Jason Barrass is the Commercial Manager of British rating agency ARC Ratings, who soon will be speaking at the international conference Tallinn Supply Chain Finance Summit 2023. The conference will take place over 8-9 February, gathering top players from the digital finance world in Estonia and Europe. In this article, he discusses the positive contribution made by credit rating when it comes to simplifying the supply chain finance process, a topic he will address in more depth at the conference itself.
First, could you please explain what a credit rating is?
A credit rating, carried out by a rating agency, is an independent assessment of a company, indicating business risk and creditworthiness. In essence, it is a signal to investors, to banks, and also to your customers about how reliable your company is and whether or not you are likely to be able to meet your financial obligations in the near future.
When your company has a good credit rating, advantages include being able to take out loans at preferential interest rates, or an increased likelihood of finding investors, etc., as well as demonstrating that you are a more reliable business partner.
ARC Ratings, where you work, is one of Europe’s seven largest credit rating companies. Of interest to many readers will be why a company from a nation like Estonia should use such a large company to obtain a rating, when in fact there are also smaller, local players offering the same service. How should a company choose whom to take an assessment from?
Whilst it’s true that banks too can assess creditworthiness, traditionally they primarily assess a company’s financial capacity and leave other indicators aside. However, modern ratings processes take a much broader perspective, i.e. we evaluate the company’s management team, their experience and their leadership ability, plus we analyse systems security, economic environment, supply chain security and also the work culture.
Additionally, what is increasingly important for investors these days is whether or not the company is socially and environmentally responsible.
Such broader rating models used by rating agencies enable correct evaluation of even smaller companies, for which the existence of a rating has a clear competitive advantage. Even if they are not looking for investors, a positive rating makes it easier for them to find cooperation partners and new customers.
If the goal is to attract foreign investors, the international reputation of the rating agency is a guarantee.
Investors would be concerned that there is no uniform standard by which they can evaluate the environmental and social impacts of companies. How can a rating agency give an assessment if there is no common understanding?
This is a very good question. ESG (Environmental, Social and Corporate Governance), i.e. how a company performs socially, environmentally, and in terms of management principles, is currently one of the main indicators used by investors to make investment decisions, but this field is not really uniformly regulated and this is a problem. Rating companies do not currently provide a direct score for ESG, but rather a general assessment.
However, there is currently a heated debate on how to create a single set of ESG rules that companies can follow. Several large technology companies are trying to bring raw data together and offer a homogeneous solution based on that set.
The company pays for its own credit rating. This sets the stage for a conflict of interest, i.e. “I pay more, I get a better rating”. How would you respond to that?
The credit rating process is strictly regulated and rating agencies are under constant scrutiny. The work of analysts is structured in such a way that they are independent. In addition, the credit rating agency’s reputation in the financial sector, and especially among financiers, is important.
What do you say to companies who receive a worse rating than expected? Apparently, many expect a good grade, but the result brings disappointment.
I am saying that a credit rating can also be taken as a type of audit. If you are not satisfied with the result, at least you have a document where the strengths and weaknesses are precisely mapped, and from there it is easy to make improvements and move forward. Thus, the credit rating helps to develop the company’s management systems.
There is a war going on and sanctions have been imposed on Russia. All this affects the operation and success of Eastern European companies. So, will the companies here receive a worse credit rating?
We look at the company’s performance and financial strength from several aspects. If geopolitical problems really have an impact on the company, then of course it will be reflected in the credit rating.
Does this mean that Eastern European companies will no longer be attractive to investors in the near future?
When we provide a credit rating, we do not say whether you should invest in a company in a certain region or not. Investors have different goals; some are more cautious than others. We describe the risks, but if the interest or margin has increased due to the risks, this can be a good opportunity for some investors to earn higher returns.
In this sense, the credit rating is a necessary sign that, even in difficult times, gives lenders, investors or consumers fairly accurate knowledge and confirmation of the extent to which the company can be trusted in the near future.
Recently, there has been talk that credit ratings can also be applied to trade and supply chains. What does this mean?
This means that trade liabilities in supply chains have become alternative investment assets for investors. Traditionally, banks have been partners of companies in financing the supply chain; instead of waiting for the payment of the invoice from their buyer, the bank pays for it, and the buyer in turn transfers the money to the bank. In this way, cash flows are better controlled, risks are mitigated, etc.
Such financing could be provided by non-bank investors, but it requires a lot of administrative work and a credit analysis of each company. This is where the credit rating comes into play, which gives an assessment of the reliability of assets in the supply chain and makes a separate asset class from the approved invoices of rated buyers. Ultimately, alternative investors improve access to capital for rated companies and their suppliers alike.
The reason why purchase invoices are becoming an investment product is only now raising its head is a prosaic one. Collecting data, especially documents, from all parties in the supply chain is difficult. Digitalisation has reduced these bottlenecks and it also makes approved purchase invoices easier to finance.