The Securities and Exchange Board of India (Sebi) will likely ask rating agencies to set up independent internal assessment teams, which will be required to assess whether the rating assigned to a company is appropriate or not, said two persons familiar with the regulator’s thinking. These in-house teams will offer a second level of check on recommendations made by the ratings committees of these agencies and act at an arm’s length from the latter, they said.

In addition, rating agencies will be asked to give clear reasons if they choose to withdraw their rating on a company. The changes, though, may not make a huge difference, said experts.

The move is primarily aimed at avoiding sudden and sharp downgrades in the rating of fixed-income instruments. Such sharp downgrades can impact investors such as mutual funds and insurance firms who hold these instruments. The relook at the strength of the rating system in India has been sparked off by a sharp cut in the ratings of Amtek Auto Ltd, which forced JP Morgan Asset Management Co. (AMC) to restrict redemptions for two of its funds in September. Other instances of sharp downgrades and ratings withdrawals have also come to light, forcing a wider relook at regulation.

“The regulator received several submissions on improving the practices adopted by the rating agencies. Among them was the setting up of an additional team to look through the rating before being assigned. The regulator is positively inclined towards this move," said the first person quoted above requesting anonymity since the discussions are still private.

“Will urge rating agencies to relook at the practice of suspension of ratings. In India, when there is a lack of information flow, rating is allowed to be suspended," said Sebi chairman U.K. Sinha at the 25th anniversary of rating agency Icra.

Suspension shouldn’t be allowed to be done without adequate reason, he said. “We are looking into time taken for disseminating information about default in interest payouts by issuers to investors by debenture trustees and credit rating agencies. Also being looked into is the issue of conflict of interest between debenture trustees and the holding companies and rating agencies," said Sinha.

An email sent to Sebi about the specific proposal remained unanswered on Thursday.

Ananda Bhoumik, managing director and chief analytical officer, India Ratings, said, “India Ratings follows global best practices and look forward to Sebi’s initiative to improve local standards. We are confident that our investments in systems and process help us meet both the regulatory requirements and investor expectations."

India Ratings and Research Pvt. Ltd is among the five largest rating agencies in the country, along with Crisil Ltd, Icra Ltd, Credit Analysis and Research Ltd (Care) and Brickwork Ratings India Pvt. Ltd.

Following the crisis at JP Morgan AMC, Sebi held a series of discussions with these credit rating agencies and, in October, formed an internal committee to recommend ways to make the rating process more reliable for investors. The rating agencies submitted a report to the regulator in November, based on which the regulator will decide on an amendment to its rules.

One of the biggest issues that Sebi wanted the agencies to address was the practice of withdrawal of ratings. Often, when a rating agency doesn’t get access to enough information, it withdraws the rating on the firm. This, however, leaves investors, who may have invested based on earlier ratings, in the lurch.

While the regulator wanted this practice to stop, rating agencies have maintained that they cannot continue to rate a company if they have no access to information. As a compromise, rating agencies may be asked to give clear reasons for the suspension of a rating, said both the people cited above.

“Principally, the agencies have agreed that the rating of a company would not be suspended without according a reason for the same, which was the largest concern of the regulator," said the second person quoted above, requesting anonymity.

If a client, which is being rated, is withholding information that is pertinent to the rating process, then the first step would be to issue a warning, said the first person, adding that as a second step, the rating agency can withdraw a rating.

Most rating agencies declined to comment on the likely changes in regulations.

“Crisil has continuously strived to adopt best practices in the credit rating industry. We have worked closely with the regulator in the past to ensure standardization of the rating scales across credit rating agencies (CRAs) as well as enhance the quality and extent of disclosure of information, some of which include data on rating transitions and default rates," said a spokesperson for Crisil, adding that they are not aware of the specific changes but will work with Sebi to strengthen best practices in the industry.

A spokesperson for Care Ratings said the agency already has an external rating committee with majority external members for assigning investment grade ratings. The spokesperson added that Care has aligned its code of conduct with the ‘Code of Conduct Fundamentals for Credit Rating Agencies’ issued by the International Organization of Securities Commissions.

“For example, Care has separate teams for business development and rating analytics, which are vertically separated," said the Care spokesperson in an email.

An email sent to Icra on Thursday was not answered.

The new rules being considered by the regulators will do little to improve the reliability of ratings, said experts.

“Cessation of the practice of suspending ratings of a company without assigning a reason only addresses one part of the problem. Default after withdrawal of a rating by the agencies should be fully captured in the default and transition matrices. This will ensure that the bond holders and investors are aware of the initial rating quality," said Amit Tandon, of Institutional Investor Advisory Services India Ltd, a proxy advisory firm.

The new norms for rating firms, which are likely to be released by Sebi for public consultation in the next few weeks, may also require rating agencies to provide an additional annual disclosure, confirming that there is no conflict of interest between their ratings business and other divisions such as business development.

Currently, the company to whom a rating is issued pays a fee to the rating agency. This is seen as a conflict of interest as a rating agency may be tempted to offer higher initial ratings in order to generate business.

Tandon feels that an annual disclosure will not suffice and adds that the rating business should be separate from other businesses.

D. Ravishankar, founder director, Brickwork Ratings, said, “Globally, a lot is changing and the systems always have scope to be more robust. Finally, it is a matter concerning investors and thus the industry more than welcomes a relook at the systems to make them robust and bring them in line with best global practices." He added: “The industry is moving towards a level that there is only one language and that there is a limited scope for interpretation."

According to a third person familiar with the ongoing deliberations, Sebi will look closely at the rules followed by rating agencies in other markets like the US before finalizing its guidelines. He declined to be identified as the discussions are confidential.

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