The IL&FS, Dewan Housing, Zee debt paper fiascoes in the last one year have cast a serious spell of doubt and fragility about the rating agencies. Regulators have sought more information from rating companies on rating qualities, processes, and conflicts of interests.
A credit rating agency is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default.
Credit rating agencies in India do not have a distant past. They came into existence in the second half of the 1980s. As of now, there are six credit rating agencies registered under SEBI namely, CRISIL, ICRA, CARE, Acuité Ratings and Research, Fitch India and Brickwork Ratings.
Ratings provided by these agencies determine the nature and integrals of the loan. Higher the credit rating, lower is the rate of interest offered to the organisation.
Institutions like mutual funds, insurance, and pension funds are left in lurch with their debt assets suddenly downgraded steeply lead to a fall in value.
In September 2018, CARE downgraded ILFS Non-convertible debentures of Rs 9641.94 crore downgraded from 'AA+' to 'BB'.Debt instruments with 'AA' rating are considered to have a high degree of safety whereas Debt instruments with 'BB" rating are considered to have a moderate risk of default. ILFS
Commercial Paper (CPs) issue aggregating Rs 2,500 crore was steeply downgraded from 'A1+' to 'A4' by CARE.NCD of Dewan downgraded from CARE A to CARE BBB minus in May 2019.
Such sudden rating downgrade action flags the credibility issue of raters and whether they have continuous transparent financial information from the debt issuer.
The entire mutual fund industry and institutions like insurance and pension funds depend on debt ratings for their total debt portfolios. SEBI has been concerned for long as to why mutual funds have no back up in-house rating department for independent vetting of the ratings received from agencies, said a former Deputy General Manager of SEBI who worked in its mutual fund department.
On public fora, whenever called upon to clarify their stands on in-house rating systems, mutual funds are not seen forthcoming with precise replies.
The onslaught of sudden downgrades of rated papers has made mutual funds suffer earlier in Global Liquidity crisis of 2008 when they approached SEBI for non-saleable short term debt papers. That time SEBI stepped in for higher flexibility in debt paper valuations, on a temporary basis, of more than 300 basis points to help reflect the current value of debt holdings for mutual funds, said the ex-SEBI official. Further RBI had to help mutual funds providing a borrowing window of Rs 20,000 crores to help tide over panic redemptions, said the official.
The problem of rating agency credibility and its use by fund managers rubs deeper when one looks at the conflict of interest. Rating agencies are paid by debt issuer corporate like ILFS, Dewan and other corporate for the rating exercise.
There are credible murmurs in the industry that this allows corporate to do rating shopping where the rating mandate goes to the agency giving highest rating. If true, it appears a backstage manipulation of rating.
Buzz is that RBI-SEBI coordination committee has set out to examine whether the rating agency should choose the only subscriber pays model from the issuer-pays model.
It is imperative for rating agencies to address their internal conflicts on their own also. Rating agencies are the conscience keepers of debt issuance quality, if that comes under cloud, the entire debt market asset management is under risk that includes FIIs buying debt, the mutual funds, insurance funds, and pension funds.
Rating agencies are not sales organisations that should have annual targets of how many debt papers were rated in terms of volumes. Rating agencies should rather look at the quality and credibility of their rating judgments that would their subscriber base in the long run.
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