The Securities and Exchange Board of India (Sebi) on Tuesday tightened disclosure standards for credit rating agencies while assigning ratings to debt instruments. Here is a lowdown on what prompted the move and what it means for rating agencies.
What did the regulator do?
On Tuesday, the regulator issued a circular tightening disclosure norms for rating agencies when they rate companies and their debt. The regulator directed that rating agencies must now disclose the liquidity position of a company. If the rating is assigned on the assumption of cash inflow, the agencies would need to disclose the source of the funding. Experts say rating agencies in India often failed to consider cash flows and ground conditions before assigning a rating. Sebi also said rating agencies must disclose their rating history and how the ratings have transitioned across categories.
Why were norms revised?
Rating agencies came under the spotlight following the crisis at Infrastructure Leasing & Financial Services Ltd (IL&FS) and its group entities. Mutual fund houses were caught unaware as major credit rating agencies in August started to cut ratings from high investment grade to default or junk. The agencies faced criticism that they had failed to see the financial troubles in the group and adjust its rating of IL&FS when its debt jumped by 44% at the end of March 2015. This prompted the regulator to review the rating standards and whether there is a need for increased accountability, and insist on more disclosures.
How has Sebi dealt with credit raters in the past?
Sebi, in the last two years, has undertaken four reviews of credit rating agencies and each one has been prompted by a “crisis". Reviews have been aplenty but sans penalization.
Will this help?
To an extent, it will. Disclosures of a company’s financial situation, cash flows, fund infusion and ability to meet debts will help certain investors and funds in making an informed decision and prevent over-reliance on ratings. A rating rationale will increase accountability as ratings assigned would need to be backed by strong reasons. Disclosure of ratings track record will help investors decide on the quality and trustworthiness of the rating. Investors can also be more discerning in comparing ratings.
What’s the flip side?
According to Moin Ladda, partner, Khaitan and Co, too many disclosures are not a good thing. “Too many disclosures and providing a complete rationale for the rating can put additional onus on the rating agency, prompting them to assign a conservative rating which may not be good for investor sentiment," said Ladda. The disclosures still do not address the fundamental issue of regulatory norms insisting on companies using rating agencies and then issuers paying the rating agency for the ratings.