For rating agencies, the panel suggests a regulator-pays model; industry players advocate for a time-tested issuer-pays model

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As credit rating agencies come under scrutiny for delays in action in recent defaults by various companies, the government is examining whether the ‘issuer-pays model’ can be streamlined and whether a model of l investor or regulator-payer can be put in place. The issuer-pays model — in which the company whose securities are rated pays the rating agency — has time and again been criticized for an apparent conflict of interest. The Reserve Bank of India and the government planned in 2017 to set up a pooled fund to pay rating agencies, but it was shelved.

In light of the perceived laxity of rating agencies during recent defaults by IL&FS Group, the Parliamentary Standing Committee on Finance in its February report recommended that the government consider introducing an investor pay-as-you-go model. or the regulator in the case of rating agencies. Even as industry players have argued in their discussions with the Ministry of Finance that the issuer-pays model is proven and used by most countries, the government and the Securities and Exchange Board of India ( SEBI) are reviewing regulations to incorporate the committee’s suggestions and to further strengthen the regulatory framework, government sources said.

Recently, companies have also defaulted on some of the rated debt securities underwritten by mutual funds in their fixed-term plans, resulting in delayed or partial payment for investors. Currently, seven rating agencies are registered with SEBI, three of which are publicly traded. These include CRISIL, CARE Ratings, ICRA, India Ratings and Research, Brickwork Ratings India, Acuite Ratings & Research and Infomerics Valuation and Rating.

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Debate to strengthen the regulation of credit rating agencies again

Since the Lehman Brothers crash in 2008 and the resulting global financial crisis, rating agency reform has been a recurring theme in the markets, as regulators and investors have viewed it as the inability of these agencies to detect the risk of default in time. Recent debt defaults by IL&FS Group and many other Indian companies have reignited the debate on tighter regulation of rating agencies. SEBI announced key changes to the regulation of its credit rating agencies last year and the government is now deliberating whether to change its business model.

To strengthen the framework for rating agencies, SEBI last year revised its 1999 Credit Rating Agencies Regulations, when it raised the minimum net worth criteria for rating agencies to Rs 25 crore from Rs 5 crore and asked agency promoters to have a minimum stake of 26 per cent. The market regulator has also mandated the agencies to separate rating activities from other activities. Sources said further changes were planned by finance, SEBI and the Reserve Bank of India to regulation.

These agencies provide ratings for securities offered in initial public offerings, rights issues, bank loans, commercial paper, non-convertible debentures, and term deposits, among others. RBI regulations require that companies which issue commercial paper of more than Rs 1,000 crore during the calendar year must obtain a credit rating from at least two agencies and the lowest of the ratings must be adopted. The RBI rules further restrict issuers who have defaulted on CPs from accessing the CP market for 6 months. IL&FS was the main defaulter in the CP market, leading to a sudden liquidity squeeze in the commercial paper and commercial debt market last October.

While Infrastructure Leasing & Financial Services Ltd. began to miss maturities on short-term debt instruments in August 2018, rating agencies ICRA, India Ratings and CARE intervened late to abruptly downgrade IL&FS and its subsidiary from a high investment grade rating (AA plus and A1 plus) to undesirable status, indicating an actual or impending defect.

Even in recent cases where mutual funds have invested in Zee Group and IL&FS Group companies, the investments had high ratings and were only recently downgraded. In the case of Harzaribagh Ranchi Expressway Limited, a subsidiary of IL&FS Transportation Network Limited, the company was downgraded to non-investment grade on 24 January 2019 and India Ratings further downgraded CRS issued by HREL from “IND C (SO) to ‘IND D(SO)’ on Monday, April 15, 2019, after defaulting on its payment obligations.

On April 14, 2019, HREL defaulted on principal repayment of Rs 12 crore owed to HDFC Short-Term Debt Fund, as well as interest amount of Rs 10 crore owed to HDFC MF’s six investment schemes.

Earlier in 2012, in the case of Deccan Chronicle Holdings Ltd which had borrowed over Rs 4,300 crore in June 2012, CARE gave the highest ratings to most of the company’s financial instruments. The agency continued to maintain the highest rating of A1+ on DCHL’s short-term instruments until July 2, 2012, although the Hyderabad-based listed company had already defaulted on short-term debt owed to several lenders almost a week earlier on June 26.

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