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

Sunny Verma, Sandeep Singh
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 the government to look at putting in place an investor or regulator pays model in case of rating agencies (Reuters/File)

With credit rating agencies coming under watch for delayed action in recent debt defaults by various companies, the government is examining whether the 'issuer pays model' can be streamlined and investor or regulator pays model be put in place. The issuer pays model-wherein the company whose securities are being rated pays the rating agency-has time and again come under criticism for apparent conflict of interest. The Reserve Bank of India and the government in 2017 planned to set up a pooled fund for paying rating agencies, but it was put on the back burner.

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 the government to look at putting in place an investor or regulator pays model in case of rating agencies. Even as industry players argued in their discussions with the finance ministry that issuer pays model is time tested and used by most countries, the government and the Securities and Exchange Board of India (SEBI) are reviewing the 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 papers which were subscribed by mutual funds in their fixed maturity plans, resulting in delayed or partial payment for the investors. Currently, there are seven rating agencies registered with SEBI, out of which three are listed on stock exchanges. These include CRISIL, CARE Ratings, ICRA, India Ratings and Research, Brickwork Ratings India, Acuite Ratings & Research, and Infomerics Valuation and Rating.


Debate to strengthen rating agencies' regulations on again

Since the crash of Lehman Brothers in 2008 and consequent global financial crisis, the reform of rating agencies has been a recurring theme in markets, as regulators and investors perceived it as failure of these agencies to spot default risks on time. The recent defaults on debt papers by IL&FS group and by many other Indian companies, has rekindled the debate on strengthening regulations for rating agencies. SEBI last year announced key changes in its credit rating agency regulations and the government is now deliberating on whether their business model needs to be changed.

To strengthen the rating agencies framework, SEBI last year revised its Credit Rating Agencies Regulations, 1999, when it raised minimum net worth criteria for rating agencies to Rs 25 crore from Rs 5 crore and asked agency promoters to have minimum shareholding of 26 per cent. The markets regulator also mandated agencies to separate ratings and non-ratings business. Sources said further changes are being planned by the finance, SEBI and Reserve Bank of India to the regulations.

These agencies provide ratings for securities being offered in initial public offers, rights issues, bank loans, commercial papers, non convertible debentures and fixed deposits among others. The RBI regulations require that companies that issue commercial papers more than Rs 1,000 crore in calender year need to obtain credit rating from at least two agencies and lower of the ratings is to be adopted. The RBI rules further restrict the issuers who have defaulted on CPs to access the CP market for 6 months. IL&FS has been the major 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. started missing deadlines on short-term debt instruments in August 2018, rating agencies ICRA, India Ratings and CARE belatedly swung into action to abruptly downgrade IL&FS and its subsidiary from a high investment grade (AA plus and A1 plus) all the way down to junk status, indicating actual or imminent default.

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

On April 14, 2019, HREL failed to honour principal repayment of Rs 12 crore due to HDFC Short-Term Debt Fund, along with interest amount of Rs 10 crore due to all the six investee schemes of HDFC MF.

Earlier in 2012, in the case of Deccan Chronicle Holdings Ltd that had borrowed in excess of Rs 4,300 crore by June 2012, CARE assigned the highest ratings to most financial instruments of the company. The agency continued to maintain the highest rating of A1+ to DCHLs short-term instruments until July 2, 2012, although the Hyderabad-headquartered listed company had already defaulted on short-term debt raised from several lenders almost a week earlier on June 26.