Market regulator's default benchmark rates leave rating agencies in a lurch

Sebi has put default benchmark rate at zero for certain ratings, tenures

Rating agencies have approached the Securities and Exchange Board of India (Sebi) to relax the default benchmark rates introduced by the market regulator last year.

"The benchmark default rates have been pegged at zero for certain tenures and ratings. It is not feasible to put in place benchmarks with no room for deviations as entities with high-ratings are also susceptible to defaults on their obligations," said a senior director at a rating agency.  

For AAA-rated papers, the market regulator has laid down probability of default benchmark at zero for one-year and two-year periods. For the three-year period, a tolerance level of 1 per cent is allowed, while default benchmark is kept at zero.

"We are in discussions with the regulator to review these benchmarks. Globally, there are no parallels of such a framework," he added.

For the lower-end of the credit curve -- which is more susceptible to default -- Sebi's benchmark rates remain tight. For AA-rate papers, the benchmark is pegged at zero default rate for 1-year period, without any recourse to any tolerance levels. For a two-year period, the benchmark default rate is zero with tolerance level of 2 per cent.

For A-rated papers, the benchmark default rate is zero with a tolerance level of 3 per cent.

According to sources, rating agencies -- which are already under heavy scrutiny over their role in IL&FS crisis -- are worried whether such norms could lead to punitive actions if raters fail to comply with these benchmarks.

The Sebi circular says that the benchmark default rates are being introduced so that investors can discern and assess the performance of the rating agencies on their ability to appropriately grade corporate bond papers.

Rating officials say that they remain susceptible to getting caught off-guard as they don't have access to the Reserve Bank of India's information framework -- Central Repository of Information on Large Credits or Crilic.

"There is information asymmetry when it comes to disclosures that corporate entities make on bank loans and bond loans. Any default of interest or principal repayment in case of bonds is reported immediately. However, companies get a 30-day grace period for bank loans, before disclosure norms kick in," said a rating agency official.

"We have approached the RBI and Sebi on allowing access to Crilic. This would help in assessing bond issuers on a more real-time basis and flag-off credit risks as and when the bond issuer has fallen back on its bank loan obligations," he added.

Rating agencies came under regulatory glare in September 2018, after the AAA-rated IL&FS was downgraded to default or 'D' grade in matter of few weeks.

After levying penalty of Rs 25 lakh on rating agencies in December last year, the regulator is considering  raising its penalty as officials feel the penalties need to act as a deterrent given the seriousness of the lapses.

The series of rating downgrades in quick succession severely impacted the investments of debt mutual funds (MFs) that were holding the bonds of IL&FS group entities. This in turn hurt investments of retail and institutional investors exposed to MF schemes carrying the IL&FS debt securities.

Under lens

Default benchmark rate for AAA-bonds is at zero

Even for lower-rated bonds, the rate is kept at zero

Raters say defaults cannot be avoided whether AAA, AA-rated bonds

Have approached Sebi to express reservations on the rates