Fixed Income

Lessons learned from the "grotesquely complicated"

29/05/2013

Peter Fullerton

Peter Fullerton

Credit Analyst

In early November 2012, the Federal Court of Australia handed down a landmark ruling* establishing that investors were entitled to claim for damages after suffering material losses from relying on a AAA rating provided by one of the global credit ratings agencies**. The ruling not only has material ramifications for the rating agencies but it also has significant implications for any individual or organisation providing opinions on investments in Australia. In a nutshell, it was not that investors lost a substantial amount from investing in a security originally rated AAA per se, but the court reinforced the need for ratings agencies to conduct a suitable amount of their own research and analysis before arriving at their opinion.

It’s important to point out that this article is not looking to join the chorus of criticism levied against the rating agencies and to acknowledge that it’s unreasonable to expect any provider of investment advice to have a perfect record. Against this backdrop, this article looks to objectively identify how in this particular circumstance, the highest possible credit rating came to be assigned to securities that eventually returned only 10% of its original principal and what providers of investment opinions can learn to avoid making similar mistakes in the future.

*Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200 (5 November 2012)

**The specific investment in question was a Constant Proportional Debt Obligation (CPDO), created in the years immediately prior to the financial crisis involving complex investment concepts usually only familiar to those with specialist knowledge of structured finance.

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