Private Credit: Seeing the System Clearly

The headline caught my attention: ‘Private credit could “amplify” next financial crisis, study finds’. It appeared in the Financial Times recently, summarising findings from a comprehensive report from Moody’s Analytics that uses sophisticated econometric tools to examine how private credit has become more central to financial contagion during stress periods.

This is not my usual domain - I am more at home analysing the governance structures that shape financial decision-making than dissecting loan covenants or fund structures. But as someone who has spent years watching how systemic risk migrates through financial systems, I find myself drawn to what these developments might mean for how we understand and manage financial stability.

The Moody’s study, published in this month, employs principal component analysis and Granger-causality network modelling to map interconnections across the financial system. Their findings suggest something significant: during periods of stress, business development companies (BDCs) - their proxy for private credit - have become more prominent in the network of financial linkages, while banks have become relatively less central. Moody’s argues the financial system has shifted from a ‘hub and spoke’ structure centred on banks to a denser, web-like configuration - where private credit now occupies critical nodes.

The Growth and Scale

Private credit - essentially nonbank lending to companies, often middle-market firms that fall between traditional bank loans and public bond markets - has grown explosively since the global financial crisis. From a niche asset class, it has expanded to roughly $2 trillion in global assets under management, with about three-quarters concentrated in the United States. To put this in perspective, it now rivals the high-yield corporate bond and syndicated leveraged loan markets in size.

“Unlike public markets, most private credit offers no real-time pricing and relies on bespoke contracts”

This growth was not accidental. Post-crisis banking regulations tightened capital and liquidity requirements for traditional lenders, creating space for institutional capital to fill the gap. Private credit funds stepped into this void, offering speed and customised terms to borrowers in exchange for higher interest rates than typical bank loans. What began as direct lending to middle-market companies has since expanded into specialty finance, asset-based lending, and increasingly complex structures.

Emerging Systemic Concerns

The concerns are not just about size - they are about structure and visibility. Recent analysis from multiple regulators highlights several interconnected risks. The IMF’s April 2024 Global Financial Stability Report warns that private credit’s growth creates potential risks if the asset class remains opaque, noting that ‘credit migrating from regulated banks and relatively transparent public markets to the more opaque world of private credit creates potential risks’.

The Moody’s study documents how this opacity combines with increasing interconnectedness. Banks are becoming more involved in private credit through partnerships, fund financing, and structured risk transfers that allow them to maintain economic exposure while shifting assets off balance sheet. While such arrangements may offer capital efficiency, they can also obscure the true distribution of risk.

“What began as direct lending to middle-market companies has since expanded into specialty finance, asset-based lending, and increasingly complex structures.”

Three particular vulnerabilities stand out from the research. First, layered leverage creates cascading risks - borrowers with high debt-to-EBITDA ratios funded by funds that themselves use subscription lines and other credit facilities. The Moody’s report notes that private credit managers are increasingly financing their loan portfolios through private collateralised loan obligation structures, with well over $100 billion of private credit CLOs outstanding. This introduces another layer of leverage and structural complexity that is not always visible to end investors.

Second, liquidity mismatches are emerging as funds experiment with semi-liquid structures to attract broader investor bases. These models introduce a potential duration mismatch, as funds commit to holding long-dated, illiquid assets while offering investors periodic liquidity supported by credit lines or cash buffers.

Third, transparency gaps complicate risk assessment. Unlike public markets, most private credit offers no real-time pricing and relies on bespoke contracts. As the Moody’s report observes, private credit’s lack of standardisation and limited disclosure complicate efforts to monitor its risks. Mark-to-model assets are vulnerable to swings in market confidence, and when pricing gaps emerge, attention quickly shifts to the balance sheets of those holding similar exposures.

Recent regulatory analysis supports these concerns. The Federal Reserve’s May 2025 research reveals that banks have become a key source of liquidity for private credit lenders through credit lines, with 22% of large U.S. banks’ commercial loans now going to private credit-backed firms. The European Central Bank warns of ‘hidden leverage and blind spots’ from growing interconnections between banks and private market funds, noting that exposures ‘can involve layered leverage’.

Shadow Banking Echoes?

These developments inevitably invite comparisons to pre-crisis shadow banking, though the parallels are not straightforward. Recent academic analysis reveals structural similarities: 63% of private credit loans lack standardised covenants compared to 41% in 2007 syndicated loans, and 35% of funds use leverage exceeding 2:1, approaching 2006 CLO levels.

Yet, there are meaningful differences. The investor base is fundamentally different - dominated by pensions, insurers, and endowments rather than the retail-driven flows that characterised pre-crisis structured products. The Systemic Risk Council’s May 2025 report explicitly places private credit within ‘shadow banking’s global risks,’ while acknowledging that longer lock-up periods may reduce near-term liquidity risks compared to pre-crisis structures.

The Moody’s study captures this evolution well: ‘Rather than a hub-and-spoke centred on large banks and broker-dealers as was the case in the GFC, the network is more distributed. BDCs and other nonbanks have become more central to network connectivity over time, while banks’ centrality has somewhat diminished.’

Risk has not vanished - it has changed form, location, and visibility. Where pre-crisis risks concentrated in bank-backed off-balance-sheet vehicles, today’s risks may be dispersed across private vehicles with limited regulatory visibility.

Financial Governance Implications

From a governance perspective, what strikes me most is how this evolution challenges our existing frameworks for understanding and managing systemic risk. We have spent the post-crisis years strengthening bank oversight and improving transparency in public markets, but systemically important activities have quietly shifted to spaces with different oversight regimes.

The Moody’s report argues that regulators should consider expanding the regulatory perimeter to include significant private credit funds, enhance transparency through improved reporting requirements, and integrate private credit trends into macroprudential policy frameworks. They suggest that central banks should consider how they would respond if a systemic event in private credit markets materialised, noting that traditional lender-of-last-resort tools may not reach these markets directly.

This is not about stifling innovation or imposing bank-like regulation on fundamentally different institutions. It is about ensuring that our risk monitoring tools can see clearly across the financial system as it actually operates today, not as it operated fifteen years ago. The Financial Stability Board’s 2024 annual report acknowledges this challenge, noting ‘private credit is growing rapidly and there is increasing evidence of its connections with the banking system and with institutional investors’ while highlighting the opacity that makes assessment difficult.

The International Organization of Securities Commissions has begun updating frameworks around liquidity risk management and valuation principles for collective investment schemes, indirectly addressing some transparency issues relevant to private credit. However, these efforts remain fragmented across different regulatory domains.

The Path Forward

I enter this conversation not as a private credit expert, but as someone who has watched how financial systems evolve and how governance structures struggle to keep pace. What concerns me is not necessarily the growth of private credit itself - it appears to serve legitimate economic functions and has attracted sophisticated institutional investors who understand the risks they are taking.

What concerns me is the possibility that we are creating new systemic vulnerabilities without adequately updating our tools for seeing and managing them. As the Moody’s study notes, ‘the lack of transparency allows risks to accumulate. Data gaps remain a serious issue in the current landscape, as there is limited information on loan covenants, true portfolio valuations, and the overlap of fund investors’.

This echoes past moments - like the 1990s derivatives boom or the 2000s structured credit surge - where innovation moved faster than oversight. The lesson from those episodes is not that innovation is inherently dangerous, but that transparency and appropriate oversight need to evolve alongside market structures.

If private credit is here to stay - and it is - we owe it to ourselves to see it clearly. The consequences of not doing so are all around us, if we care to look.

Simplifying Sustainability - Or Surrendering It? How Europe’s ESG Rollback Undermines Ratings and Credibility

Green Central Banking’s recent analysis of the EU’s Omnibus Proposal deserves careful attention – not because it breaks news, but because it captures a deeper unease about the direction of EU sustainability governance. In their piece ‘EU regulators warn omnibus proposal could increase financial risk,’ they have captured something that extends far beyond technical regulatory adjustment. The EU’s sustainable omnibus package promises to simplify climate reporting requirements for companies, reducing the scope for 80% of firms, but what Green Central Banking reveals is a deeper tension between administrative convenience and systemic integrity.

This post offers a response to their arguments; not to disagree, but to extend and deepen them. Green Central Banking raises a crucial point: this isn’t just a recalibration of reporting scope. It may be the first visible crack in one of the EU’s few remaining pillars of policy coherence.

What the Omnibus Changes – and Why It Matters

The Omnibus Proposal aims to reduce disclosure requirements under the Corporate Sustainability Reporting Directive (CSRD), potentially exempting 75-80% of companies from mandatory sustainability reporting. The changes would raise thresholds so that only companies with more than 1,000 employees or revenue exceeding €50 million would face mandatory reporting requirements, with smaller firms able to report voluntarily.

The stated rationale is compelling and deserves recognition: reducing administrative burden on small and medium enterprises, improving proportionality in regulatory requirements, and addressing legitimate concerns about compliance costs. Business groups have welcomed these changes as necessary realism in the face of regulatory overreach. The European Commission has emphasized that the Omnibus represents simplification, not abandonment of the Green Deal agenda.

Humberto Delgado Rosa, director for biodiversity and environment at the European Commission, said during a panel at the Sustainable Investment Forum Europe conference in Paris that the simplification process doesn’t mean deregulation for the sake of less red tape: ‘The simplification agenda is a very legitimate one, one that aims to maintain competitiveness, because without it we would not be able to move towards sustainability.’

These are reasonable arguments, reflecting genuine tensions between regulatory ambition and economic practicality. But proportionality without visibility is a dangerous trade. The very firms seen as too small to report may still carry climate, supply chain, and governance risks that accumulate systemically.

What the Risks Really Mean

Green Central Banking has identified where this reasonable-sounding adjustment creates unreasonable systemic problems. As they report, the European Central Bank has cautioned the EU from drastically reducing the scope of the corporate sustainability reporting (CSRD) and due diligence directives (CSDDD), warning that the changes could increase risk for the economy, investors and the EU’s wider sustainable goals.

The ECB’s concern is precise and technical: with dramatically fewer companies providing standardized sustainability data, financial institutions will face what amounts to systematic blind spots in risk assessment. Vincent Vandeloise, senior researcher at Finance Watch, captures the paradox perfectly:

‘Today, financial lobbies welcome the omnibus package but tomorrow they will be back to complaining about data availability and the quality of the information communicated by their data providers.’

This matters because, as Green Central Banking notes, 70% of the banks reported that they rely on ESG ratings to manage their risks. When ESG ratings lose access to standardised data, they turn to estimates. The result: less coherence, less comparability, and greater risk across the financial system.

For ESG rating agencies, this isn’t a minor inconvenience. It undermines the scaffolding of comparative risk analysis. Ratings will become more model-dependent, less verifiable, and more prone to regulatory challenge – precisely at a time when banks, asset managers, and public bodies are integrating them into capital allocation. The ESG Rating Agencies are also now under the new regulatory regime created by the EU, which actively tries to prevent these issues.

The ECB is particularly concerned about the impact on third-country companies. The reduction in scope also means that a large number of third-country companies with operations in the EU would not be required to report, and the ECB recommend the threshold for other countries not be amended as it ‘increases the gap in data availability between Union and third-country undertakings, with negative consequences for financial institutions’ risk management’.

When ESG Becomes a Governance Crisis

What Green Central Banking has identified as a financial risk is something deeper: a governance coherence problem. The EU built its global sustainable finance credentials on regulatory innovation – the CSRD, the EU Taxonomy, the Sustainable Finance Disclosure Regulation – and on a narrative of leadership by example. These were not just technical instruments; they were statements about European values and institutional capacity.

Helena Viñes Fiestas, chair of the EU platform on sustainable finance and commissioner of the Spanish Financial Markets Authority, gets to the heart of this when she points out that going back to voluntary measures defeats the whole purpose of the legislation which is about comparability:

‘In my CV, I’m going to report the best, I’m not going to report certain things. [The voluntary sustainable reporting] is the same. Why would your company report on something that performed really badly? It is not mandatory, right?’

This creates a selective transparency problem that goes beyond data quality. When 80% of companies can choose what to report, the resulting information landscape will systematically favour larger, listed companies who were already subject to disclosure requirements. The market will have comprehensive data on some actors and patchy, voluntary data on most others. This is not just inefficient – it’s a form of selective regulatory coherence that weakens the credibility of sustainability assessments as a whole.

As Green Central Banking reports, this also would undermine other rules such as the ESG rating regulation which focused on governance and transparency from rating providers. The regulation assumes that transparency and access to data would encourage rating agencies to develop their offerings, but with fewer companies reporting under CSRD rating providers will instead divert ‘resources to fill data gaps, rather than enhancing their methodologies’. In effect, the EU has built a regulatory feedback loop – ratings assume data; data assumes compliance; compliance now assumes opt-in. The loop is breaking.

Fragility at the Heart of the Union

Here’s what makes this more than a sustainability story: the EU’s institutional strength has always rested on coherence rather than power – on its ability to act as one, especially around shared values and long-term priorities. The CSRD wasn’t just about climate data; it was proof that the EU could sustain ambitious, coordinated policy even when it was difficult.

This is not just a matter of political compromise. It reflects a deeper tension inside the EU – between its ambitions to lead globally on sustainability, and its structural vulnerability to internal lobbying, institutional fatigue, and fragmented commitment. If the EU cannot maintain its flagship sustainability framework under internal political pressure, what signal does this send about institutional resilience more broadly?

The ECB’s warning about physical and transition risks from climate change having ‘profound implications’ on price and financial stability points to why this matters systemically. ‘The availability of sustainability information is a minimum requirement to enable it to do so’, they note about their monetary policy responsibilities. In other words, the data infrastructure that the Omnibus Proposal would weaken is not a regulatory nice-to-have – it’s operationally essential for European financial stability.

This retreat sets a precedent. If ESG rules collapse under lobbying pressure, what’s to stop the same happening to other core priorities? The Clean Industrial Deal that the Commission references as justification for these changes will itself require sustained institutional commitment and data infrastructure. The Clean Industrial Deal will require ESG data at scale. To weaken that data while rolling out the Deal is to sabotage one agenda with another.

The Choice Ahead

The EU still has time to revise and refine this approach. The concerns raised by the ECB, the Dutch Authority for the Financial Markets, and the European Banking Authority represent just some of the institutional wisdom about the relationship between data infrastructure and systemic stability. These are not abstract regulatory preferences – they are practical warnings from the institutions responsible for European financial stability.

The ECB recommends the EU limit the reduction of the scope of companies covered by CSRD to 500 employees instead of 1,000. It also proposes any credit institution, regardless of size, that is a ‘significant institution’ be subject to CSRD ‘due to the importance of ensuring sufficient ESG data from the banking sector’. These are compromise positions that acknowledge the need for proportionality while maintaining systemic coherence.

The choice facing European policymakers is not between burdensome regulation and competitive simplicity. It’s between governance integrity and institutional expedience. As the ECB notes, harmonised, standardised, and reliable sustainability data will also help investors and facilitate capital, which is needed as the EU transitions to a green economy and puts its Clean Industrial Deal in place. Data infrastructure isn’t bureaucratic paperwork – it’s the foundation of institutional trust and market function.

Green Central Banking has done important work in highlighting these risks early, when there’s still time for institutional course correction. Their early intervention isn’t just timely – it may be the canary in the coal mine. The question now is whether policymakers will treat these warnings as technical inconveniences – or as signs of something deeper: a system under stress.

Europe’s reputation rests not just on what it regulates, but on what it refuses to abandon when the pressure builds.

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Opening the Black Box: How Africa’s New Credit Rating Agency Could Redefine Financial Credibility

Credit ratings are seen as technical grades. In truth, they are high-stakes political and economic decisions made behind closed doors. When Ghana's sovereign rating was downgraded to CCC+ in 2022, the immediate impact translated to higher borrowing costs that constrained the government's ability to fund healthcare and education. This is the hidden power of credit rating committees: institutions that operate in near-complete opacity while wielding enormous influence over sovereign destinies.

The African Continental Free Trade Area has created momentum for new continental institutions. Among these, the African Credit Rating Agency (AfCRA) represents more than just regional competition to established players. It offers an unprecedented opportunity to reimagine how sovereign creditworthiness is assessed – not just through different methodologies, but through fundamentally different governance structures that prioritise transparency over secrecy.

What Happens Inside a Credit Rating Committee?

Credit ratings appear deceptively simple. A country receives a letter grade – AAA, BB+, or CCC – that seems to reflect objective financial analysis. The reality is far more complex and considerably more subjective.

Every sovereign rating begins with quantitative analysis: debt-to-GDP ratios, fiscal balances, economic growth projections. Rating agencies publish detailed methodologies explaining how these metrics should translate into ratings. Yet research consistently reveals significant gaps between methodology-based predictions and actual ratings assigned by committees.

A 2020 study by the Centre for Advanced Financial Research and Learning found that credit rating agencies demonstrate substantially lower predictive accuracy for developing economies compared to advanced economies. More troubling, isolated research has identified cases where methodology-based predictions diverged from actual ratings by two to three notches – particularly for Asian economies like Hong Kong and China. When public methodologies suggest one rating but committees assign another, questions arise about what additional factors influence final decisions.

The answer lies in what agencies call ‘qualitative adjustments’ – subjective assessments that occur during committee deliberations. These deliberations happen behind closed doors, produce no public records, and offer no meaningful appeals process. Committee members, often based in New York or London, make judgments about political stability, institutional quality, and economic prospects in countries they may have never visited.

This opacity creates a fundamental accountability gap. When objective metrics suggest one rating but committees assign another, neither markets nor sovereign borrowers understand why. The process becomes a ‘black box’ where inputs are visible but the decision-making mechanism remains hidden.

The AfCRA Opportunity: Transparent by Design

AfCRA is not just offering a new rating scale. It is prospectively proposing a new way of governing how ratings are made. This is not merely about regional representation or alternative methodologies – it is about transforming the institutional structures through which sovereign creditworthiness is assessed.

Public Deliberations: The Central Bank Model

AfCRA could establish a precedent by publishing committee transcripts within 30 days of each rating decision. This mirrors the practice of major central banks, which publish meeting minutes to enhance policy transparency and market understanding. The Federal Reserve, European Central Bank, and Bank of England all recognise that monetary policy credibility benefits from transparent decision-making processes.

Central bank minutes reveal how policymakers weigh competing evidence, handle uncertainty, and reach consensus. They allow markets to understand not just what decisions were made, but why. Similar transparency in rating committees would illuminate how qualitative factors are weighed against quantitative metrics, how political risks are assessed, and how committee members handle disagreements.

Critics might argue that transparency could compromise committee independence or create market volatility. However, central bank experience suggests the opposite. Ben Bernanke once discussed that transparent monetary policy committees often enjoy greater credibility and market confidence than opaque ones, while OECD analysis concluded that ‘transparency contributes to the successful conduct of monetary policy’.

Hybrid Committees: Diversifying Expertise

Traditional rating committees typically consist of analysts from similar backgrounds, often with limited regional expertise. AfCRA could pioneer hybrid committees that include not only credit analysts but also regional economists, sectoral specialists, and civil society observers – all with recorded votes and public positions.

This diversified approach would address a critical weakness in current rating processes: the geographic and intellectual distance between committee members and the economies they assess. A hybrid committee evaluating Nigeria's sovereign risk might include a Lagos-based economist familiar with local banking sector dynamics, a regional infrastructure specialist who understands power sector challenges, and a governance expert who can assess institutional quality from direct experience rather than global indices.

Such diversity is not unprecedented in financial governance. The Basel Committee on Banking Supervision (which develops global banking standards) includes representatives from central banks, regulatory authorities, and supervisory agencies. The Financial Stability Board brings together finance ministry officials, central bankers, and regulatory experts. Recent research suggests that committees in the financial governance realm are more effective when they are diverse.

AI Governance Tools: Pattern Recognition and Bias Detection

AfCRA could leverage artificial intelligence to enhance committee transparency and consistency. AI systems could analyse patterns across committee discussions, flagging potential regional biases or inconsistent methodology application. Such tools could identify when similar economic circumstances result in different rating outcomes, or when committee discussions reveal systematic biases against particular regions or economic models.

More ambitiously, AfCRA could explore blockchain technology to create immutable records of rating decisions and committee deliberations. This would ensure that rating processes remain transparent and tamper-proof, building long-term credibility through technological innovation.

Why the Big Three Stay Closed

The established rating agencies – S&P Global, Moody’s, and Fitch – have strong incentives to maintain opacity. Their business model depends on providing clear, authoritative signals to investors who prefer fewer, stronger signals rather than multiple competing perspectives. Transparency might reveal the subjective nature of rating decisions, potentially undermining the perception of scientific objectivity that supports their market authority.

The industry’s natural oligopoly structure reinforces these incentives. With regulatory requirements and institutional mandates driving demand for ratings from recognised agencies, the Big Three face limited competitive pressure to reform their governance structures. Investors have become accustomed to the current system, and changing established practices involves costs and risks that incumbent agencies prefer to avoid.

Research by economists has documented how sovereign ratings increasingly rely on qualitative assessments rather than purely quantitative models. This shift toward subjectivity naturally disadvantages developing economies, where data may be scarcer and committee members may have limited local knowledge. Studies have identified systematic biases in rating outcomes, with agencies demonstrating what researchers characterise as ‘pro-Western’ tendencies in their qualitative adjustments.

The consequences of these biases are severe. Research by the World Bank demonstrates that rating downgrades – particularly around the investment-grade threshold – can increase sovereign borrowing costs by more than 100 basis points. For African economies seeking to finance infrastructure development or social programs, such increases represent millions of dollars in additional debt service costs.

While this article critiques the structural opacity of the current system, it does so with the aim of inviting reform and reflection, not rejection. Existing CRAs have deep institutional experience and global coverage; their analytical sophistication is not in doubt. But AfCRA’s proposal for transparency is not a rebuke — it is an opportunity. In fact, there is scope for collaboration. AfCRA’s transparency innovations could serve as a pilot for broader industry reflection, offering a new governance blueprint that other agencies may voluntarily choose to explore

AfCRA’s Real Test: Balancing Credibility and Courage

AfCRA’s transparency agenda will face significant challenges. Initial market reactions might be sceptical, viewing openness as a departure from established practice rather than an improvement. Committee members might face political pressure from governments unhappy with rating decisions. Transparency alone does not guarantee fairness or accuracy in rating outcomes.

Yet implementing this vision will require more than design principles. Securing investor trust, building a credible track record, and insulating rating deliberations from undue political interference will be vital. Markets tend to prize predictability — and even positive reforms can generate caution if they are not communicated carefully. AfCRA will need to signal its standards early and often, lean on credible regional institutions to back its independence, and frame transparency not as a concession to politics but as a shield against it. Consistent accountability will be key.

However, these challenges are not insurmountable. Central banks successfully navigated similar transitions toward transparency, building credibility through consistent communication and demonstrated expertise. Constitutional courts operate with full transparency – publishing decisions, dissenting opinions, and legal reasoning – while maintaining institutional authority and independence.

AfCRA’s success should not be measured by whether it immediately displaces established agencies, but by whether it demonstrates that transparent governance can coexist with market credibility. The agency could begin with a limited number of sovereign ratings, gradually building a track record of transparent decision-making that serves both market needs and sovereign interests.

The key lies in balancing radical transparency with institutional gravitas. AfCRA must prove that open deliberations enhance rather than undermine analytical rigor, that diverse committee membership strengthens rather than weakens decision-making, and that public accountability improves rather than compromises rating quality.

That said, transparency alone will not insulate AfCRA from headwinds. Investors accustomed to established agencies may initially hesitate to rely on a new body, particularly one proposing governance departures from orthodoxy. Political pressure from rated governments — especially if ratings remain unfavourable despite open processes — may also challenge committee independence. AfCRA will need robust legal safeguards, strategic alliances with central banks, and an unwavering commitment to procedural discipline if it is to weather the scrutiny that transparency invites.

From Critique to Construction: AfCRA’s Path Forward

By 2050, one in four people on Earth will be African. The financial architecture serving this population must evolve beyond colonial-era risk frameworks toward systems that recognise Africa’s economic potential and institutional diversity. AfCRA represents more than a new rating agency – it embodies an opportunity to reshape how sovereign creditworthiness is conceived and assessed.

The path forward requires specific commitments to transparency and governance innovation:

Immediate Steps:

• Establish committee composition rules that mandate diverse regional and sectoral expertise

• Commit to publishing committee minutes within 30 days of rating decisions

• Develop AI tools for pattern recognition and bias detection in committee deliberations

• Create clear appeals processes that allow sovereign borrowers to challenge rating decisions with supporting evidence

As AfCRA advances this transparency agenda, it should also position itself as a constructive partner in global credit reform. While the aim is to model alternative practices, this does not preclude existing agencies from evolving too. Indeed, AfCRA’s success could catalyse reform beyond Africa, showing that transparency and rigour are not mutually exclusive. Opening the black box is not an act of opposition — it is an invitation to re-imagine shared credibility in global finance.

Medium-term Objectives:

• Build partnerships with African central banks and finance ministries to enhance local data collection and analysis

• Develop specialised methodologies that capture Africa's unique economic structures and growth patterns. This may include integrating satellite and alternative data sources to track infrastructure development, agricultural productivity, and climate risk exposure in real time, to building sovereign resilience metrics that capture future-oriented capacities like green transition readiness, youth-driven innovation, and regional value-chain integration.

• Establish academic partnerships to conduct ongoing research on rating accuracy and market impact

• Create training programs for African financial professionals in credit analysis and rating methodologies

Long-term Vision:

• Demonstrate that transparent rating processes can achieve market credibility and acceptance

• Influence global rating practices through successful precedent and competitive pressure

• Support Africa’s financial market development through improved sovereign ratings and reduced borrowing costs

• Establish AfCRA as a recognized authority in sovereign credit assessment with global influence

The transformation from critique to construction begins with recognising that current rating processes are not inevitable – they are institutional choices that can be changed. AfCRA has the opportunity to prove that transparency, diversity, and accountability can coexist with analytical rigor and market credibility.

The black box of sovereign rating has remained closed for nearly two centuries. AfCRA’s challenge is not to beat the Big Three at their own game, but to change the game entirely. By opening the committee room door, diversifying decision-making expertise, and embracing technological innovation, AfCRA can redefine what sovereign credit rating means – not just for Africa, but for the global financial system.

The continent that will house one-quarter of humanity deserves financial institutions that operate with the transparency, accountability, and sophistication that such responsibility demands. AfCRA’s moment has arrived – not to compete with opacity, but to lead with light.

Lead with light.

From Ratings to Relationships: Re-imagining Sovereign Engagement with CRAs

The relationship between the leading Credit Rating Agencies (CRAs) and the Global South is becoming an increasingly prominent topic in discussions around global financial architecture. Views in this space diverge sharply. Some argue that the lack of CRA presence on the ground - particularly in regions like Africa - leads to systematic underappreciation of local context. Others suggest that criticisms of CRAs are overstated or fail to recognise the complexity of their role in global markets. Media investigations have offered inconclusive findings, while academic research has uncovered limited evidence of systemic anti-African bias - highlighting instead a modest pro-US bias. These debates have their place. But are they helping us move forward?

Examining whether or not such views are conducive to development is not my aim here. As I prepare to contribute to the Spring Meetings in Washington and the PrepCom in New York, my focus turns toward actionable ideas - ideas shaped by years of critique but tempered by dialogue, collaboration, and the privilege of engaging with experts across sectors. In every space I work in - from credit rating reform to sovereign finance – I am struck by the same theme: trust.

Trust, when built, transforms relationships. Trust, when absent, distorts them. So I ask: can trust be re-centred in the sovereign-CRA relationship?

In this short piece, I offer two proposals that seek to move us in that direction. They are grounded in practicality, responsive to longstanding concerns, and designed to empower both sides of the rating relationship. They are:

1. A model of Structured Engagement Forums, and

2. A voluntary CRA–Sovereign Engagement Charter.

Structured Engagement Forums

Bringing context, continuity, and collaboration to the credit rating conversation

Drawing on models like the IMF’s Article IV consultations, the OECD’s peer review mechanisms, and the World Bank’s Debt Sustainability Framework, I see a clear gap in the sovereign ratings space: while informal engagement between CRAs and sovereigns exists, there is no structured forum designed to support collaborative understanding ahead of ratings decisions.

So here is a proposal. Not a finished product - but a tested idea ready for development.

The aim is to establish dedicated, recurring spaces where sovereigns and CRAs can engage in pre-rating dialogue. These would be hosted by neutral convenors - regional development banks, multilateral bodies, or trusted third-party institutions. Participation would include senior finance ministry officials, regional political or economic representatives (e.g., the African Union), CRA analysts responsible for regional portfolios, and optional observers from multilaterals or technical bodies.

Crucially, these forums would be off the record, focused not on influencing outcomes, but on creating shared understanding. Key topics might include:

• Reform timelines and policy justifications;

• Development-linked trade-offs (e.g. social investment vs fiscal consolidation);

• Climate and infrastructure risk strategies;

• Clarification of technical data or risk model inputs.

The benefits?
For sovereigns: fewer rating shocks, better framing of complex narratives, improved internal capacity.
For CRAs: richer context, reduced reputational risk, stronger institutional links.
For the system: a more stable, transparent, and accountable sovereign finance environment.

There is precedent for this kind of initiative in other domains of financial governance:

As I have said elsewhere: sovereigns do not want to influence ratings - they want to be understood before they are interpreted. Structured forums offer a way to meet in that middle space: independent, voluntary, and mutually valuable.

The CRA–Sovereign Engagement Charter

A voluntary compact to foster clarity, respect, and mutual understanding

As Official Development Assistance declines, many Global South countries are increasingly turning to the Eurobond market - deepening their dependence on private capital and, by extension, the decisions of CRAs. This intensifying relationship calls for more than ad hoc engagement. It calls for shared expectations.

The Charter is not a regulatory tool. It is a voluntary, principle-based agreement - a living document that defines what good-faith engagement looks like. Its purpose is to reduce ambiguity, rebalance the relationship, and provide a stable framework for engagement without compromising analytical independence.

A working draft might include:

• Article I – Timeliness and Transparency of Communication
  Predictable disclosure from sovereigns and clear review timelines from CRAs.

• Article II – Narrative Context and Developmental Trade-Offs
  Recognition of long-term investment trade-offs by CRAs; proactive framing by sovereigns.

• Article III – Contact Protocols
  Named contacts on both sides to ensure continuity and reduce reliance on informal networks.

• Article IV – Clarification Mechanisms
  A post-rating window for clarification, with optional third-party facilitation if needed.

• Article V – Capacity Building and Mutual Education
  Opportunities for joint learning—CRA workshops, sovereign briefings, and shared insights.

This is not about regulating engagement. It is about making it visible, predictable, and respectful. We already see this kind of soft governance in ESG charters, public–private development compacts, and climate finance frameworks. Why not here?

Conclusion: A New Compact for a New Era

Taken together, these two initiatives could begin to reshape the sovereign rating space - not by displacing agencies or constraining markets, but by deepening understanding and expanding the possibilities of engagement.

They offer the financial system an opportunity to evolve. They offer sovereigns a greater sense of dignity and voice. They offer CRAs a pathway to deeper credibility and relevance.

Now the question is yours: Can this work? Can we imagine enough will and determination to finally rebalance one of the most consequential relationships in global finance?

A Review of UNCTAD’s ‘Aid at the Crossroads’

UNCTAD (United Nations Conference on Trade and Development) have recently released a report entitled Aid at the Crossroads: Trends in Official Development Assistance which aims to provide an overview of the global Official Development Assistance (ODA) picture. It provides understandings on current rates of ODA, who is providing what, and how ODA is being used by recipient countries. It also provides helpful pointers as to what may be coming next. It also provides insight into where the coming Financing for Development 4 Conference in Seville may focus its efforts. In this short piece, the focus will be on a. identifying some of the more pertinent pieces of data revealed by the report, and b. contextualising the data from the perspective of the debt crisis and the ‘credit rating impasse’.

ODA remains high but has declined for developing regions for the third year running

Whilst ODA reached a record level in 2022, it actually decreased in real terms in 2023. ODA remained high during 2023, increasing by 4%, but accelerating global inflation meant that this 4% increase resulted in a decline of 1% in real terms. The result, as the report notes, is that ‘the actual purchasing power of aid – and therefore its impact – diminished due to inflation’.

In relation to developing countries, the situation is stark. The report reveals that ODA to developing countries decreased for the third year in a row; in 2023 it stood at $160bn, $15bn less than at the height of the COVID-19 pandemic. Conversely, ODA towards developed countries, to be spent on issues such as refugees and asylum seekers (as well as Ukraine) increased by 23%.

When examined on a regional perspective, this loss for the developing world is felt most intensely in Africa, Latin America, and the Caribbean. The report illustrates that ODA decreased the fastest for Latin America and the Caribbean (down 14.5%) and that Africa saw the biggest decrease in absolute terms, down by 6.8%, or $5.3 billion. As the report notes, ‘the protracted decline in aid to Africa is particularly severe, as the region accounts for the majority of men and women living in extreme poverty, suffering from compounding forms of deprivations’.

Taking a more granular view, Least Developed Countries (LDCs) and Small Island Developing States (SIDS) have also been on the negative side of ODA rates, although in 2023 rates for both groups actually rebounded, with LDCs receiving 3.5% more and SIDS receiving 2.6% more. However, landlocked developing countries saw their share decrease by more than 5.5%, returning that group to pre-COVID levels.

Where Does ODA Come From?

While ODA from multilateral donors has been increasing, the majority still comes from bilateral sources. Notable multilateral donors include the International Development Association (IDA) which accounting for almost half of all multilateral aid between 2022 and 2023 ($24 billion). However, the vast majority does indeed come from ‘Development Assistance Committee’ (DAC) and non-DAC donors. Notable DAC donors include the USA, the UK, the EU (and various European Countries), and Australia while notable non-DAC countries include China, Russia, the UAE, and Saudi Arabia. DAC countries contributed the most ODA by far, but its rate of contribution continues to decline. In 2023, contributions from DAC countries accounted for 61% of ODA, down from more than 70% just a decade ago. In contrast, multilateral aid has been stable, at around 25%. As a result, the role of the multilateral aid provider has become more important for the developing world, with more than 30% of developing world aid now coming from multilateral donors.

There has also been a welcome shift in ODA grants compared to ODA loans. This is in a worsening context however, as the report notes that ‘the share of ODA grants in total ODA has been continuously falling over the past two decades’. Between 2010 and 2020 grants made up 70% of total ODA, but since the pandemic that figure has fluctuated (at its lowest to below 65%, but in 2023 rebounding to 67%). This rebounding as been welcome. In 2023, ODA loans dropped to $52 billion, ODA grants increased to $108 billion, and equity investments plummeted to just $300 million. However, when viewed from the regional perspective, ODA rates for both loans and grants reveal staggering pictures: for Africa, both loans and grants decline by 6% each.

What is the ODA being spent on?

The report shows that ODA is mostly being directed towards social infrastructure and services, representing 39% of the total. Other avenues include Economic Infrastructure and services, Humanitarian Aid, and Production Sectors. Granularly, Humanitarian Aid has been the fastest growing ODA item for the past 15 years and has witnessed a double-digit expansion. Important, despite increasing concern about debt sustainability, ODA for ‘debt action’ has continued to decline; it reached an historic low in 2023. Also, after further disaggregation, it is Health that is suffering the largest decline, down 27%.

 What next?

With FFD4 in Sevilla only three months away, the report opines on what the Conference should focus on after ingesting the report’s data. The report also provides key commentary on the global environment. First, it notes that the aid target of the SDGs remains nearly 50% unmet. It notes that DAC donated ODA in 2022 and 2023 represented only half of what was targeted – 0.37% of Gross National Income compared to 0.7%. Only Norway, Sweden, Luxembourg, Germany, and Denmark achieved their SDG target. Second, public announcements regarding ODA and providing wider support have become particularly negative in recent years. Political and media focus has been actively turning towards fiscal consolidation and defence spending, which has resulted in clear confirmation that aid provisions will be reduced. Because of all of these issues, the report concludes with four priorities moving forward:

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The Potential Effect of Diversification within the Leading Credit Rating Agencies

In a recent Seeking Alpha article, it was suggested that there is an increasing diversification taking place within the two leading credit rating agencies – S&P Global and Moody’s – since the Global Financial Crisis catapulted the agencies into the public spotlight. The article concludes that increasing diversification may be good for the businesses but bad for the concept of ratings (taken from an investor perspective). In this short post, the focus is on the potential implications of such increasing diversification.

Diversification

It is likely a fair summation to say that the credit rating agencies have been actively diversifying since the Global Financial Crisis. The sentiment here is that the leading agencies understood their fragility after settling for record amounts with (US) governmental bodies and responded accordingly. In actual fact, as I revealed in my PhD Thesis, the reality is that this diversification in product offering and focus began long before the Global Financial Crisis; the agencies took inspiration from the Audit industry and picked up the baton that the auditors had so spectacularly dropped. There is a strong argument to suggest that such diversification helped fuel the Global Financial Crisis, rather than appearing afterwards.

Nevertheless, the diversification cited in the Seeking Alpha article is illustrated in the financial statements of the two credit rating powerhouses. For S&P Global, rating revenue constitutes 30.8% of its overall revenue, whereas for Moody’s rating revenue constitutes 54%:

The Form 10-K of both companies show very different stories, though both are massively intertwined when it comes to their trading history, market dominance, and other metrics. S&P Global is clearly the bigger operator and derives its revenues from a variety of sources. For Moody’s, it is a different story but even within such a concentrated organisation it is clear to see that the tipping point of ratings becoming a secondary source of revenue is fast approaching. That point, for S&P Global, has long since passed. The question for this short post is what may be the implications of this diversification?

Implications

The Seeking Alpha article suggests that ‘a basic premise to begin with is that nothing is as good as ratings. Diversifying away from ratings is therefore an exercise in “deworsification”, as Peter Lynch would call it’. There is a natural constraint on this understanding in that S&P’s index business has an even higher margin than the ratings business which, in itself, already boasts one of the highest margins around. Yet, for S&P Global, according to the Seeking Alpha, the company cannot have it all. Investments into non-ratings businesses will natural deplete the margins within the ratings business, which is why operating margins for the ratings business of Moody’s is far higher (48%) than it is for S&P Global (39%) where ratings is concerned.

There are a variety of implications from these results. For the agencies themselves, this increasing diversification makes them stronger. It protects them from the harsh winds of the financial environments within which they operate. It also protects them from regulatory or legislative reactions to their involvement in the various markets that they contribute to. Equally, it further consolidates their structural roles as financial gatekeepers. Now, increasingly, they not only provide the ratings that the financial system structurally relies upon but they also provide the supportive data and strategic assistance that many financial players require. This further increases the agencies’ strength and prospects.

However, from a structural perspective the diversification is problematic. As we saw with the Audit industry in the lead up to the Enron scandal, and the credit rating agencies in the lead up to the Global Financial Crisis, the provision of consultancy/ancillary services brings with it the increased potential for transgressive behaviour. The increasing potential for conflicts on interests is not positive in such a structurally-important gatekeeper. It also presents challenges for regulators who, traditionally, have only ever utilised financial penalties for discipline. If the targets for regulatory action are increasingly a. richer and b. more diversified in terms of their revenues, the potential disciplinary power that regulators have is naturally reduced. Considering that reality in relation to a financial gatekeeper should ring alarm bells.

For the agencies themselves, it may well soon be the case that the two leading credit rating agencies derive the majority of their revenues from non-rating business. There are a variety of potential issues with this reality, ranging from a lack of incentive to properly resource the ‘cash-cow’, to advancing the ratings business to secure non-ratings business. There is also the theoretical risk that credit rating agencies could discipline market participants with credit ratings to secure long-term non-rating business, or that market participants recognise this dynamic and utilise that knowledge to gain higher ratings. Such behaviours were alleged during the lead up to the Global Financial Crisis.

Ultimately, the credit rating landscape is evolving every day and this coming tipping point for the duopoly that controls the credit rating marketplace will be impactful. In what way we are yet to see, but the potential for that impact to be substantial is significant.

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Review of the US SEC Staff Report on Nationally Recognized Statistical Rating Organizations (January 2025)

Today’s focus is on the Staff Report released by the US Securities and Exchange Commission’s Office of Credit Ratings (OCR) which focuses on Nationally Recognized Statistical Rating Organizations (NRSROs). The SEC are mandated by Congress – via Section 6 of the Credit Rating Agency Reform Act of 2006 and Section 15E(p)(3)(C) of the Securities Exchange Act of 1934 – to collate information on the previous years’ worth of investigation into the NRSRO industry, as well as pertinent data on the shape of the industry. This piece reviews that report and presents the more important and relevant highlights. All aspects of this piece are derived from the Staff Report, unless otherwise stated.

Monitoring

The Report starts out with an overview of what the OCR suggests as key issues that they have been monitoring over the past year. Interestingly, the Report focuses on two areas of direct relevance to the NRSROs: the commercial real estate market, and private credit. On commercial real estate and CMBS ratings (Commercial mortgage-backed securities), the Report says that NRSROs had reported a deterioration in the sector and that subsequently the NRSROs had been conducting increased reviews, stress tests, and had issued downgrades. NRSROs appeared to agree that the sector outlook will remain unclear in the near future until rents and vacancies started to stabilise. On the issue of private credit, and its proliferation, the Report notes several concerns. One main issue was the variety of instruments that are backed by collateral that has originated in the private credit market, including private credit funds, business development companies, and collateralised loan obligations. The rise in the private credit market has led to responses from NRSROs, with specialised departments now existing and the rate of private credit ratings provided by NRSROs – not to be made public – increasing markedly.  

Essential Findings and Responses to Material Regulatory Deficiencies

Apart from the useful statistics that the Report brings to the field every year (which will be reviewed next), one critical aspect of the Report is when the OCR reveal its findings regarding breaches of law and code by the NRSROs. For a variety of reasons, most of which are challenged, the SEC has maintained its approach of anonymising its findings so that we do not get to know which NRSRO has transgressed in particular. Instead, we are told whether a ‘large’, ‘medium’, or ‘small’ NRSRO has transgressed. Most transgressions are often concluded with a comment akin to: ‘the Staff recommended to the NRSRO that they take a particular action to prevent this from happening again’. However, what the Report does help with is revealing the culture within NRSROs and how they seek to resolve the issues (if at all).

The large NRSROs (either S&P Global, Moody’s, or Fitch) committed the following material breaches:

1.      One large NRSRO did not enforce policies relating to conflicts of interest around securities ownership, resulting in ‘several instances’ where analysts continued to own securities that ought to have been divested and, in one instance, one of these analysts participated in a credit rating committee for an obligor in whom the analyst owned securities. The NRSRO responded that they had convened a new committee, suspended and then terminated the contract of the analyst, and reviewed policies and hiring rounds to see if there had been any further breaches of the same type. It went on to update analyst training as a result.

2.      For the same NRSRO, a non-independent director did not preclear three securities transactions or subject their related brokerage accounts to monitoring by the NRSRO, in breach of internal policy. There is no additional information to reveal what happened in this instance.

3.      Another large NRSRO’s independent directors used personal email accounts to conduct NRSRO business, including transmitting nonpublic information and potential material nonpublic information. The Staff recommended new controls, but no information is provided on what happened next.

4.      The same NRSRO was found to have an analyst who sent a draft rating report to an issuer ‘that inadvertently disclosed a contemplated rating action’, contrary to NRSRO policy. Again, while Staff recommend action, we do not get to find out what happened next. The theme is clear and I will not repeat it from this point on.

5.      The same NRSRO did not disclose complete and correct credit rating histories in mandatory disclosures. For ‘several years’, the NRSRO posted disclosures that ‘did not include a significant number of credit ratings of a particular rating category’.

6.      The remaining ‘large’ NRSRO was cited for not making nor retaining a rationale for a material difference between the credit rating it assigned to a security issued as part of an ABS transaction ‘and the credit rating implied by a model that was a substantial component of the process of determining the credit rating’. In simple English, the NRSRO said they would do one thing, and then did another. Further investigation found this issue to be replicated in other sectors.

7.      The same NRSRO’s policies and procedures did not require that it promptly publish notice of the existence of a significant error in a procedure or methodology used to determine credit ratings.

The ‘medium’ NRSROs – A.M. Best, DBRS, and Kroll – also had a litany of breaches cited. They included:

·         The process of submitting complaints anonymously was not apparent nor intuitive.

·         A medium NRSRO did not enforce a policy designed to ensure adequate records are made and retained to allow for after-the-fact reviews of a rating action.

·         A medium NRSRO’s board of directors did not approve the entirety of a methodology, with a quantitative tool that was not approved then being used by the NRSRO.

·         A medium NRSRO did not made or retain records of the rationale for a material difference between the rating assigned to an ABS transaction and the model used to create it.

·         Another medium NRSRO did not apply all applicable methodologies when determining an entity’s credit rating.

·         An independent director used a personal email account to conduct NRSRO business, including potentially sensitive and material nonpublic information.

·         A medium MRSRO’s complaints policies and procedures did not adequately address the receipt, retention, and treatment of employee complaints.

Smaller NRSROs, like Demotech, Japan Credit Rating Agency, Egan-Jones Ratings, and HR Ratings de Mexico also were cited in the report. Their breaches collectively included:

·         Not enforcing policies relating to withdrawing ratings when not receiving the required surveillance information.

·         Did not ensure that annual surveillance reviews were conducted on a timely basis.

·         Sales and marketing employees had discussed ratings with rating analysts (although the NRSRO disagreed with and challenged this conclusion).

·         A small NRSRO did not adhere to policies relating to the receipt, retention, and treatment of complaints relating to credit ratings, models, methodologies, and more.

·         A small NRSRO did not complete and correct credit rating histories in their mandatory disclosures.

The Report concludes this section by reviewing some of the instances where changes were requested by the Staff. However, it concludes with confirming that many changes have not been actioned, but this is because it is difficult to confirm with the NRSROs because some changes are actively being actioned and can only be judged upon completion of the revised process or provision.

Important Statistics

The Report is often cited throughout the field and especially for its data. Every year it provides for information relating to market share, outstanding rating ratios, areas of ratings, and more. Below are some of the key statistics from this year’s Report with some short commentary to each.

Market Share by Outstanding Rating

The amount of ‘outstanding ratings’, i.e. ratings that are live and active, is usually the marker by which the field understands the relevant positions of a NRSRO with respect to other NRSROs. This year’s Report confirms a similar trend, with S&P Global dominating the space in front of Moody’s, with Fitch rounding out the oligopoly and the rest operating in much less smaller circles. Collectively, the Big Three accounted for 94.15% of all ratings that were outstanding for 2023 (virtually unchanged). It is interesting to note that the year-on-year change indicates that only Fitch are rating more this year (of the largest NRSROs). Additionally, in the second chart, we can see in what areas the NRSROs are rating:

It is also important to understand the constitution of the rating sector by looking at the staffing levels. This year’s Report indicates that despite S&P Global rating a lot more than Moody’s, Moody’s actually has more analysts:

However, whilst outstanding ratings and staffing levels are good indicators for the development of the NRSROs, the financials usually take priority. This year’s financials reveal that the large NRSROs are capturing more of the income from the collective NRSRO pot than ever before. Additionally, Moody’s revenue for 2023 was up 6% from 2022, now reported at $2.9 billion, and S&P Global was up 9%, now at $3.3 billion (the Report does not cite Fitch’s financials here).

Barriers to Entry and Conflicts of Interest

The Report concludes with assessing key issues that affect the credit rating sector. Two, selected here, are pertinent. There was considerable regulatory, political, and legislative capital wasted after the Global Financial Crisis on increasing competition in the credit rating sector and the statistics above demonstrate the size of that failure – today, the credit rating sector is become less competitive, not more. The Report cites many barriers to entry that exist, including pressure on the issuer side, the investor side, and in terms of organisational difficulties to offer ratings at scale. The Report chooses to focus on the actions taken by the SEC in terms of creating space for appropriate regulations whereby smaller NRSROs are not as burdened in certain areas to allow for growth.

In terms of conflicts of interest, the Report provides generalised information on the different conflicts of interest (and categories them by who is involved, i.e. rating analysts, relationship with issuers, internal relationships etc.) It does then provide links to interventions where they have involved themselves and recommend development in particular areas within NRSRO to prevent conflicts from occurring or being repeated.

Summary

The Report provided by the OCR is a useful addition to the field. However, despite its usefulness, some of the signals it sends are not positive. It shows a regulator intent on protecting the sector and a sector that continuously transgresses. Many of the identified transgressions in this year’s report are found in previous additions. The protection of the sector, via anonymity, has not merit. The damage that agencies may face if they were to be identified ought not to be deciding factor when determining whether anonymity should be provided. If a registered NRSRO breaches not only their own codes of conduct and procedures, but those of the regulator (or the law) then the public should be made aware. The anonymity is a moral hazard that needs to be reconsidered.

Beyond that, the Report makes clear that attempts to affect competition amongst credit rating agencies in the US has been an abstract failure. The largest credit rating agencies grow ever larger, bring in more and more revenues, and continue to dominate the act of providing credit ratings in the world’s largest economy and afar. This realisation ought to correct the reform agendas being presented in various fields, ranging from debt treatment to sustainability. The signal this Report sends is that the credit rating agencies are getting bigger, more important, and there is simply no evidence to suggest that is going to change any time soon.

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Are Debt-for-Nature Swaps a Viable Alternative? The Credit Rating Agency Issue

El Salvador recently concluded a $1bn Debt-for-Nature swap (DFN) which, according to White & Case who facilitated the swap, is ‘both the world’s largest conservation-focused operation of this kind to date and the world’s largest DFN conversion for river conservation’. As a result, the team at White & Case have suggested that such swaps ‘offer a promising alternative to traditional financing sources’.  At the same time, Ecuador has also just completed a large DFN. The question is whether this is really the case?

The concept of a project-based ‘swap’ is increasingly becoming common parlance. The concept is a simple one, as explained by the African Legal Support Facility (ALSF): ‘Debt-for-Nature swaps are financial transactions whereby a portion of the foreign debt owed by a developing nation is eliminated, decreased, or erased in return for locally supported conservation initiatives being funded by (at least in part) the reduced debt burden the nation will face after the swap’. This ASLF report provides a really good review of the concept and its history, including criticisms relating to DFNs not focusing on the underlying issue of unsustainable debt. For this post though, the issue is in the detail of the description above. As the IGSD mention in relation to Debt-for-Climate swaps, ‘much of the world is awash in unsustainable public and private debt… efforts to relieve the debt crisis provide opportunities to advance the climate protection, health, and economic goals together, specifically through Debt-for-Nature swaps’. From a credit rating perspective, it is accepted that ‘Official’ debt – that from bilateral or multilateral sources – is not of concern, but ‘Private’ debt certainly is. In the description above from the ASLF, everything points to altering the original contract-based agreement between Issuer and Creditor. For a Credit Rating Agency (CRA) examining the relationship between Issuer and Private Creditor, this is a potential problem.

How CRAs judge DFNs varies and for good reason. For example, when Belize issued a DFN swap in 2021 totalling $364 million, complete with credit enhancement from the US Development Finance Corporation, the DFN rating was higher than Belize’s sovereign rating from Moody’s and, subsequently, S&P Global upgraded Belize’s sovereign credit rating to B-. The precise details of the Belize swap are available here and reveal that the reason for the credit rating was based almost solely on the fact that the swap constituted ‘US risk with a little sprinkle of Belize’. This is just one example that has led onlookers to conclude that ‘as a country’s external debt decreases thanks to DFC swaps, it can lead to better credit ratings, which can, in turn, lead to favourable borrowing conditions in international markets…’ It is worth noting an inconsistency in the field’s literature at this point. Many point to a seeming fact that ‘in the recent debt-for-nature swaps, the debt buy-back was assessed by Moody’s as “distressed exchange” for Ecuador and Belize, but not for Gabon and Barbados’. The problem is that this view contradicts the common view that Belize were actually positively-rated by Moody’s (at least, their swap was, and S&P upgraded the Sovereign Rating) and these views seem to all stem from the very same source – an article by Thorsten Nestmann, a Group Credit Officer for Sovereign and Supranational Issuers at Moody’s – in which he says: ‘by contrast, Belize had already missed debt payments a few months before the swap, indicating extreme credit stress at its Caa3 rating. Similarly-rated Ecuador appeared to lack market access as it was going through a period of severe political turmoil around the time of the transaction. Bond yields for both Ecuador and Belize were also at highly distressed levels, trading north of 20%. This was reflected in the deep discount that the bonds were bought back at, at 45% for Belize and over 60% for Ecuador’. At the time of writing, I have been unable to verify this understanding with even one other source, not even the Moody’s website itself – Moody’s, on its website, actually said that the superbond buyback was credit positive, but that future default risk remains high.

If there is potential confusion over Belize, there was none over Ecuador. The South-American Country had attempted the largest swap on record, organising for nearly $1.6 billion with funds to be directed to conserving the Galapagos Islands. However, Moody’s took a dim view of this, stating in a report that ‘the operation retired 10.5% of the total $15.6 million value of the three bonds but did so by repurchasing them at deeply distressed prices, constituting a loss to investors compared to the original promise of the bond contracts and generating a substantial reduction on principal for the sovereign’. As a result, Ecuador was deemed to have undertaken a ‘distressed exchange’ and was placed into default by Moody’s as a result.

The aforementioned Thorsten Nestmann explained why there is a difference. He said that: ‘with regard to bond buyback offers, Moody’s analyses factors including the size of the buyback relative to total debt and/or market debt with the likelihood that larger transactions, affecting around 5% or more of outstanding debt, are more likely to help avoid an eventual default. Furthermore, the loss severity, measured as the discount to par, often signals the likelihood of the issuer being unable to meet its debt obligations and impacts the magnitude of debt reduction. Moody’s takes into account sources of cash used to buy back the debt. If new cash is being raised externally in the debt markets, this can signal that the issuer has access to the debt markets and is not in distress’. S&P, in a report earlier this year, confirmed that they view each swap on its own merits and that debt restructurings qualify as distressed if they meet two conditions: (i) the investors receive less than the original promise, and (ii) should the debt restructuring not take place, there is a realistic possibility of a conventional default on the instrument over the medium term. S&P later confirms that both conditions must be met. Furthermore, S&P reveal that they generally view an Issuer’s sovereign credit rating as an indicator i.e. ‘if the issuer credit rating is “B-” or lower, the debt restructuring “would ordinarily be viewed as distressed”’. Fitch, in relation to Ecuador’s exchange this month, essentially confirmed that they deploy the same two-stage conditionality test to determine whether a swap is a distressed exchange.

It does appear that it is Moody’s leading the way in constraining the development of DFNs, as they are the only CRA seemingly to penalise a given DFN with a downgrade for the country involved. Nevertheless, the understanding from the CRAs above really brings into question the mainstream insistence that DFNs can be an ‘alternative’ form of finance for the developing world. First, the DFNs already contain issues in relation to their transparency and how to verify that the resources have been used for the stated purposes. But, from a credit rating perspective, the use of proceeds is not of concern. The call for more countries to utilise DFNs is somewhat blind to this reality. As a researcher at the International Institute for Environment and Development said, ‘these transactions (DFNs) are not necessarily suitable for countries in severe debt distress, as by that point they would need extensive debt restructuring and relief… debt swaps are more suitable for countries with high but not prohibitive debt burdens who want to manage their to improve their economic situation’. If we believe this to be true, then the takeaway message is a simple one: debt-for-nature swaps are a good option for particular countries, but certainly not all. Therefore, promoting them as a ‘viable alternative’ during a debt crisis is potentially irresponsible and feeds into the major criticism of those who are advocating for the systemic adoption of such products – that energy takes away the necessary energy for resolving an underlying debt crisis that has no modern debt treatment system. More focus on developing a debt treatment infrastructure fit for modern purpose is a better way forward. There is a lesson to be learned from the DFN experience for all involved – ignore the credit rating infrastructure at your peril. The involvement of Private Creditors means that the credit rating infrastructure must now become front and centre and for all aspects – be it relating to DFNs, debt-for-climate, ‘pause clauses’, debt jubilees, or alterations to the International Financial Architecture. Not doing so will inevitably result in failure, on many levels.

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The EU’s New ESG Rating Regulation Reveals Familiar Regulatory Patterns

Back in June 2023 when the EU revealed its proposed regulations for ESG Rating Agencies, I pondered whether the EU had gone far enough. Now, the EU has confirmed and published its final Regulation for ESG Rating Activities, titled Regulation (EU) 2024/3005 on the transparency and integrity of Environmental, Social and Governance (ESG) Rating activities. Many fantastic scholars have already opined on the Regulation and reviewed it more than adequately – see the excellent Prof. Andreas Rasche’s review here – so instead I will assess some more nuanced takeaways from the Regulation (and also respond to some issues identified in the 2023 commentary).

The first issue identified in the 2023 commentary was that the Regulation has seemingly decided to avoid bring ‘Second-Party Opinions’ (SPOs) within the regulatory perimeter, which I had indicated was a missed opportunity. This has been maintained in the final Regulation, with SPOs being categorically placed outside of the regulatory perimeter. I discussed why this is an important failure in a recent chapter as part of Danny Busch et al.’s Sustainable Finance in Europe book (available here) and you can also find an interesting discussion on SPOs here via Alexander Coley. The effect of SPOs and their growing importance, together with the prospective conflict of interests that arise from their provision, mean this is very much a missed opportunity for the European legislators.

The second issue identified was that, like the Credit Rating regulatory frameworks, the Regulation was allowing anonymity to dominate the regulatory reviewing system. In the credit rating regulatory frameworks, regulators are permitted to only publicise the broad category of those who infringe the rules – for example, they will say that a ‘large credit rating agency’ has broken this rule or that rule, or that a ‘medium-sized credit rating agency’ has transgressed. I have long since called for this practice to be stopped and that those guilty of breaching the rules are adequately identified for the public. It was interesting to see whether the legislation would force the regulator – ESMA – to break this practice, but no such luck. In the final Regulation, there are only two references to the ‘annual report’ the regulator must file, and no details about particular elements within it.

This is a particular theme of the Regulation which warrants scrutiny. The most obvious section to examine is Article 28, which reads: ‘in carrying out their duties under this Regulation, ESMA, the Commission or any Member States public authorities shall not interfere with the content of ESG Ratings or methodologies’. This same sentiment is seen across each and every credit rating-focused Regulation and for good reason. Any perceived amount of interference has the potential to negatively affect one of the core tenets of a ‘rating’ system – the rating must be produced by an independent and impartial third-party. There is a balance that a Regulation must find and the question here is whether the EU have found that balance.

It appears that the answer depends on one’s perspective. I do not believe they have gone hard enough, leaving out key elements like SPOs, as well as providing quite a soft-touch approach to the general constraining sentiment of the Regulation. However, consider it from the EU’s perspective… they are essentially first out of the gate (in terms of a full formal piece of legislation for leading ESG Raters), this is the first time they have regulated the industry, and the industry itself is quite the moving target. In between the proposal and the final Regulation, Moody’s have completely vacated the space, leaving really only two main players – MSCI and S&P. Also, it is becoming abundantly clear that the ESG Rating game is perhaps not as impactful as people first feared, with it starting to resemble a side-business for those who primarily sell indices. Add to this that, across the board, there appears to be a general retreat from ESG by the business sector (even before Donald Trump re-assumes the Presidency in the US). Take all that and put it together, the real question becomes whether the EU have just regulated the industrial version of a ghost – it was there when they started, but is it any longer?

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