Over the years, the capital market regulator – the Securities and Exchange Board of India (SEBI) has taken a variety of measures, and even revised some, in the interest of investors. For example in 2007, the regulator made grading of IPOs mandatory. But in 2013 made it voluntary; realising that it wasn’t serving the intended purpose for both, retail and institutional investors.

 

This time too, vide a circular to all Credit Rating Agencies (CRAs) the regulator has ensured that greater transparency is instilled in the policies of CRAs to enhance the standards.

 

“The CRAs shall at all times observe high standards and fairness in conduct of the business and any act of omission or commission in contravention of the provisions of clauses 12 and/or 23 of Code of Conduct, as specified under Third Schedule of the SEBI (Credit Rating Agencies) Regulations, 1999, in letter or spirit, may result in violation of the provisions of section 12A of the Securities and Exchange Board of India Act,1992 and SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.”, the circular stated.

 

The objective is, to protect your interest, the investor, whereby understanding ratings are made easy, plus promotes development along with regulations of the securities market.

 

What has changed…

 

1. Until now the practice was that a rating was made public only if the issuer accepted it. But now, all ratings will have to be disclosed compulsorily.


2. CRAs will need to frame a detailed rating criteria include the same in its Operations Manual/ Internal Governing Document and disclose this on their website.


3. Each rating and the criteria for the rating will have to be reviewed periodically, and the periodicity for such a review will have to be disclosed on the CRAs website. Since ratings are forward-looking (based on what the CRA perceives based on a host of parameters in the rating process), the agencies will have to now keep a watch if the hypothesis proves true. Thus, if there’s a change in outlook – an upturn or a downturn – will have to be reported. Likewise, if the outlook remains the same, CRAs will need to reaffirm it. Further, if the CRA is unable to come out with a review at the right time, the reasons for delay in the periodic review need to be stated.  


4. Alongside the ratings, SEBI has asked CRAs to mention “issuer did not co-operate; Based on best available information”, when there is a case of non-cooperation by the issuer (such as not providing information required for rating, non-payment of fees for conducting surveillance), the CRA shall continue to review the instrument on an ongoing basis throughout the instrument’s lifetime, on the basis of best available information (in accordance with the rating process and policies set forth). This will stop the custom of companies withholding vital information   when things turn bad for them resulting in suspension of ratings.


5. If a company goes from one rating agency to another, the second rating agency will have to disclose the aspect of non-cooperation.
    

   These guidelines and the compliance thereto will come to effect 60 days from November 1, 2016 – the date of the circular – for all CRAs.  

 

But a loophole still remains…

 

Rating agencies earn their revenue (fees) from the issuer(s). This is a serious conflict of interest permeating some element of risk for investors.

 

We believe ratings should be independently conferred with a “user pay model”. Simply put, those who you use it, are beneficiaries, should pay for it. Only then ratings will be free from bias supplemented by prudent regulations.

 

The care investors should take…

 

SEBI is aware about tricks of the game of the ratings industry and therefore, is vigilant. But as an investor, placing too much credence on ratings can be perilous to your investment decisions. Instead, pay attention to the fundamentals – not only the financials, but even the background of the promoters, how satisfied the stakeholders are (employees, customer, suppliers, shareholders, amongst others), and even the corporate governance practice followed. This will help you take prudent investment decisions in the interest of your long-term financial wellbeing.  

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