Sebi must take a tough stance in dealing with Indian credit rating agencies
The Securities and Exchange Board of India (Sebi)’s disappointment with the Indian credit rating agencies is understandable given the series of goof-ups in evaluating the individual enterprises or according a sovereign rating for India. Their failure to foresee the global markets collapse in 2008 is also well documented, proving beyond doubt that the rating agencies were not doing their job.
The market watchdog’s outburst seems to be the logical extension of pent up anger against the agencies that squarely failed to report the credit defaults of companies and build up of non-performing assets (NPAs) with banks, financial institutions, equity and debt investors. For instance, the inordinate delay in reporting the credit defaults of a leading telecom company has come under Sebi scrutiny. The market watchdog’s view was that the credit repayment defaults and contingent financial stress in the company were not reported by the rating agencies. As Sebi chief Ajay Tyagi inferred, reporting the defaults three months after the incident does not make any sense.
Tyagi has made a case for stringent norms that govern credit rating agencies whose analysis form the basis for both equity and debt investments by large and retail investors alike. In the case of the telecom company, rating agencies Care and Icra had downgraded its debt to “default” category three months after the company actually defaulted big time.
That was not the only case where investors and lenders were stuck with virtually worthless paper. The default by an auto components company of $121 million debt repayment had hit portfolios of large institutional investors like JP Morgan Asset Management. Investors were left with “un-saleable assets” of the company while rating agencies reportedly had a cozy relationship with its “default” client.
A 1986 paper written by economists Joseph Stiglitz and Andrew Weiss had highlighted the relevance of credit rating agencies that were expected to make an objective assessment of credit sellers like banks and the intent of borrowers with their ability to repay the loans. Time and again the rating agencies like Standard & Poor’s that own Crisil, Moody’s with control of ICRA, Fitch with its Indian subsidiary and domestic player CARE owned by IDBI Bank, SBI and Canara Bank, have let down both lenders and borrowers.
In this context, Sebi’s move to tighten the governance norms for credit rating agencies assumes significance. While the draft framework would be available only next month through a discussion paper, exposing the sweetheart deals between rating agencies and their clients must happen rather quickly to build investor confidence and boost market sentiment.
Based on key financial indicators and ratios, the issuers of bonds, debentures and other debt instruments should have been rated periodically. And, this rating should have reflected in the pricing movement of companies’ debt paper. Even after the market regulator took cognizance of such defaults, rating agencies have failed to either report or downgrade their clients’ paper. Meanwhile, the rating agencies have had their own sob story to tell. Some of the best known ones have taken the position that companies often failed to report “financial stress”, making it virtually impossible for them to act. Not many market stakeholders have bought this argument. Given that the rating agencies have had unhindered access to financial data, failure to make this public has put a blot on them. Rating shopping prevalent globally, stringent competition among rating agencies to corner business and faulty revenue models have made them rudderless.
The US-based National Commission on the Causes of Financial and Economic Crisis had in a 2011 report termed the failure of rating agencies as “essential cogs in the wheel of financial destruction.” If this should not happen to nascent Indian markets, Sebi will have to act tough and now.