SEBI’s axe on Brickwork should keep rating companies in line

Rare is the case when a regulator goes after a credit rating company to put a lock on the business and succeeds. But the Securities and Exchange Board of India has done exactly that with Bengaluru-based Brickwork Ratings.

Concluding a year-long process, SEBI suspended its licence on October 6 and instructed the company to wind up in six months. The regulator’s move against the credit rating company is unprecedented, even by international standards.

Brickwork’s suspension has positive outcomes but it may also unsettle the debt market in the short term. It sets a precedent and gives the regulator teeth to pull up rating companies for errant behaviour. And, the sharper oversight should help the debt market trust rating companies a little more than before.

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“This kind of sends a message that the regulators are more watchful and that should help issuers get some comfort, especially where the rating agencies are fairly new and not established,” said Ajay Manglunia, head of institutional fixed income at JM Financial.

Amit Tandon, founder of proxy advisory firm Institutional Investor Advisory Services, said SEBI’s action perhaps stems from the assessment that the transgressions of Brickwork were systemic and unpardonable.

“You could see that repeated warnings were issued but they were perhaps callous about these. So SEBI decided to take the required action,” he said.

From surge to shutdown

Registered credit rating companies in India that assess debt include Crisil, Icra, India Rating and Research, and Care Ratings, which are the dominant ones. Acuité Ratings & Research, Infomerics Valuation and Rating, and The SME Rating Agency (SMERA) are recent entrants.

Brickwork Ratings was set up in 2008, with public sector lender Canara Bank as a strategic investor. The agency got Reserve Bank of India accreditation four years later, which enabled it to tap the vast pool of bank loans for ratings.

The population of issuers that the company rates grew exponentially over the years. According to the SEBI order, the regulator found several lapses in Brickwork’s rating process. Insufficient disclosures with respect to several credit ratings assigned, and lapses in keeping business development and rating committee at arm’s length were the key findings.

Regulations governing credit rating agencies mandate that the business development vertical and the rating committee must not interact in order to keep the process unbiased. Having encountered lapses to an alarming degree, both SEBI and the RBI jointly conducted an inspection in January 2020, which revealed that the rot ran deep at the rating company.

Some of the notable cases with questionable processes were IL&FS, Bhushan Steel, and Great Eastern Shipping Company. Note that IL&FS’s collapse in 2018 resulted in a widespread meltdown in the capital markets, necessitating regulatory intervention. The event triggered a general mistrust among market participants towards credit rating agencies.

Mighty regulator

Experts said the winding up of Brickwork shows the capital markets regulator in a refreshingly stronger avatar.

“What happened with Brickwork could affect trust when it comes to new rating agencies since they are just setting up business. To be fair, most of us seriously guard our standards,” said an official with a rating company, requesting anonymity. “Slip-ups do happen, but they are very rare and immediately rectified because the damage otherwise is quite large.”

Indeed, SEBI’s oversight of rating companies tightened after the IL&FS debacle.

“We have seen these things periodically happen. Standards tend to become lax (in good times). Everyone in the market is part of the problem,” said Tandon, adding that though credit rating companies are to be blamed, they cannot be singled out.

Recently, SEBI tightened disclosure norms for rating companies. It prescribed a standardised framework for ratings but the deadline to meet this was extended by two months to November end. The regulator also framed rules to firewall the rating business from the non-rating business.

Bond market shake-up

In the short term, the corporate bond market could see a slowdown in issuances as companies with ratings from Brickwork have to find alternatives. Bond market participants, though, do not see long-drawn pain.

“Brickwork’s rating was usually the second rating as rules require you to have two ratings for an issue. So it was more of ticking a box rather than a serious view on creditworthiness,” said a debt manager at a large brokerage firm.

Most of these issuers may have to approach other agencies now and get re-rated, said Manglunia.

The damage from Brickwork’s suspension would be felt more by companies that have a rating below AAA.

“New agencies tend to be lax to get more business and usually companies that are not AA+ or above go to them to get a good rating,” said the debt arranger quoted earlier.

In essence, the shutdown of Brickwork Ratings has done the debt market a favour by increasing credibility and showing SEBI as a tougher regulator.