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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

Critics argue that the issuer-pays model creates a conflict of interest for rating agencies. Which of the following is the most direct way this conflict could weaken rating quality?

Under the issuer-pays model, issuers can choose among agencies and select the one giving the most favorable rating. This rating shopping pressures agencies to be lenient to retain business, which is the most direct way the conflict of interest can reduce rating quality.

  1. AInvestors pay fees that are proportional to the rating assigned
  2. BIssuers can shop among agencies and choose the one offering the most favorable rating, pressuring agencies to be lenientCorrect
  3. CRegulators set ratings directly, removing agency discretion
  4. DAgencies publish methodologies, which stops them from changing criteria

Explanation

Because the issuer selects and pays the agency, it can pick the most favorable opinion (rating shopping), which pressures agencies to be lenient to win business. The other options either describe a different payment model or are not the conflict-of-interest mechanism.

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