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Continuing with its efforts to make financial system more transparent, capital market regulator Securities and Exchange Board of India (Sebi) is now tightening the noose of credit rating agencies (CRAs) by introducing a set of additional guidelines. The new norms mandate more disclosures and will make CRAs more accountable.At present, there are four main credit rating agencies operating in India: Crisil, CARE, ICRA and Fitch.New guidelinesSummary of the discussion: According to the recent guidelines, CRAs will have to maintain a record of all the important factors underlying a credit rating and a summary of the discussion held with issuers, its management and auditors. CRAs will also have to keep records of voting details of the rating committee for at least five years after the maturity of the instrument.Uniformity in default definitions: To streamline the process of rating, Sebi has introduced uniformity in definitions of default and computations of default rates. According to the regulator, default is defined as non-payment of interest or principal amount in full on the pre-agreed date. A rating agency should recognise default at the first instance of delay in servicing of interest or principal on the rated debt instrument.Rating methodologies: CRAs will have to disclose the methodology adopted for ratings and also the compensation arrangement with the issuer. It will also have to disclose details of any relationship it has with the issuer whose securities are being rated or any of its associate of such issuer and the CRA or its subsidiaries. Moreover, these agencies will need to provide a break-up of the total receipts from the rating and non-rating businesses, and names of the rated issuers who along with their associates contribute 10 per cent or more of its total revenue.Dealing with conflict of interest: In order to avoid any potential conflict of interest, a rating agency will now have to ensure that its analysts do not participate in any kind of marketing and business development, including negotiations of fees with the issuer whose securities are being rated. Moreover, the employees involved in the credit rating process and their dependants cannot own shares of the issuer.Default studies: The capital market regulator has also made it mandatory for rating agencies to publish information about the historical default rates and changes made to these ratings, if any, in the past.Shareholding: Also credit rating agencies will have to disclose their shareholding patterns as well. Commenting on the move, Roopa Kudva, managing director and chief executive officer, CRISIL says, "Disclosures on shareholding and ownership patterns of rating agencies will enhance investors' confidence in CRAs' ability to manage conflicts of interest arising out of shareholder pressures. They will give investors confidence that opinions are unbiased."Structured finance products: While rating structured finance products, agencies will now have to disclose the track record of the originator and details of nature of underlying assets while assigning the credit ratings. Further, the rating agency or its subsidiaries have been barred from providing consultancy or advisory services regarding the design of the structured finance instrument and also furnish bi-annual data on the details and performance of the rated pool.During FY2010, the issuance volume in Indian structured finance market was about Rs 47,000 crore. According to Kudva: "Indian structured finance products and instruments are very different from their global counterparts: Indian instruments are significantly simpler. The Indian market is currently awaiting final guidelines from RBI on structured finance market that has brought some uncertainty and has resulted in fall in the issuance in this market."The rating agencies have welcomed the move saying that it will boost investor confidence in ratings. "The guidelines are expected to make the system more transparent and help for investors make an informed decision. The primary concern for any investor is whether the assigned ratings have passed through a robust analytical process and are devoid of any conflict of interest or not. These guidelines will address this issue," says CARE Ratings, managing director and chief executive officer, DR Dogra.These guidelines, which are effective from June 30, mandate CRAs to make disclosures at least twice a year.Why such a move?The move comes in the backdrop of the global financial crisis. The role of rating agencies had come under the scanner during and after the financial crisis. According to Pallav Sinha, managing director and chief executive officer, Fullerton Securities and Wealth advisory: "CRAs have a very key role in the financial system and they have come under scrutiny since the recent financial crisis especially with regards to the US sub prime markets where rating agencies ostensibly underestimated the risks, providing higher than warranted ratings to securitised assets. There has been an extensive debate on how CRA norms can be modified to protect investor interest, including the 'issuer pays' model, being suggested as a solution. While this does mitigate the inherent conflict of interest, it has the downside such as - credit ratings would be available only to select investors who pay for the rating."Importance of credit ratingCredit rating is an important tool for investment decisions. Sinha believes that an average investor may not give too much significance to credit ratings. However, even this segment of investors is becoming increasingly aware of CRA ratings. On the other hand, sophisticated investors like institutions and high net worth individuals take into account credit scores while taking any investment decision.BottomlineThe current move is beneficial to investors and allows them to judge the performance of CRAs. It will help raise standards in the Indian ratings industry and add to investor confidence in ratings. "Increased disclosure requirements, such as disclosure of shareholding and ownership pattern, and criteria and methodologies, will provide additional information to investors," says Kudva. Moreover, the new guideline has proposed various measures which would go a long way in addressing the issue of conflict of interests believes Pallav Sinha.The move will definitely help investors in uniform interpretation of the reported data of rating agencies.niti.kiran@expressindia.com
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