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An End to the Biggest Conflict of Interest?

Oct 17, 2016

In this issue:
» Alarming! India is losing 550 jobs every day
» Apurva's first-ever training session
» Market roundup
» ...and more!
00:00
Richa Agarwal, Research analyst

Crisis is good. It makes us look back and reflect on what went wrong. And in some cases, set measures to avoid future calamities.

In 2008, Lehman Brothers collapsed. The world shook and stood shocked. No one saw it coming, thanks to a false sense of security created by some of the top global rating agencies. What followed was a global financial crisis from which the world is yet to recover.

The crisis exposed the serious flaws in the ways credit rating agencies (CRAs) function. It's hard for an agency to remain objective if it gets paid by the company it's rating. In compliance jargon, it is called conflict of interest. And in a business where so much is based on one's word, this is a rather serious conflict of interest.

'Put a few cents in their pockets and get the rating you want; this is how they work.' Turkey's president's words may be out of bitterness as Moody's downgraded the country's rating. However, they do highlight the distrust and the bad reputation the rating agencies have earned over the last decade.

So now, as the BRICS agree to set up a credit rating agency, it is important to ensure the basics are taken care of from the very beginning.

Back home, last year, the rating agencies were caught napping on their job once again when, in a single shot, CARE suspended the rating of Amtek Auto from AA- (that suggests low credit risk). There were no warnings. Their reason for the sudden downgrade - 'lack of management response' - sounded flimsy. Panic ensued. The stock crashed.

This was not an exceptional case. Jaiprakash Associates, Bhushan Power and Steel, and Punj Lloyd, to name a few, also witnessed sharp and sudden downgrades.

It was not just the debt securities or credit profile that bore the brunt. The equity investors in these stocks, because they took the rating agencies seriously, saw massive erosion of their net worth overnight. While other stakeholders faced the consequences of the agencies' incompetence, the agencies themselves came out relatively unscathed.

In all these cases, the rating agencies, purportedly independent watchdogs, were more like Nero fiddling as Rome burned. They were either blind or chose to look away from the risks and mismanagement of these firms.

But this might change soon. As an article Business Standard suggests, SEBI is mulling measures that may tighten the noose on credit rating agencies (and managements that go rating shopping), making them more transparent and accountable.

SEBI may ask CRAs to disclose compensation arrangements. CRAs may also be asked to define their policies when they suspend or withdraw ratings.

SEBI further plans to increase standard disclosures on important aspects such as the minimum information they need to conduct a rating exercise. Monitoring and review of ratings, policy for appeal by issuers against a rating and for placing a rating on credit watch could be considered as well. Guidelines to strengthen internal audit for CRAs and to maintain a record of ratings history are also being proposed.

We always meet with managements of the companies we consider recommending. And over the years, we have met a few managements who have admitted to ratings being 'sold' and fees being negotiated for better ratings.

We have been writing about the lack of integrity in rating agencies since 2011. SEBI's reforms are indeed long overdue. But the risk does not end here. The final blueprint is yet to be out. India is still an evolving market. It is folly to blindly rely on someone else's risk assessment of a business when it is your capital at stake.

That's why we recommend you stick to a disciplined investing approach with a keen focus on risks. Our 'Crash Score' report can help you identify and avoid risky stocks. Grab your free copy today.

03:00 Chart of the day

Regular readers are aware that we have been warning about the consequences of India's worsening demographic problem. We have been researching extensively on this impending crisis, and now believe that the crisis is much worse than what our big-picture editor Vivek Kaul had earlier anticipated.

There's more and more data that validates our worries about the big demographic crisis that is staring at India...a crisis that could impact your job, income, and wealth in the coming times.

We just came across some very shocking piece of data.

Look at the chart of the day. It shows the number of jobs (in thousands) that India created in recent years. As you can see, job creation in India has been shrinking at an alarming rate.

In the last four years, India has lost an average of 550 jobs every single day!

India's Job Crisis is Getting Worse


As per a study by Delhi-based civil society group PRAHAR, if this continues at the current rate, then employment in India may shrink by 7 million by 2050. On the other hand, the population would have expanded by 600 million. The worst affected sections of the country are farmers, petty retail vendors, contract labourers, and construction workers.

But this crisis is not limited to the marginalised sections of our economy. It is way bigger and endemic than you could have imagine. And it's also taking a toll on white collar jobs.

So, ignoring this crisis until it personally hits you would be a big mistake.

If you want to be ahead of the curve, you ought to think and prepare for it right away.

To get started, if you missed seeing Vivek's 58-minute video about "The Next Big Indian Crisis", we have recently released an abridged transcript of the interview. You can read it at your own pace and catch up on all these serious issues which we can almost guarantee will NEVER be covered in the mainstream media.

So, don't delay and read on for the transcript of our conversation...

04:00

On the topic of trading, Apurva Sheth, Managing Editor at Swing Trader, has conducted his first-ever training session with readers. You can attend the session from the comfort of your home or office and access it on your desktop or mobile. And before you ask...it's completely free. The big draw of the session is that Apurva has revealed what he calls his 'Secret Profit Signal'. The training session is live now. You can watch this training session here.

04:30

After opening the day in the green, the Indian stock market indices slipped into the red around noon time. Auto, telecom, capital goods, and realty stocks are leading the sectoral gains.

The BSE Sensex is trading lower by 114 points (down 0.4%) and the NSE Nifty is trading lower 49 points (down 0.6%). The BSE Small Cap and BSE Mid Cap indices are trading lower by 0.3% and 0.8% respectively.

04:50 Investing mantra

"An idea or fact is not worth more merely because it's easily available to you." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Ankit Shah (Research Analyst).

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