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FRM Part II · FRM Exam Part II · Credit Scoring and Rating

Which statement best describes the conflict-of-interest criticism of the issuer-pays model used by many rating agencies?

The issuer-pays model creates a conflict of interest because the entity being rated pays the fee and may choose among agencies, giving agencies an incentive to issue favorable ratings to win or keep business, despite reputational counterweights.

  1. AAgencies are paid by investors, who prefer lower ratings
  2. BBecause issuers pay fees and can shop among agencies, there is an incentive to give favorable ratings to win or retain businessCorrect
  3. CAgencies are prohibited from receiving any fees from rated entities
  4. DRatings are set by regulators, who have incentives to inflate them

Explanation

Under issuer-pays, the rated entity pays, creating pressure toward favorable ratings and enabling rating shopping, where issuers choose the most generous agency. Reputation concerns act as a counterweight but do not eliminate the concern.

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