- City's financial regulator began supervising raters in 2011
- Moody's has 30 days to challenge ruling, tribunal says
Moody’s Investors Service must pay an HK$11 million ($1.4 million) penalty after a Hong Kong tribunal upheld an action against the firm by the city’s financial regulator.
In a case that was the first of its kind in Hong Kong, the Securities and Futures Appeals Tribunal on Thursday ruled that Moody’s was acting as a regulated entity providing credit-rating services when it published a report about 61 Chinese companies in 2011. That meant Moody’s had to abide by the Securities and Futures Commission’s code of conduct, which the regulator said the report breached by failing to provide sufficient explanations for its judgments, and not ensuring the accuracy of its claims.
The decision could have wide-ranging implications for how ratings agencies operate in Hong Kong. Moody’s said in a statement it disagreed with the notion that the SFC can regulate the content of research publications. Timothy Loh, a lawyer who represents U.S. short-seller Andrew Left in a separate dispute with the SFC, said the tribunal construed the scope of what constitutes credit-rating services too broadly, which could affect what researchers say in future.
“The greater issue is whether by reason of the broad interpretation given” to rating providers, “the freedom of expression of other market participants has now been impinged,” Loh said in an interview.
The report, titled “Red Flags for Emerging-Market Companies: a Focus on China,” used a framework of warning signs that Moody’s had about weak corporate governance, opaque business models and unclear financial reporting at the companies. The note qualified as a ratings notice, according to the adjudicating panel.
“The tribunal has been drawn to the conclusion that there was a failure in clear and unambiguous terms to set out the true nature and purpose of the red flag framework,” the panel said in its ruling. “The evidence indicates that the market understood the red flag framework as providing some form of ranking system of credit risk and acted accordingly.”
Shares plunged and borrowing costs jumped for some of the Chinese companies, including Winsway Coking Coal Holdings Ltd. and West China Cement Ltd., that were named in the Moody’s report. The ratings company said that the research note was a primer on possible credit-rating reviews, rather than a review in itself.
Moody’s failed to provide sufficient explanations and justification for the red flags assigned to the companies, an SFC spokesman said after the ruling was published. As a result it “painted an unfair, unclear and misleading picture of the companies.” The regulator began supervising credit ratings in 2011, just a few months before the report was published.
“Moody’s must have appreciated that, at that time of very real concern, the report would carry considerable weight in the market and, importantly, would bear heavily on those corporations burdened with the highest number of red flags,” the tribunal said.
The three-person panel, which said Moody’s should be subject to a public reprimand, also determined that there were “substantive breaches of general principles” of the SFC’s code of conduct during the preparation and publication of the report. The tribunal announced the ruling on Thursday after holding a hearing in September.
The tribunal didn’t fully agree with the SFC, however, as it cut the penalty Moody’s must pay from the regulator’s initial HK$23 million.
“Moody’s appreciates the reduction in the fine, however we did not engage in misleading conduct and we disagree that the SFC should be able to regulate the content of research publications,” Donough Foley, senior vice president for government and public affairs at Moody’s Asia Pacific, said in a statement. “Moody’s is considering its options.”
The company has 30 days to challenge the tribunal’s decision.