Should The Rating Agencies Be Blamed For This Credit Crisis? - Outside View by PersonalFN

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Should The Rating Agencies Be Blamed For This Credit Crisis?
Jun 18, 2019

Independent credit rating agencies are in the line of fire, and rightly so.

According to The Hindu dated June 12, 2019, credit rating agencies have downgraded 163 credit facilities in 2019, which is a 51 per cent increase in the total tally for the last four years.

Have these downgrades come just too late?

The present corporate debt crisis has called rating agencies' credibility into serious scrutiny.

Looking at IL&FS, Reliance ADAG and DHFL episodes, it seems like, rating agencies have failed to give investors a heads-up on ratings downgrade. Isn't it amusing that "AAA" rated papers (so-called top-quality papers) get downgraded to "D" (Default) in just a few months?

Was that merely ignorance or something more?

On the other hand, mutual fund houses are calling themselves just pass through and shrugging off their accountability towards investors.

--- Advertisement ---
Why Buy It For Rs 1,950 When You Could Get It Virtually FREE?

The Secrets Identifying  10X StocksTanushree's Banerjee's new hardbound book – "50 Reasons Why The Rebirth of India Is Inevitable" – is selling for Rs 1,950 on Amazon right now.

But if you act immediately, you could get a copy of it mailed to your address in India for virtually FREE.

Yes! This pathbreaking book reveals all about a once-in-2000 years phenomenon and how to profit from it.

And nearly 2,000 copies of this book have been claimed already.

So don't delay even a second more…

Find out how to grab your virtually FREE copy now!
------------------------------

Who can/should investors rely on?

The capital market regulator has taken the IL&FS fiasco seriously and immediately swung into action. It's nudging credit rating agencies to modernise their corporate structure and improve governance practices.

According to media reports, listed below are the likely changes one may expect in the corporate structure of credit rating agencies going forward:

  • They must have the majority of directors as independent directors on their board.
  • Rating agencies should appoint independent directors only for a 3-year term and one director shouldn't serve more than two terms.
  • There will be a capital market regulator nominated director on the board of each rating agency.
  • Shareholder-directors can't be appointed in any position of compensation and audit committee.
  • It would be mandatory for the rating agencies to disclose their rate card and whistle-blower policies.
  • Credit rating agencies may also have to store ratings related data on servers located in India.

Moreover, the regulator has come up with the enhanced disclosure norms for credit rating agencies.

New disclosure norms:

  • Rating agencies will now have to disclose Cumulative Default Rates (CDR) based on long-run averages (of 10 financial years) and short-run averages (of the recent 24, 36, and 48 months)
  • Credit rating agencies will have to provide a Probabilistic Default (PD) benchmark for each rating category for various periods such as 1-year, 2-year and 3-year cumulative default rates for long-run as well as short-run averages.
  • In case of any credit enhancement, credit rating agencies will now have to explicitly assign the suffix CE' (Credit Enhancement) to the rating of instruments.
  • Agencies must disclose sensitivity of the rating in the press release, indicating probable changes in the rating subject to the performance of the company.
  • Now onwards, rating agencies will also have to consider liquidity parameters and the spreads in the bond yields of the rated instrument and that of its relevant benchmark as material factors that could trigger a change in the rating.

While the regulator is busy revamping the regulatory framework, some credit rating agencies have initiated an internal investigation based on complaints they received by the whistle-blower. Such instances highlight that there were possibly some compromises in the credit evaluation processes at the rating agencies.

Will anything change for the investors?

Capital market regulator's recent attempts to tighten up screws around credit rating agencies may bring in more discipline and transparency in the credit rating processes. Nonetheless, it's crucial to see if the suggested regulatory reforms and changes in the corporate structure will produce desired results. After all, the rating agencies will depend on their customers for their revenues. Thus, the conflict of interest won't disappear entirely.

Since capital market regulator is pondering on nominating directors on the boards of credit rating agencies, can we treat ratings assigned as those endorsed by the regulator? While, 'no' would be the obvious answer to this, but investors might misinterpret this change in the corporate structure.

Finally, no matter how recklessly credit rating agencies missed the deteriorating conditions in the bond market, mutual funds can't hold the rating agencies entirely responsible for the on-going debt market fiasco. There can't be any substitute for the independent credit evaluation by the fund houses. Credit ratings shall be treated just like a guiding force. No mutual fund shall base its investment decision to the credit ratings.

Remember these points if you are a debt fund investor:

  • Investing in debt funds isn't risk-free.
  • You shouldn't invest in schemes only because they have outperformed their benchmarks in the recent past.
  • Consider your financial goals, risk appetite, and time horizon before investing in any debt-oriented scheme.
  • Following your personalised asset allocation is the key.
  • Ideally, you should invest only in schemes that have a maturity profile matching your time horizon, to avoid negative surprises.
  • Last but not least, invest only in debt schemes offered by mutual fund houses which follow robust investment processes and have adequate risk management systems in place.

Editor's note: Do you want to own an Ultimate Strategic Ready-made Portfolio based on the core and satellite approach of investing?

Yes?

PersonalFN offers you this great opportunity: The 2019 Edition of PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025".

If you're looking for "high investment gains at relatively moderate risk", this report is extremely worthy.

In this report, PersonalFN will provide you with a ready-made portfolio of its top equity mutual funds schemes for 2025 that have the ability to generate lucrative returns over the long term.

PersonalFN's "The Strategic Funds Portfolio for 2025" is geared to potentially multiply your wealth in the years to come. Subscribe now!

Author: PersonalFN Content & Research Team

This article first appeared on Certified Financial Guardian.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Should The Rating Agencies Be Blamed For This Credit Crisis?". Click here!

  

More Views on News

How We Closed Our Eicher Motors Trade at a Profit of Nearly 7% in Just 9 Days (Profit Hunter)

Oct 18, 2019

I closed my latest auto stock recommendation with gains of 6.91% in 9 days.

How Amazon and Flipkart Can Help You Become a Better Investor (The 5 Minute Wrapup)

Oct 18, 2019

Like online discounts, the stock markets offers discounts too every now and then. Here is what a retail investor needs to do when it happens...

Why the Saudis Are in a Mighty Hurry to Launch the Aramco IPO? podcast (Views On News)

Oct 17, 2019

What does Saudi Aramco IPO mean for crude oil prices?

Are SIPs a Sure Shot Way to Achieve Your Financial Goals? (Outside View)

Oct 17, 2019

PersonalFN explains whether SIP investment can lead you accurately to achieve your goals.

Here's How The Merger Of Bank Of Baroda And BNP Paribas' Mutual Fund Business Impact Investors (Outside View)

Oct 17, 2019

PersonalFN explains how the merger of Bank of Baroda and BNP Paribas' asset management units impact investors.

More Views on News

Most Popular

My 3 Best Small-cap Stocks to Get Rich in this Market Rebound (Profit Hunter)

Oct 14, 2019

This is once in a decade opportunity to make a killing from smallcap rebound.

Finally, Is the Share Price of Yes Bank Ready for a Rebound? (The 5 Minute Wrapup)

Oct 7, 2019

Here's what every individual investor must know about Yes Bank...

Two Stocks to Buy in the Great Indian Festival (Profit Hunter)

Oct 11, 2019

Discounts are not just limited to E-tailers. You can buy stocks at 50% off too. Here are two stocks to buy now.

Buy these 3 Stocks for Rebound Riches

Oct 18, 2019

Equitymaster's smallcap guru and editor of Hidden Treasure, Richa Agarwal, talks to us about the rebound in the stock market, and the best stocks to profit from it. Listen in...

The One Stock I Like in this Market (The 5 Minute Wrapup)

Oct 10, 2019

There are rare periods in markets when you get good quality stocks at attractive valuations. Is this one such period?

More

Get the Indian Stock Market's
Most Profitable Ideas

How To Beat Sensex Guide 2020
Get our special report, How to Beat Sensex Nearly 3X Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Oct 18, 2019 (Close)

MARKET STATS