Sebi tightens disclosure standards of rating agencieshttps://indianexpress.com/article/business/sebi-tightens-disclosure-standards-of-rating-agencies-5779766/

Sebi tightens disclosure standards of rating agencies

The regulator has also directed CRAs to disclose sensitive factors that could potentially impact the rating of the instruments which include financials and sector specific information.

Sebi, banks defaults, Securities and Exchange Board of India, credit rating agencies, IL&FS, IL&FS crisis, IL&FS debt, Indian express
Rise in instances of debt defaults, rating downgrades. (File Photo)

With the financial sector roiling under a spate of defaults and rating downgrades, the Securities and Exchange Board of India (Sebi) on Thursday asked credit rating agencies (CRAs) to start disclosing a probability of default (PD) benchmark for the companies rated by them. The regulator has also directed CRAs to disclose sensitive factors that could potentially impact the rating of the instruments which include financials and sector specific information.

In a circular issued on Thursday, the regulator said CRAs, in consultation with Sebi, should prepare and disclose standardised and uniform PD benchmarks for each rating category on their website for 1-year, 2-year and 3-year cumulative default rates, both for short-run and long-run. The Sebi’s directive follows a series of defaults involving IL&FS and Jet Airways in last few months.

Rating agencies had given AAA rating to IL&FS at a time when the firm was in dire financial conditions. As a result, investors and lenders didn’t get financial status of the company at the right time which eventually led to defaults on repayments by IL&FS. Besides, there is intense competition in the credit rating industry which has tended to dilute the disclosure standards favouring the issuers.

As per the Sebi, CRAs should take marginal default rate (MDR) approach, using monthly static pool, for last 10-year period. “The short-run benchmarks may account for spikes due to economic cycles or unforeseen events, and hence, may have a wider band. The same should be computed based on a confidence interval of 99.7 per cent over weighted average of 1-year, 2-year and 3-year default rates pertaining to last 10- year period, making adjustments to achieve ordinality, wherever required,” it said.

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“The long-run benchmarks iron out economic cycles since these are over a longer tenure (10-year period) and may, therefore, be narrower. The same should be computed based on a confidence interval of 95 per cent over the weighted average default rates (1-year, 2-year and 3-year) pertaining to 10-year period, making adjustments to achieve ordinality, wherever required,” Sebi said.

According to the Sebi, the same format should be adjusted for rating withdrawals. For securities, rating should be included in computation of default rates till completion of cohort or maturity of the instrument, whichever is earlier. “Ratings of non-cooperative issuers should be included in the cohort under the rating category in which the instrument is currently being rated,” it said.

Explained

Investors, lenders to get idea about a firm’s probability of default

The Sebi’s latest directive to rating agencies follows a series of defaults involving IL&FS and Jet Airways in the last few months. Rating agencies, which were normally late in identifying the worsening financial status of a company, will have to disclose a probability of default benchmark for the companies rated by them. This step is likely to aid investors and lenders to get an idea about the probability of default by a company, enabling them to take the right decision before the situation turns grim.

In order to make the disclosures meaningful to the end users, the Sebi has also decided to mandate disclosure of liquidity indicators using standardised terminology. Accordingly, CRAs should also disclose the liquidity indictors using one of the following indicators and give an explanation thereon: Superior/ strong, adequate, stretched and poor, Sebi said.

According to a recent Crisil report, with India’s sovereign rating in the BBB category serving as a ceiling, the ratings on nearly 32,500 Indian firms — including ‘AAA’ and ‘AA’ firms — will be boxed on a far narrow bound between ‘BBB’ category and ‘D’ on global scale. In other words, while as much 85-90 per cent of bond issuances in India are by ‘AAA’ and ‘AA’ rated companies, if they are assessed on the global scale, their ratings would be rated below the ‘BBB’ category. In India, ‘AAA’ rated companies have defaulted, the latest example being IL&FS which was rated ‘AAA’ by rating agencies.

In a recent meeting, RBI governor Shaktikanta Das questioned dual practice of rating agencies to rate a bond as well as decide its valuation which is used by mutual funds to calculate net asset value (NAV) of an MF scheme. It’s unlikely that a rating agency, which carries out both businesses, will downgrade security of an issuer.