Let the raters be rated

Tue, 31 May Pre-Open

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Credit rating agencies (CRAs) in India are badly influenced. Sharp downgrades or suspension of ratings have become their usual norm. Whatever their ratings, they have done more harm than good to the investor community.

Take the case of Amtek Auto for example. It is a clear case of rating agencies having been caught napping on their job. The agencies should have seen the company's default coming. But that did not turn out to be the case. Care Ratings suspended the rating of the company on August 7, 2015. Before suspending the company, Care had rated Amtek Auto at AA-. Another rating agency Brickwork Ratings downgraded the debt of the company from a level of A+ to C-. This was a downgrade of 12 levels in a single shot. This led to a crisis-like situation. The stock plunged and investors felt the brunt with their wealth wiped out in a matter of days. As ratings get downgraded sharply, it is not just debt securities that bear the brunt. A sharp downgrade sets a chain reaction that involves shareholders as well.

We have discussed the lessons that this saga offered in one of the editions of The 5 Minute WrapUp.

Ratings from CRAs are fraught with conflict of interest. The agencies get paid by the company whom they rate. Thus, there are chances of their ethics being compromised. We know what happened to the sub-prime mortgage debt that was rated AAA by renowned rating agencies. It was effectively a junk debt, which saw a series of defaults later. The reason why this is still in play is nobody has questioned the base for such ratings.

The only way out here is the regulation of these agencies. And if the news is to be believed, some relief is around the corner. This we say as Securities and Exchange Board of India (SEBI) is in the final stages of formulating new disclosure regulations on credit rating agencies.

An article in Economic Times states that SEBI might soon ask CRAs to make greater disclosure about suspension and subsequent withdrawal of ratings. Further, the regulator might mandate CRAs to make public the criteria used for rating. Also, here would be a periodic review of the criteria used for rating and public disclosure of the periodicity of reviews.

The above development, if executed, will bring in much relief. The need for regulatory oversight of such companies, and the agencies that rate them is higher than ever. Meanwhile, investors would do themselves a service to not rely blindly on the views of rating agencies and do their own homework and independent thinking.

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