Securities Exchange Board of India (SEBI) has revoked the licence held by Brickwork Ratings and asked it to wind down its credit rating operations within six months. This move has sent ripples across bond markets, as it shrinks the choice of rating agencies available to issuers from seven to six. It also casts doubt on the reliability of credit ratings for over 8,699 instruments which were under Brickwork's coverage at the time of the order. This order has implications not just for Brickwork but also for other rating agencies, bond issuers and investors at large.

SEBI’s order shows that though the ruling may have come as a surprise to the market at large, it could not have come as a surprise to Brickwork, which has been the recipient of a series of adverse observations from SEBI since 2015. SEBI’s first inspection in 2014-15 unearthed basic flaws in its functioning, with Brickwork found to have unaccountably delayed downgrades in bonds issued by Bhushan Steel and Gayatri Projects, even after their debenture trustees intimated defaults. Employees involved in Brickwork's rating decisions were found to be negotiating with issuers on fees, suggestive of ratings shopping. SEBI imposed a monetary penalty of ₹3 lakh, later lowered by SAT to ₹2 lakh. On a second inspection in 2017-18, SEBI found instances of Brickwork not promptly recognising defaults of Diamond Power, Great Eastern Energy and Essel Corporate Resources and critiqued its lack of surveillance mechanisms. This time, SEBI’s charges were only partly upheld by SAT, with the penalty slashed from ₹1 crore to ₹10 lakh. Despite the agency promising remedial steps, a third inspection by SEBI and RBI in 2018-19 revealed further instances of non-compliance. Among SEBI’s new findings were the agency’s failure to independently assess issuer projections, not taking banker feedback and incomplete rating releases, apart from a rating committee member having a business development role. Data shared in the SEBI order clearly show higher rates of slippage and default for Brickwork's AAA and AA-rated instruments, than for other agencies. All this lends credence to SEBI’s final finding that Brickwork failed to exercise proper skill, care and diligence while discharging its duties as a rating agency.

Given the nature of the infractions, one wonders why SEBI did not impose harsher penalties on the rating agency -- such as curbs on accepting new mandates -- at a much earlier date. Retail investors, pension funds and insurers have been relying on Brickwork's ratings for the last eight years to make their allocations, even as the investigative process wound on. In addition, following SEBI’s order, investors and other rating agencies may now view the issuers under the agency’s coverage with a jaundiced eye. Rating agencies may not be as systemically important as banks, but it does dent public confidence when they are summarily wound up. SEBI therefore needs to come up with a clear transition plan to make such regulatory actions less disruptive for investors and issuers in future, by migrating issuers to competing agencies before a winding up order.

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