Opinion | Who will rate rating agencies?

Shishir Asthana

In the financial services industry, there is a running joke -- 'Behind every successful crisis, there is a credit rating agency (CRA)'. Unfortunately, the joke has now started hurting and is no longer funny, given the number of companies defaulting and with credit rating agencies either looking the other way or waking up at the last moment.

In India, the latest occurrence of such oversight has provoked a reaction from Securities and Exchange Board of India (SEBI). We are, of course, speaking about infrastructure lender IL&FS, which was rated AAA (the highest rating) right up until it defaulted on its mountain of debt. With IL&FS being too big to fail -- it accounts for 16 percent of the banking sector's exposure to the shadow banking sector -- and its defaults provoking a public outcry, SEBI has come out with a fresh set of disclosure norms for credit rating agencies.

The capital markets regulator has now asked rating agencies to look at the liquidity situation of an issuer and take into account any asset-liability mismatch. The agencies will also have to disclose any linkage to external support for meeting near-term obligations. The rating criteria will have to take into account an assessment of holding companies and subsidiaries in terms of their inter-linkages, the holding company's liquidity, financial flexibility and support to subsidiaries, among others.

It comes as a surprise that rating agencies were not looking at these parameters before assigning a rating. As all borrowings – both short and long-term ones -  are rated, rating agencies should be covering all aspects of liquidity. Not looking at a holding company as a sum-of-parts is unthinkable. Even equity analysts, who only have public information, do that. Rating agencies have access to more data, the same set of data that a banker has access to, and have the right to demand more data till they are satisfied, unlike an equity analyst.

This is not the first time that SEBI has reviewed credit rating agencies. In the past couple of years, the regulator has undertaken four reviews of rating agencies because of a crisis of some sort. In July 2017, for instance, SEBI said credit agencies should review ratings after every "material event" and request monthly "no default statements" from issuers.

In a sense, SEBI has stated the obvious. It has called for more disclosures and has given a checklist of sorts to rating agencies, who will now have a tough time explaining their oversight. However, a disclosure-based regime can go only so far and the regulator has failed to been touch upon an important issue -- the issuer-pays model for rating agencies.

In India, as in many countries, the company looking to raise debt, picks the rating agency. It is but natural that it would approach the one that is 'most compliant'. To make matters worse, there are investment bankers and debt syndicators who have mastered the art of window dressing a balance sheet and guiding their clients on 'rating shopping'.

Bankers also hide behind the ratings of a company to sanction debt. This makes the role of the rating agency the most critical one in the entire lending space.

While SEBI’s norms add another step to the methodology for rating a company, and call for more disclosures, as long as the company has a right to choose and pay a rating agency, there will always be the threat of conflicts of interest and oversight.

Perhaps, it is also time to rate rating agencies themselves. The ones who have been liberal in their ratings and have seen the most number of defaults. So they should be picked up, penalised and made a party to the default recovery process.