Debt default bogey forces SEBI to tighten screws on rating firms

PALAK SHAH Updated - December 06, 2021 at 09:35 PM.

Credit rating agencies told to focus on risk factors that are specific to debt issuer

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The ticking time bomb of debt defaults has lead the Securities and Exchange Board of India (SEBI) to put in place a rigorous disclosure regime for credit rating agencies (CRAs).

In their score card relating to a particular issuer, the CRAs now have to specify upfront key details, which they think could lead to a default. They should also provide their rationale for their rating.

Public funds in India mainly invest in debt instruments based on ratings from CRAs, which now have to list out sensitive factors, including financials and sectoral details, that could impact the rating of a debt instrument.

They should also delineate various probabilities that could constitute a default. Most importantly, the exercise should not look like a listing of general risk factors but stress on areas specific to the debt issuer.

“In order to enable investors to discern the performance of a CRA, vis-à-vis a standardised Probability of Default (PD), benchmark scale, the CRAs, in consultation with SEBI, shall prepare and disclose standardised and uniform PD benchmarks for each rating category on their website for one-year, two-year and three-year cumulative default rates, both for short-run and long-run,” SEBI said in its guidelines.

 

Crisis situations

Defaults or crisis-like situations at entities such as IL&FS, DHFL, Essel Group, Yes Bank and Reliance Anil Ambani Group, where debt instruments were rated AAA or equivalent at the time of investment and de-rated later have amplified the shoddy job done by CRAs.

With the new disclosure norms, SEBI is attempting to bring in global practices, as credit decisions in large markets are based on criteria including PD, which would provide the likelihood of default over the years, and tracking deviation of bond spreads.

The latter is a market phenomenon wherein increasing bond spreads could forecast potential trouble. SEBI had already asked CRAs to track deviation in bond spreads from November last year.

Rating sensitivities

The disclosure of factors which could impact the rating is critical to gauge the credit-worthiness of an entity. Hence, in order to improve transparency, the CRA shall have a specific section on ‘Rating Sensitivities’ in the ‘press release’ which shall broadly outline operating and/or financial performance levels that could trigger a rating change, upward and downward. Such factors shall be disclosed in quantitative terms to the extent possible, discernible to the investors, and should not read like a general risk factor, SEBI said.

Published on June 13, 2019 16:58