By DK Aggarwal
It all started with the surprise default of AAA-rated IL&FS group in September, 2018, which had earlier enjoyed high ratings from rating companies due to window-dressing of its books.
That default and others that followed turned attention on credit rating agencies. Besides, a crippling liquidity crunch has spooked the confidence of investors and a crisis has engulfed the entire NBFC sector. This is not the first instance when credit rating agencies have been caught slumbering in a debt market crisis.
Market regulator Sebi has now tightened the norms for credit rating agencies in an attempt to restore investor faith in the system. Actually, the crisis in the NBFC sectors has cascaded into the entire financial sector, threatening to disrupt the economy.
RBI’s new circular said credit rating agencies will now have to make more disclosures about the quality of debt instruments they rate. The new guidelines require disclosures on cumulative default rates, probability of default benchmarks and liquidity indicators. Sebi has also tweaked the methodology to arrive at default rates. They now need to disclose all factors that ratings are sensitive to.
Sebi has also proposed appointing independent director on the board of each credit rating company for a period not exceeding three years.
The new benchmark, ‘Probability of Default’, will be used for both short- and long-term instruments. Sebi says rating agencies need to disclose on their websites by December 31 one-year, two-year and three-year cumulative default rates for each rating category.
If there is an explicit credit enhancement, the credit rating agencies will assign a ‘CE’ suffix to a rating. The raters will also have to evaluate whether a credit enhancement structure is sufficient, under various scenarios, including stress, and disclose it in ratings press releases.
The new regulation also states that in consultation with Sebi, the rating agencies will need to frame uniform standard operating procedures (SOP) to track debt defaults and their timely recognition.
For liquidity Indicators, Sebi has made it mandatory for the rating agencies to publish a standardised liquidity indicator, indicating poor, stretched, or adequate to superior/strong classifications.
These steps will not only bring transparency in the system but also align our rating agencies with globally followed standards, especially in terms of rating methodology. This, in turn, should help reinforce confidence among investors.
The changes will bring in the much-needed transparency in the system, help investors make more informed decisions and give them global-level play. Enhanced disclosures will give investors more clarity on the rated companies. Appointment of independent directors will help rating agencies improve credibility and governance standards.