Sebi, RBI examining business models of rating agencies2 min read . Updated: 16 May 2019, 11:56 PM IST
- The aim is to prevent ‘ratings shopping’, in which companies seek out the firm that promises the highest rating
- One of the key proposals by the committee was changing ratings from a subscriber-based model to an issuer-based model
MUMBAI : Instances of rubber-stamping the highest credit rating without doing proper due diligence have prompted regulators to review how rating agencies and debt issuers conduct their business, said two people familiar with the developments.
The Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) have held discussions to examine the business model of rating agencies, the people cited above said on condition of anonymity.
Under the proposals being considered, issuers of high-value debt would need to get mandatory dual ratings and invite bids to select a rating agency, while the agencies themselves must shield their rating committees from the management, said the first of the two people cited earlier, who is directly involved in the discussions at the markets regulator.
The aim is to prevent so-called ratings shopping, in which companies seek out the agency that promises the highest rating.
“Some of the norms will also ensure greater accountability of the CRAs (credit rating agencies) such as explaining in greater detail when they change rating stance all of a sudden," said the first person cited earlier.
“Sebi has had a series of discussions with stakeholders to examine how to address the inherent conflict of interest in rating actions. Some proposals are not being taken forward, while some of them have found merit and acceptability amongst stakeholders," said the second person cited earlier.
Despite four changes to ratings rules in the last three years for improving transparency and processes, agencies still make abrupt, multi-level downgrades from top ratings to junk, rattling the market. A case in point is the sudden downgrade of bonds sold by Infrastructure Leasing and Financial Services Ltd (IL&FS) and related entities after they defaulted on payment obligations in September.
In another case, non-convertible debentures of Dewan Housing Finance Corp. Ltd were cut from Care A to Care BBB- on 14 May.
The proposal to review the business model of rating agencies follows a parliamentary standing committee report in February. The committee had studied the conduct of rating agencies after the IL&FS crisis.
One of the key proposals by the committee was changing ratings from a subscriber-based model to an issuer-based model.
However, stakeholders said the model was fraught with problems.
“The idea of allowing the consumer of ratings such as mutual funds, banks to pay for ratings is not new and has been considered globally, but it possesses greater issues of implementation and practicality," the second person said. “The regulators are mulling whether the rating fee structure has room for tweaks and thresholds."
Considering the feedback, the regulators are not likely to go ahead with the proposal and issuers will continue to pay for the ratings.
“However, to address the conflict of interest, there would be complete insulation of the rating committee from the management by introducing another layer of team, which will review the ratings," the first person said. “All issues of more than ₹100 crore would have a dual rating. Sebi is in talks with RBI to introduce a bidding system for high-value debt."
The markets regulator also wrote to rating agencies earlier this month to gauge how they rate papers, which have promoter shares as an underlying, popularly known as loan against share papers.
“Typically on pledged shares, the cover is two times," the second person said.
“Sebi is trying to understand from rating agencies how the rating action is affected when the value of pledged shares (share price) falls due to volatility."