The global might of the "Big Three"

According to influential reports in the early 2010s, the two largest U.S.-based CRAs - S&P and Moody's - controlled some 80 percent of the global market share. In turn, the "Big Three" - S&P, Moody's plus Fitch Ratings, which is dually headquartered in the U.S. and the U.K. and majority-owned by a French holding company - dominate 95 percent of the ratings business across the world. Not only is the industry concentrated, so is their geography.

In both advanced and emerging economies, governments borrow money by issuing government bonds and selling them to private investors, overseas or domestically. However, emerging and developing economies enjoy neither the history of capital accumulation nor the high living standards that most advanced economies take for granted. Consequently, their efforts to borrow are far more challenging and constrained.

Yet, current credit ratings are based on advanced-economy CRAs' perceptions of a sovereign's ability and willingness to repay its debt. Of course, emerging and developing economies can seek funds from international multilateral organizations, such as the World Bank and the International Monetary Fund. However, the latter reflect the interests of their primary owners in advanced economies, which select their leaders, set their policies and control enforcement.

It is precisely for this reason that emerging economies led by China have recently established new alternatives, such as the BRICS New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB), which stress borrowing in the emerging and developing world.

Nevertheless, the "Big Three" continue to dominate the ratings business.

Sovereign ratings and sovereign debt

Currently, China's sovereign debt is adversely impacted by local debt, not by the central government's debt. It is not the result of a long historical process, which is the case in the advanced economies. Rather, most of it was accrued as an unintended side-effect of the large stimulus package of 2009. The latter did sustain confidence amid the global crisis; it contributed to infrastructure in China; it spared advanced economies from the Great Depression 2.0; and it enabled global growth at a time when the latter was most desperately needed.

Yet, it also resulted in excessive, inadequately managed liquidity, which generated huge challenges in property markets and local debt. So, the government has engaged in a balancing act and structural reforms that seek to defuse the debt challenge in the medium-term, while ensuring adequate growth in the short-term.

If the "Big Three" see China's downgrade as warranted, that raises the question whether the ratings of most advanced economies remain justified.

Without effective growth, major advanced economies rely on ultra-low interest rates (U.S.), continued quantitative easing, or both (Europe, Japan). Despite their high credit ratings, these economies have high, even excessive government-debt-to-GDP levels, as evidenced by Japan (close to 250 percent), Italy (over 130 percent), U.S. (105 percent), France (over 95 percent), U.K. (90 percent) and Germany (over 70 percent).