yang Hao, a fixed income analyst at Nanjing Securities Co. “Financial intermediaries will become more cautious and in the future, investors may also actively explore this approach to seeking compensation.”

The 2020 edition of Robert Prechter’s book Conquer the Crash provides an example of why you shouldn’t rely on rating agencies for timely financial warnings. The book quotes from a financial forecast for Elliott Waves on February 28, 2008:

Share prices for MBIA and Ambac are down more than 90% from their peaks last year. Throughout the rise and fall of S&P and Moody’s, the two major credit rating agencies, maintained each company’s AAA rating. Despite the sharp drop in share prices, rating agencies this week “confirmed” their AAA status for both companies, maintaining a farce of financial stability. We are quite sure that this will not succeed. First, risk assessments conducted by government agencies have replaced free market assessments. This was not a big problem during the rally, because the upward trajectory of prices kept even the most precarious prospects afloat. But the recent shift towards growing pessimism means there is a long-term attack on agencies and their ratings that will do the same for a downturn as complacency for growth. Don’t be surprised if corporate health claims accompany short-term peaks, and an imminent downgrade near the bottom is mistakenly seen as a sell-off.

The 2020 edition of Conquer the Crash continues:

A year later, all those expectations were met: ratings of government-approved companies were declared too positive, unsuspecting holders of weak debt suffered huge losses, the services were criticized for incompetence and nepotism, and they ultimately downgraded many issues when it was too late.

translation from here

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