Last week Moody’s Investors Service have given credit downgrades to Credit Suisse Group AG (CSGN), Morgan Stanley (MS) and 13 other banks, highlighting the risk in the financial system and the need for regulators to quickly adopt a swaps-clearing rule, according to a coalition of proprietary traders and hedge funds. According to Moody’s, even though these banks had moved to strengthen their operations, there remained structural weaknesses within their core trading businesses, leading to downgrades that may prove to have lasting effects on the banking industry.
While the rating service downgrades may seem to reside squarely in the world of investment due diligence, investor’s should be conscious of the operational ramifications such downgrades may have vis-a-vis their hedge funds. Some key operational risk points related to the downgrades include:
- Investor’s should understand any counter-party risks exposures their hedge funds may have to banks. Downgrades can affect balance sheets and could have a disruptive effect on the banks which could affect hedge funds and cause losses for investors.
- Many investors claim that the Moody’s downgrade of bank is too late. To stay ahead of the curve and not simply be reliant on credit rating agencies investor’s need to perform their own due diligence
- Many investors also believe that the credit ratings predicted downgrades were already anticipated by markets and built into the current price levels of the securities
In general, ratings can be misleading. This is especially true in the world of operational due diligence.
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