Securities and Exchange Board of India (SEBI) expanded its probe into the role of five credit rating agencies after a forensic audit mandated by the new board of crisis-ridden Infrastructure Leasing and Financial Services (IL&FS) flagged serious lapses. They also addressed their possible complicity with the former top brass of the group in giving top ratings despite weak financials.

While CEOs of two rating agencies have een forced to go on leave pending completion of the probe on the advice of SEBI, officials said the regulator is now looking into possible systemic lapses at all five rating agencies. They also said that they are looking into the role of multiple people suspected to have intentionally manipulated the rating procedures.

The special audit conducted by Grant Thornton found that its review of emails exchanged by the former key executives of IL&FS group and the top officials of rating agencies showed that they were aware of the serious liquidity concerns and weakening financials of the group.

“However, various strategies deployed by the then key officials of IL&FS group and certain favours/gifts provided to rating agency officials suggest the possible reasons for consistent good ratings provided to IL&FS group during the period June 2012 to June 2018,” an interim report of the special audit said.

The report has also highlighted instances where CRAs had initially decided to downgrade the ratings, but a combination of tactics employed by then key employees of IL&FS and favours/gifts extended to key officials of CRAs resulted in either consistent/good ratings or avoidance of rating downgrade.

The new board of IL&FS had mandated Grant Thornton to carry out a special audit for all high-value transactions undertaken by IL&FS Ltd and some of its group companies for the period between April 2013 and September 2018.

The board was appointed in October 2018 after massive defaults by the group post its debt burden ballooning to over Rs 90,000 crore and suspected wrong-doings by the former top management.

The audit is aimed at identifying siphoning or misuse of funds, fraudulent transactions, their modus operandi, the quantum of the financial loss and fixing of responsibility.

A few details of the probe

Grant Thornton was also asked to review the ratings provided by various credit rating agencies (CRAs) to IL&FS Transportation Networks Ltd (ITNL), IL&FS Financial Services Ltd (IFIN) and IL&FS Ltd.

In its interim report, Grant Thornton said it appears CRAs had consistently provided and maintained good ratings over the years until in July/August 2018 when they downgraded ratings for the first time for ITNL due to a default of repayment of commercial papers.

During the review period, IL&FS Group had availed rating services from Crisil Ltd, CARE Ratings, ICRA, India Ratings (a Fitch group company) and Brickwork.

Officials at the rating agencies denied any lapses on their part and some even said the interim report seems to suggest limited knowledge of the rating process and was based on one-sided information.

A higher rating typically helps a borrower get a lower rate of interest and is aimed at assuring investors about the credit worthiness of the company. Besides, it helps create a wider borrowing landscape for the company and is also often used as a marketing tool in the form of a better image in dealing with customers.

Grant Thornton said it identified multiple e-mails over the period from 2008 to 2018 which indicate that the IL&FS group was under stress or faced liquidity issues since 2015.

The main reasons for the liquidity crunch have been identified as a significant increase in debt in the various group companies, majorly ITNL, high capital requirement for ITNL and its various SPVs, decreasing profit of IL&FS group and support to weaker group companies.

It has also identified instances which suggest that CRAs had multiple concerns for the last 6-7 years on the operations of the IL&FS group, but the ratings assigned by them remained consistently high until they were reversed or downgraded after June-July 2018.

Listing potential strategies undertaken by the former top brass of IL&FS to get good ratings or avoid a downgrade, the report said the rationale which is supposed to be drafted by the rating agencies were materially modified on suggestions from the then key employees of the group.

In cases where IL&FS became aware that ratings were not going to be favourable, they either delayed the process of rating surveillance or avoided the rating being made public.

In certain instances, intentionally incorrect or incomplete information was being provided to the CRAs to avoid rating downgrade. In cases of desired ratings not being received, the IL&FS management used to exert pressure on rating agencies to either withdraw the ratings or approach other rating agencies who would provide the desired ratings.

The audit also cited several e-mails suggesting that the CRAs, after meeting with the then key employees of IL&FS, would not downgrade their ratings as initially decided.

The special audit has also flagged a potential conflict of interest between IL&FS and CARE, as for the period 2007 to 2013, IL&FS Ltd and IFIN owned equity shares of approximately 5-9 per cent in the rating agency.

During the same period, CARE had also provided ratings to instruments of IFIN, ITNL and IL&FS Ltd, indicating a potential conflict of interest as CARE was rating its equity shareholder.