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