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Regulatory mandates requiring credit ratings for debt issuance create captive demand, while issuer-pays economics and near-zero marginal cost per rating produce operating leverage that persists despite periodic credibility crises.
A structural look at how a credit rating agency became embedded in the regulatory architecture of global capital markets.
The Regulatory Embedding
Moody (MCO)’s is not merely a company that evaluates creditworthiness. It is a structural component of the global debt market—one of three agencies whose opinions are woven into financial regulation, institutional mandates, and capital requirements worldwide.
When Moody’s assigns a rating, it triggers regulatory consequences: banks must hold more capital against lower-rated assets, and pension funds face restrictions on holding bonds below certain thresholds. This regulatory embedding is the defining feature of Moody’s structural position.
The common framing presents Moody's as an information business—analysts producing research that investors consume. This framing understates the structural reality. Moody's ratings function less like research and more like regulatory infrastructure. Issuers do not pay Moody's primarily because investors demand the analysis; they pay because the absence of a rating from a recognized agency constrains their access to capital markets. The distinction between providing information and providing market access is the key to understanding Moody's economics.
Understanding Moody's arc reveals how regulatory dependency, network standardization, and the issuer-pays business model interact to create a position of extraordinary durability—one that has survived financial crises, congressional investigations, and sustained criticism of the rating industry's accuracy and incentive structure.
The Long-Term Arc
Moody's development spans more than a century. The structural patterns that define the business today were not designed at the outset but emerged through the interaction of market needs, regulatory evolution, and business model choices made at critical junctures.
How did Moody's begin as a bond-statistics publisher?
John Moody published his first credit analysis in 1909—a manual of railroad bond statistics designed to help investors evaluate the creditworthiness of bond issuers. The early business model was straightforward: investors paid for the publication. Information asymmetry between bond issuers and investors created demand for independent analysis, and Moody's filled that gap with systematic, standardized ratings.
For decades, the business operated as a subscription-funded research service. Investors subscribed to Moody's publications to inform their bond-buying decisions. The ratings had market influence because of their analytical reputation, not because of regulatory mandate. This investor-pays model aligned incentives naturally—the party consuming the analysis was the party paying for it. The model would eventually be abandoned, but its logic was clean: those who benefit from information should fund its production.
How did the SEC's NRSRO designation embed Moody's in regulation?
The structural transformation of Moody's position began in the 1970s when the SEC created the Nationally Recognized Statistical Rating Organization (NRSRO) designation. This regulatory act converted credit ratings from market opinions into regulatory inputs. Banking regulations, insurance regulations, and investment mandates increasingly referenced NRSRO ratings as thresholds for permissible holdings and capital requirements. The rating agencies did not merely inform the market; they became part of the market's regulatory machinery.
Simultaneously, the business model shifted from investor-pays to issuer-pays. Issuers—corporations, governments, structured finance vehicles—began paying rating agencies for the privilege of being rated. The economic logic was that widespread dissemination of ratings benefited market efficiency, and issuers had clear incentives to pay since an unrated bond faced a smaller investor base and higher borrowing costs. This shift created extraordinary economics: the entities being evaluated paid for their evaluation, and they paid because regulatory architecture made ratings functionally mandatory for capital market access.
What protects the three-agency rating oligopoly today?
Today, Moody's operates within a regulated oligopoly of three major agencies that collectively rate the vast majority of global debt. The barriers to entry are structural rather than technological. A new entrant would need to achieve regulatory recognition, build analytical credibility across asset classes and geographies, and convince issuers to pay for ratings that investors and regulators do not yet recognize. This coordination problem—where recognition depends on adoption which depends on recognition—protects the incumbents' position.
Moody's has also expanded beyond ratings into Moody's Analytics, a division providing risk management software, economic research, and data services. This diversification reduces dependence on the ratings cycle while leveraging the analytical expertise and data assets accumulated over decades. Moody's Analytics now generates roughly half of the company's revenue, transforming the business from a pure rating agency into a broader financial intelligence operation. The analytics business carries its own structural advantages—customer switching costs, data accumulation effects, and integration into institutional risk management workflows—that complement the ratings franchise.
Structural Patterns
- Regulatory Embedding — Moody's ratings are woven into financial regulation worldwide. Banks, insurers, and pension funds must reference NRSRO ratings for capital requirements and investment mandates. This converts ratings from market opinions into regulatory necessities, creating demand that exists independent of the agencies' analytical accuracy.
- Issuer-Pays Economics — The entities being evaluated pay for their evaluations. This model creates potential conflicts of interest but also creates extraordinary economics: issuers pay because the absence of a rating constrains their capital market access, not because they value the analytical content.
- Near-Zero Marginal Cost — Once the analytical infrastructure exists—trained analysts, rating methodologies, historical databases—the incremental cost of rating an additional bond issuance is minimal. Each new issuance in existing asset classes generates revenue with little additional expense, producing margins that expand as debt markets grow.
- Oligopoly Stability — Three agencies dominate global ratings. The structure has remained stable for decades because new entrants face a coordination problem: achieving regulatory recognition, analytical credibility, and issuer willingness to pay simultaneously.
- Recurring Revenue from Debt Cycles — Debt is continuously issued, refinanced, and re-rated. Corporate bonds mature and are reissued. Governments roll over their debt. Structured finance creates new instruments. This perpetual issuance cycle generates recurring demand for ratings regardless of market direction.
- Reference Standard Network Effects — Moody's rating scale—Aaa, Aa, A, Baa, and so on—functions as a shared language across global debt markets. Investors, regulators, and issuers reference this scale as a common standard. The universality of the language reinforces its continued use.
Key Turning Points
1909: First Rating Publication — John Moody's manual of railroad bond statistics established the concept of systematic, standardized credit analysis. The publication addressed a genuine market need—investors lacked reliable tools for comparing bond quality across issuers. This founding act created the analytical identity that would prove durable across subsequent transformations of the business model.
1975: NRSRO Designation by the SEC — The creation of the Nationally Recognized Statistical Rating Organization designation embedded credit ratings into financial regulation. This single regulatory decision transformed the rating agencies from influential market participants into structural components of the financial system. The ratings were no longer merely useful; they became functionally required. The designation created the regulatory moat that defines the industry to this day.
2008: Financial Crisis and Aftermath — The subprime mortgage crisis exposed the rating agencies' role in evaluating structured finance products that performed catastrophically. Moody's and its peers had assigned investment-grade ratings to securities backed by mortgages that defaulted en masse. Congressional hearings, public outrage, and regulatory scrutiny followed. The Dodd-Frank Act of 2010 attempted to reduce regulatory reliance on credit ratings and increase agency accountability. Yet the structural outcome was paradoxical: despite sustained criticism and modest regulatory reforms, the oligopoly persisted. The coordination problem that protects incumbents proved stronger than the political will to restructure the industry.
Risks and Fragilities
The issuer-pays model contains an inherent tension that periodic crises expose but do not resolve. Agencies are paid by the entities they evaluate, creating incentives—however managed through internal controls and regulatory oversight—that can bias ratings in the direction of the paying client's interest. The 2008 crisis demonstrated this fragility at scale. While reforms have addressed some of the most egregious practices, the structural conflict remains embedded in the business model. The risk is not that the conflict exists—market participants understand it—but that it can interact with novel financial instruments in ways that produce systemic failures.
Regulatory dependency cuts both ways. The same regulatory embedding that creates demand for ratings also subjects the industry to political and regulatory risk. Governments that once mandated the use of NRSRO ratings could reduce or eliminate those mandates. The Dodd-Frank Act took steps in this direction, and European regulators have explored alternatives. A sustained effort to decouple financial regulation from agency ratings would erode the structural demand that underpins the business. This has not happened meaningfully in the fifteen years since the crisis, but the risk persists as a latent vulnerability.
Competition from alternative credit assessment models—algorithmic credit scoring, market-based credit measures like CDS spreads, and AI-driven risk analytics—represents a longer-term structural question. These alternatives do not currently threaten the regulatory role of traditional ratings, but they offer functional substitutes for the analytical content. If investors increasingly rely on alternative tools for actual credit assessment while traditional ratings serve only as regulatory checkboxes, the agencies' position becomes more fragile—dependent entirely on regulation rather than on the perceived value of their analysis.
What Investors Can Learn
- Regulatory embedding creates structural demand — When a company's product is woven into the regulatory architecture of an industry, demand becomes partially decoupled from product quality. Understanding the source of demand—market choice versus regulatory mandate—reveals the true nature of a competitive position.
- Oligopolies protected by coordination problems are durable — When displacing an incumbent requires simultaneous adoption by multiple parties with misaligned incentives, the incumbent's position persists even when the product is imperfect or the incentives are conflicted.
- Business model conflicts can coexist with structural strength — The issuer-pays model creates genuine conflicts of interest, yet the business has thrived for decades. Recognizing that structural position and incentive alignment are separate dimensions prevents overly simplistic analysis.
- Crises that expose structural flaws do not necessarily break structural positions — The 2008 crisis revealed deep problems in the rating industry's practices and incentive structure. The structural oligopoly survived intact. The distinction between reputational damage and structural displacement is critical.
- Diversification from a structurally advantaged base compounds advantages — Moody's expansion into analytics leveraged data, expertise, and relationships accumulated through the ratings franchise. When diversification builds on existing structural assets rather than departing from them, it tends to strengthen the overall position.
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