Rate and tell

The Securities and Exchange Board of India’s latest circular calling for enhanced disclosures by credit rating agencies appears to be a half-hearted attempt to plug the gaps in their workings, starkly exposed by the IL&FS crisis. The guidelines ask rating agencies to add more details into their rating release, review their criteria and publish transition studies on long-term instruments so that investors can gauge their track record. But such enhanced disclosures put the onus of interpreting credit ratings mainly on the investors buying bonds. They do very little to fix accountability for rating agencies in cases where their material misjudgements cause significant losses to investors.

The changes that SEBI has called for span three areas. One, rating agencies will now be required to add a section to their press release specifying if they factored in funds infusion from the promoter, parent or group company while assigning their ratings. They will also be required to list out all the group firms consolidated into the numbers to arrive at the rating. Both seem to be a direct fallout of the IL&FS fiasco, where parentage and the partial consolidation of group firms led to IL&FS bagging high investment grade ratings even as its group entities were in dire straits. Mandating a section on liquidity factors for the issuer — unutilised credit lines, cash balances, cash flows — may add to the quality of information flow to the investor, but it remains to be seen if rating agencies will go beyond the published numbers to stick their neck out on a firm’s liquidity position. SEBI’s advice that rating agencies factor in intra-group linkages and monitor repayment schedules and bond spreads seems to be a case of stating the obvious. Rating agencies in India are backed by global leaders in this business and it is difficult to believe that such checks are not already part of their review process. Requiring rating agencies to publish transition studies for a five-year period is intended to help investors gauge their track record. But all the five rating agencies already publish such studies at yearly intervals. SEBI’s new norms will perhaps ensure that their methodology is standardised and audited.

Overall, SEBI seems to be focussing mostly on a disclosure-based regime to raise the bar on quality of credit ratings. But it is a moot point if retail investors have the knowledge or the wherewithal to read and interpret such technical disclosures before making their decisions. Institutional investors, in any case, should not be relying on third-party ratings and need to have independent capability to assess credit. Therefore, these enhanced disclosures may not really prevent a recurrence of IL&FS-like episodes in future. Instead, seeking an explanation from rating agencies for belated downgrades and levying penalties for clear cases of negligence may have a bigger deterrent effect. SEBI also needs to initiate a discussion on moving away from the issuer-pays model for ratings, which is a sure recipe for conflict of interest.

COMMENT NOW