The Regulator Wants Credit Rating Agencies To Be More Responsible

Oct 20, 2016 · 3 min read

“Responsibilities fall heaviest on those willing to take the load.” — Heather Day Gilbert

At present, the question is, are Credit Rating Agencies (CRAs) ready to take the load? Following the Amtek Auto fiasco, the Securities and Exchange Board of India (SEBI) is thinking about making the disclosure norms for CRAs more stringent. Similarly, it endeavours to tighten the noose around exchanges, intermediaries, and brokers.

Amtek Auto defaulted on its short-term debt last year, causing the investors of JP Morgan Mutual Fund to lose a chunk of money. This wasn’t the first occasion where CRAs failed to recognise and report the risk in time. Even in the case of Bhushan Steel and Jaiprakash Industries, the CRAs had failed to accurately gauge the solvency issues and had probably misconstrued them as short term cash mismanagement. Both these companies enjoyed good rating just before the crisis came forth. Although rating agencies suspended the ratings, the timing of the suspension served little purpose. Massive downgrades in quick time tend to create panic and are equally ineffective.

To make the matters worse, investors, even institutional investors such as mutual funds, have been relying excessively on independent credit rating agencies for the credit quality of debt. SEBI seems to have recognized the need to take the corrective steps and make CRAs more accountable for their job.

The need for higher disclosures:
A company seeking to obtain a credit rating pays for the services of independent CRAs. This may create a conflict of interest. The global financial crisis of 2008 exposed the limitations of CRAs in predicting the trouble. Moreover, CRAs find it easy to hide behind disclaimers, as the current disclosure framework is not as robust as it needs to be given the importance of credit appraisals in today’s times.

What will change for CRAs if the capital market regulator revises the rules?

  • They will have to disclose the criteria they used for rating, and this will have to be featured in their press release.
  • Independent rating agencies will owe the public an explanation for the suspension of ratings. The idea is if CRAs give a rationale for the upgrades and downgrades, they should also explain reasons for the suspension of ratings.
  • The press release format will become standardize for all rating suspension related disclosures.

In cases where the company has provided CRAs incorrect, deficient, or misleading information, the regulator won’t hold CRAs responsible. However, if the regulator finds any negligence on the part of CRAs, it will take disciplinary action against them.

In another development, the capital market regulator is also willing to amend the risk management norms for exchanges including those for stock exchanges, besides bettering the disclosure standards for intermediaries and brokers. This is expected to make it easy to deal with the issues of compliance and disclosure of listed companies. The capital market regulator has also been working on making the complaint redressal mechanism stronger and more responsive.

PersonalFN believes SEBI is trying to pull out all the stops to safeguard the interest of investors. That being said, we are of the view that one shouldn’t depend only on credit ratings while investing in Non-Convertible Debentures (NCDs) andcompany fixed deposits. One should look at other parameters too, including the credit history of the issue.

When investing in debt funds, check the credit quality of the portfolio of a scheme along with running a check on returns. For those who lack the time or expertise to make sound investment decisions may subscribe to the unbiased mutual fund research services of PersonalFN.

Apart from greater disclosures what in your view will make the credit rating agencies more responsible? Share your views here.

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