Concerns over cost and the lack of competition in the world of credit research and ratings are prompting the creation of new services designed to shake up the status quo. But with many firms seeing ratings as a “check-the-box” compliance cost rather than a revenue contributor, there seems to be little appetite to embrace new models or providers. However, some still see the potential to disrupt the ratings business.

In the US, there are currently nine registered nationally recognized statistical rating organizations (NRSROs) regulated by the Securities and Exchange Commission (SEC)—AM Best Rating Services, DBRS, Egan-Jones Ratings Co, Fitch Ratings, HR Ratings de Mexico, Japan Credit Rating Agency, Kroll Bond Rating Agency, Moody’s Investors Service, and S&P Global Ratings.

In Europe, last December’s annual report on the market share of ratings agencies by the European Securities and Markets Authority (Esma) counted 27 ratings agencies operating in the region, though it withdrew the registrations of six UK-based agencies in January, following Brexit. The “big three”—S&P, Moody’s, and Fitch—accounted for 40%, 33%, and 18% of the market, respectively. DBRS had about 3%, while the remainder all had market shares of less than 1%.

And for those firms trying to introduce some competition but struggling to gain any significant foothold, it’s an uphill battle. Despite consumers continuing to complain about the prices charged by the “big three” for their ratings and data—for example, one consultant working at a sell-side firm says ratings agencies have raised fees by up to 40% by adjusting how they assess fees to take into account a firm’s size rather than its usage—they are unlikely to take a chance supporting smaller competitors, and are more likely to focus on trying to “squeeze out” one of their existing providers. Most firms buy ratings from at least two of the major providers.

“For the foreseeable future, new entrants have no chance unless they have very wide coverage. Most don’t have the scope, let alone the brand,” says a market data manager at one buy-side firm.

In fact, most consumers aren’t even thinking about replacing ratings vendors with alternative providers that—while perhaps lesser-known—may offer more affordable and potentially more accurate models.

“You might find a portfolio manager at a hedge fund who uses some alternative to gain an edge, rather than to replace one of the ‘big three,’” says Bernardo Santiago, founder and CEO of market data consultancy S4 Market Data. “I would say that would be where smaller players might start to see traction, but it may take some time. Sometimes you need someone to cause disruption.”

A new entrant hoping to cause disruption is New Constructs, a Nashville, Tennessee-based provider of stock research and recommendations based on the footnotes of financial statements that counts former BNY ConvergEx CEO John Meserve among its advisors.

The vendor has introduced a series of credit ratings for the more than 2,800 companies that it provides equities ratings and research for in North America, and plans to expand its coverage to Europe and Asia. The credit ratings went live on New Constructs’ website in December and recently made their debut on Refinitiv’s Real-Time Research and Aftermarket Research platforms. Real-Time Research is accessed via Refinitiv’s Eikon, Thomson One, and Workspace desktops, while Aftermarket Research is also available on Eikon and Workspace, as well as via Refinitiv’s Knowledge Direct and Refinitiv On Demand channels.

“Over the years, we’d had people asking for it because they like our analysis, and our better fundamental data. We already had research and ratings for equities and exchange-traded funds, so it made sense to add debt,” says David Trainer, founder and CEO of New Constructs. However, credit ratings and research focus on different metrics from those used in equities research. “We added credit factors for stocks last summer, so then we started looking at things like leverage, coverage and liquidity—the factors people care most about—and decided to build a ratings system around that,” Trainer adds.

New Constructs rates companies on a scale of 1 (“Very Attractive”) to 5 (“Very Unattractive”), based on its adjusted fundamentals data sourced from footnotes in financial statements. For each company, the vendor provides a credit rating summary that shows how it ranks versus peers in one of eight rating groups, charts that compare traditional ratios to adjusted ratios over the past five years, and an adjusted ratio breakdown that shows how each ratio—such as adjusted debt to capital ratio—is calculated.

The result is a rating that enables clients—from institutional to self-directed investors, and the brokers that serve them—to not only support and justify investment decisions, but to identify conflicts between equity ratings and credit ratings they can take advantage of.

“For example, if a company has a really good credit rating and a poor equity rating, it might be a leading indicator that its credit rating may decline, because equities tend to take a hit before credit. It’s a more complete analysis of a company’s capital structure,” Trainer says.

David Hendler, founder and principal of New York-based Viola Risk Advisors, has used New Constructs’ equities offering for around eight years, and plans to also use its credit ratings as a way to differentiate his company’s own offerings, since he believes the vendor’s equities-based approach provides more of a leading indicator of credit markets than traditional credit analysis.

“The obvious challenge is that bonds are not like stocks. They have different structures, different types of orders, and notes,” Hendler says, and could comprise senior unsecured debt or many junior bonds and covenants, unlike vanilla equities. “But this will still help investment managers outperform and stay ahead of the curve. It’s an unbiased, data-driven rating, rather than the qualitative approach used by traditional rating agencies.”

Because those traditional ratings are so “deeply embedded” in the practices of major asset managers, they add little advantage, Hendler adds. “For those who want to outperform and get out of the way of negative cycles, New Constructs’ combination of methodology—which has been well received by academics and accounting firms—can help investors who are willing to invest in another data point that’s more forward-looking,” he says.

Whether or not firms are willing to invest another data point around credit ratings remains to be seen. But if New Constructs’ data lives up to its promises of delivering better results for less money, firms may be willing to give it a shot and support the company and other disruptors as it grows its coverage and scale—two must-have capabilities to compete with the larger players. And while the barriers to entry for new pure credit rating agencies would be high, New Constructs has a proven track record in equities and data collection activities, and citations in academic research, as well as Trainer’s personal experience, giving the company an established base on which to build.

For example, Hendler is no stranger to New Constructs, having worked together with Trainer in the late 1990s at then-Credit Suisse First Boston, where he was director of its US banks equities research and Trainer was a research analyst responsible for the bank’s Value Dynamics Framework initiative, a value-based research project designed to improve the quality of the bank’s research.

Investment firms often complain that they feel “held hostage” by ratings agencies. Yet few seem to have the appetite to investigate those who may be building a “better mousetrap.” As Esma’s survey shows, there are plenty of options available, but little real competition—and ultimately, consumers will be instrumental in creating a more competitive landscape, by being prepared to put their money where their mouths are, and explore new alternatives. Perhaps ratings that provide a leading indicator of revenues or risk will provide the impetus for wider adoption.