SEC Denies Market Entry to China's Dagong; Dagong Unlikely to Go Away Quietly

The U.S. Securities and Exchange Commission (SEC) on Thursday denied the application by China's largest credit rating firm--Dagong Global Credit Rating Co.--to become a Nationally Recognized Statistical Rating Organization (NRSRO) in the U.S.

The SEC cited concern regarding cross boarder supervision since “It does not appear possible at this time for Dagong to comply with the record keeping, production, and examination requirements of the federal securities laws."

Media report quoted an SEC official that Dagong is the first firm to be denied by the SEC since the regulations governing the application process went into effect in 2007.

Dagong’s claim to fame came with its first international sovereign ratings report released in July of this year. In the report, Dagong stripped the U.S. the AAA rating, while giving emerging economies like Brazil and China higher credit ratings than the U.S. , the UK, and Japan. Those ratings widely contradict the ones assigned by the Big Three – Moody’s, Standard & Poor's, and Fitch.

Dagong, then followed up with some sharp criticism of its western counterparts, and a verbal clash with Harold "Terry" McGraw III, whose company owns Standard & Poor’s credit agency.

So, it is of no surprise that Dagong immediately issued an angry rebuff calling the SEC’s decision discriminatory against China and a barrier specifically set for Dagong. It also takes the matter a few octaves higher –citing China’s sovereignty and financial assets safety are at issue here. From People’s Daily Online:

“….the contention by U.S. authorities… amounts to bias against Chinese credit-rating agencies. Dagong will not accept the NRSRO status at the price of betraying national sovereignty….. Dagong will consider conducting activities at the right time to protect its rights, including seeking legal actions against the SEC."

China Daily also cited Dagong's statement that having China's own say in credit rating in the United States is significant to safeguarding the security of China's overseas financial assets. And Dagong aims to enter the U.S. market to protect China's interests as the largest creditor there. As of July, China held $846.7 billion worth of U.S. Treasurys, according to official U.S. data.

Although Dagong’s ownership structure is not public information, the company works closely, and undoubtedly has a significant linkage to the Chinese government. So we can pretty much take whatever coming out of Dagong as “quasi-official,” at the minimum.

Meanwhile, quite interestingly, a Xinhua editorial quoted Jiang Yong, director of the Center for Economic Security Studies, that he was "shocked" as to how the Western 'Big Three' ratings agencies have been able to penetrate and accumulate a database “far bigger” than that of the Chinese government over the past three years.

With its increasing wealth and presence, China is becoming more aggressive and assertive in global affairs. While China’s been successful in entries into sectors such as energy, mining, and banking, credit rating is one financial niche that China has not been able to crack. Beijing is obviously getting anxious as the world's largest sovereign debt holder, and Dagong is the only major Chinese rating company without foreign ownership.

SEC’s delivery of this denial of entry news coincides with Japanese PM’s rejection to China’s demand for apology and compensation for the seizure of the fishing boat and its crew. And Beijing is already upset with Washington’s involvement in the sea border disputes with Japan and China’s other neighboring countries, and had signaled for the U.S. to stay out of it. This is on top of the newly escalating yuan and trade dispute.

In the midst of it all, Beijing is most likely going through a heightened sense of national identity and image crisis right now. As such, Dagong is unlikely to go away quietly, while the U.S. is not going to let Beijing breathe down the neck of its T-bill. Now, I wonder to which jurisdiction Dagong would bring this lawsuit against the SEC?