SEBI and RBI to tighten credit agencies’ biz models, to avoid another IL&FS

• SEBI and RBI are looking into how rating agencies conduct due diligence, to stall the practice of “ratings shopping” where companies pay them for high ratings on their debt.
  
• The regulators are assessing proposals that would mandate debt-issuers to seek dual ratings and select ratings agencies through a transparent bidding process.
  
• In the wake of the IL&FS crisis, India’s financial regulators have been cracking down on credit ratings agencies -- which are accused of failing to monitor IL&FS’s liquidity situation closely in the build-up to it’s default.

The crisis of IL&FS has led Indian financial regulators to tighten the workings of rating agencies.

The Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) are said to be looking into the practice of ‘ratings shopping’, Mint reported, citing sources.

They are also in favour of a Chinese wall between the agencies and management of the client.

Ratings shopping is where companies pay agencies to provide them with high ratings. And, these ratings form the basis of investors, bankers and creditors to assess assess the company's ability to repay its debts.

Markets regulator SEBI and central bank RBI will now check the process of due diligence conducted by these agencies, before they assign a rating on an institution.

This is one of the many steps that were taken to change the loophole ridden system of assigning ratings. Interestingly, a model wherein an investor or regulator pays the rating agency instead of the debt issuer, has also been mooted in the recent past.

Rating agencies and their activities have also been at the center of the 2008 sub-prime crisis in the US, where agencies chose to assign interesting-sounding ratings, to bundled bad debt.

Second opinion

SEBI and RBI are assessing proposals that would mandate companies to seek out dual ratings and select ratings agencies, through a transparent bidding process.

Concurrently, ratings agencies will be required to prevent direct interaction between the personnel tasked with assigning a rating and, the client’s management.

India’s financial regulators are doing what they can to prevent a repeat of the IL&FS crisis.

As the main lender for government infrastructure projects, the cash-strapped IL&FS benefited from regulatory oversight, while its promoters failed to carry out adequate due diligence before extending loans.

The SEBI and RBI have apportioned a part of the blame to credit rating agencies, which are accused of failing to monitor IL&FS’s liquidity situation closely in the build-up to its default.

As a result, investors had no idea they were propping up the cash-strapped lender. Following a series of defaults, IL&FS’s bonds were finally given a junk rating in September last year.

In November 2018, the SEBI imposed stricter disclosure and review requirements on the country’s credit rating agencies.

Liquidity section

Under the new requirements, credit ratings agencies will have to include a special section devoted to liquidity in their ratings actions press release. This involves a regular and rigorous assessment of a bond or stock issuer’s liquidity situation and repayment performance.

In addition, credit ratings agencies will have to publish information related to the historical average rating of the issuer, highlighting any gradual change in the company’s rating.

The new norms will help institutional and retail investors get a better picture of the financial health of an issuer and allow red flags to be raised well in advance, of an actual default.



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India’s securities regulator is forcing rating agencies to comply with stricter assessment norms to prevent a repeat of the IL&FS crisis