The Use of Credit Ratings in Investment Management in the US and Europe

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Abstract
We analyse a survey of 200 plan sponsors and investment managers in the US and Europe regarding the use of credit rating guidelines in the conduct of their investment activities. We find that ratings-based guidelines are widespread, but their forms and motivations vary considerably. The usage of ratings appears remarkably similar in the US and Europe. The adoption of ratings-based investment guidelines appears driven by the private sector, with regulation playing a relatively minor role. Guidelines generally reference ratings of specific agencies, rather than the ratings of all officially "recognized" agencies. Ratings-based guidelines seem unlikely to destabilize markets because although asset retention guidelines are common, rapid forced selling upon downgrades is not. Market participants express a preference on the margin for more accuracy over more stability, but stability is valued and guidelines rarely include agency outlook designations, which could be used to increase rating accuracy. These findings generally support the hypothesis presented in Cantor (2004) that ratings are used as governance tools by market participants to ameliorate principal-agent problems between asset managers and their clients.