As large corporate groups grapple with high debt and delay loan repayments , the risk of such distress afflicting other segments of the financial system remains a live one. Some leveraged firms raise bonds and deposits directly from the public; others borrow from debt mutual funds which deploy retail money. In such cases, investor interests are sought to be protected mainly by requiring issuers to obtain credit ratings from independent rating agencies. But certain incidents in the past year have exposed chinks in the armour of the rating agencies themselves. A sudden default and suspension of credit ratings on a bond rated ‘investment grade’ from Amtek Auto led to sharp write-downs and losses for investors in two debt funds run by JP Morgan Asset Management Company. Sudden and steep downgrades in the bonds of some steelmakers have delivered nasty jolts to investors. SEBI’s recent circular calling for “enhanced standards for credit rating agencies” is ostensibly aimed at addressing these chinks.

The circular seems to be devoted mainly to standardising the policies and processes at the rating agencies. Therefore, SEBI lays down detailed checks on what will constitute a ‘default’ on each instrument, asks rating agencies to specify financial ratios used for credit assessments, and provides a template for the rating released to the public. Rating agencies will also be required to make public disclosures of the periodicity at which ratings will be reviewed or placed on watch. There are just a couple of new rules that may serve a useful purpose for investors. One, when rating a new instrument, agencies will now be required to carry a three-year rating history of all other instruments from the same issuer. This should help investors gauge the overall creditworthiness of the borrower. Two, raters will no longer be allowed to suspend ratings and blank out issuers if they refuse to disclose information. They will instead be required to monitor a debt instrument over its entire life (with requisite disclaimers), even if the issuer fails to cooperate.

While these tweaks are useful to avoid a repeat of JP Morgan-type episodes, SEBI has stopped short of actually pulling up rating agencies for abrupt rating suspensions and downgrades. It has also tiptoed around the biggest regulatory challenge confronting the rating business worldwide — the blatant conflict of interest arising from issuers (and not users) paying the rating fee. In India, this problem is compounded by rating agencies also offering a range of advisory services to corporate clients which may allow them to subtly influence ratings. SEBI has mandated a Chinese wall by requiring that people with business responsibilities play no part in rating decisions. But stronger regulatory checks are needed to ensure that rating agencies work in the best interests of investors, rather than their rating clients.