The move by the Securities and Exchange Board of India (Sebi) to bring more transparency into the functioning of credit rating agencies is timely in view of the growing discomfort in the financial sector and among investors with the way companies shop for ratings. The policy of choosing and displaying only the best rating and not divulging the unflattering ones is a serious corporate governance issue. Similarly, companies choke information to rating agencies during testing times, causing a lot of trouble for investors. The other part is the process of rating itself, which is cloaked in secrecy. Sebi has justifiably asked rating agencies to define the basis on which they rate companies and explain how the process works. This would include a clear set of criteria, to be disclosed on their websites, for analysing financial ratios, treatment of consolidation of firms and so on. These criteria need to be reviewed regularly, and if there are any changes, those too have to be shared with the public.
The Sebi decision followed the recommendations of its committee, which deliberated on strengthening guidelines to improve governance standards and help investors understand ratings better. The regulator has defined the structure of the communication that the agency will issue, which will have more details than are available now. Also, persons with business responsibilities cannot be a part of the rating committee, except the managing director or chief executive officer, and that too if there is a majority of independent members. The history of all past ratings must be available and even if a company does not accept an agency’s rating, it has to be declared on the agency’s website. Suspension of a rating due to lack of data, after the issue, has been barred. Instead, ratings have to be maintained till the lifetime of the instrument. And if there is inadequate data from the company, the rating symbol can include “issuer did not co-operate; based on best available information”. This is a well considered move as it gives rating agencies some additional teeth against companies that refuse to cooperate.
With more companies seeking to raise funds via the bond route, the market regulator wants to ensure that investors are not swayed by rating inflation — a common feature when companies are looking to raise funds aggressively in a growing economy. Between April and September this year, companies have raised Rs 23,901 crore from the bond market, compared to Rs 2,000 crore in the same period last year. The system of rating has long been challenged, as agencies are paid by companies whose securities they rate. Since companies benefit from higher ratings, there is a direct conflict of interest between the rating agency and the issuer. There is a big reason why Sebi’s confidence in the rating of debt paper has gone down — there have been several cases where companies with high ratings were downgraded by agencies only after it became public knowledge that they were not doing well. Instances of sudden downgrades and ratings withdrawals leave investors in the lurch, and it is high time the rater and the rated were monitored more carefully. After all, global regulators have been cracking down on credit rating agencies in the aftermath of the 2008 financial crisis, which many say was a result of inflated ratings assigned by agencies on complex mortgage-backed securities.