Ratings agencies hit back over pay-to-play claims

Ratings agencies hit back over pay-to-play claims

Fund rating agencies have hit back against criticism they harbour conflicts of interest that hurt investors.

The UK’s best known fund scorers have defended their independence in the face of claims from some in the industry that ratings are given on a ‘pay-to-play’ basis.

A 'pay-to-play' basis refers to the practice where funds aren’t rated if the fund house refuses a commercial arrangement with the ratings agency.

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A damning review of the value for money of the asset management industry, published by the Financial Conduct Authority on 18 November, flagged industry concerns about the rating agencies’ business models.

In one example, pointing to how influential the ratings agencies can be, the FCA stated: "Our analysis also suggests that retail investors use third party ratings when they make investment decisions.

"In particular, our econometric analysis shows that investors react to changes in the Morningstar Star rating, one of the most used ratings systems. A change in star rating from not-5-stars to 5-stars leads to a significant increase in the total net assets that are invested."

The FCA's paper revealed a belief that “some rating providers do not offer a whole of market review and some rating providers have to manage a conflict of interest where an asset manager agrees to pay the rating firm for a licence”. 

Asset managers told the FCA they will not be rated if they do not pay fees for a licence to use the ratings agencies’ logo, ratings or research. 

The watchdog’s paper concluded: “The third party rating providers’ business model may result in investors and advisers not being able to access information that helps them assess investment products.”

The regulator's comments left the door open for further investigation of the fund rating sector.

Richard Romer-Lee, managing director of Square Mile, branded claims about bias “absurd”, while Morningstar’s director of communications, Tina Gould, said any fees paid by asset managers are “entirely subsequent and separate to the analyst rating”.

FE portfolio manager Oliver Clarke-Williams said his organisation's ratings were “fully independent” and whole of market, and Geoff Mills, director at Rayner Spencer Mills, said, “anyone who suggests there is any bias or favouritism or that the fund group or manager can influence our decision is wrong”.

Defaqto chief executive Zahid Bilgrami said the company's Diamond Ratings are whole of market and not ‘pay-to-play’: "We do not have conflicts as others may have in this space.  The vast majority of our ratings are not paid for."

All of the ratings agencies FTAdviser spoke to commercialise their ratings in some way. 

Rayner Spencer Mills makes fund houses pay for a marketing licence to use the ratings logo on their marketing material. The fund is still rated and appears on its ratings hub even if the fund house refuses to pay.