Risk capital and ratings

Risk capital and ratings

No developed market insists on mandatory rating of new equity issues. And there is no reason why India should swim against the global tide. Yet, market regulator Sebi has asked issuers to get their offers compulsorily rated.

The move is conceptually wrong. Rating works for bonds because investment in them is based on minimalism. Investors want to know whether the bond issuer can earn enough to pay interest and the principal over the limited life of a bond, or if it has enough assets to liquidate during financial stress.

These factors can be judged by credit raters. Equity investing is radically different. Investors want to maximize profits. They try to estimate future profits and then discount them to their current value. Plus, each investor has a unique time frame and risk profile.

Judgements of the fair value of equity differ from investor to investor. Shares are risk capital. They can’t have generic ratings like bonds do.