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With their role in rating the financial facilities of the debt-ridden IL&FS Group and Cox & Kings under its scanner, SEBI may prescribe a peer review of the ratings done by credit rating agencies (CRAs). The markets regulator will also take a hard look at the need for employee stock option plans (ESOP) for CRA employees.
Sharp rating downgrades of the financial facilities of the stressed companies may prompt the regulator to come up with a peer review mechanism akin to that of the Institute of Chartered Accountants of India (ICAI). This is to ensure that the rating assignments they undertake adhere to the highest technical, quality and ethical standards.
The recent downgrades have shaken the confidence of the financial system and investors about the reliability of the ratings. In this regard, the regulator may also seek rotation of CRAs for taking up rating assignments for India Inc.
Rotation of CRAs
Peer review and rotation of CRAs are important in the context of Grant Thornton India’s recent review of the e-mails of 11 key IL&FS Group representatives. It found that although the CRAs had concerns/issues with the operations of the group (including potential stress and liquidity indicators) between June 2012 and June 2018, the ratings assigned by them were consistently high. These were reversed/downgraded only after June-July 2018.
S Ravi, a practising CA, said the CRAs have not lived up to the expectations of the stakeholders. So, there is a need to put in place a peer review and rotation mechanism for reassuring the stakeholders about the reliability of credit ratings.
Market experts are of the view that ESOP for CRA employees creates an incentive for them to chase business to improve their company’s profitability and its stock valuation. If the ESOP element is taken out of their compensation equation and remuneration is sufficiently high, CRA employees can resist clients’ tactics to get favourable ratings by playing one agency against the other.
Self-regulation
Meanwhile, CRAs are expected to become more stringent with their rating process. They may conduct internal inspections, let go of rating assignments where adequate information is not provided by companies seeking rating, and insist on document trails.
The expected regulatory tightening, coupled with CRAs turning conservative, may see the universe of ‘AAA’ and ‘AA’ rated companies coming down, said a top rating agency official.
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