Sebi asks rating agencies to explain failure in detecting IL&FS crisis

The Securities and Exchange Board of India (Sebi) has issued notices to credit rating agencies seeking an explanation for their failure to spot the liquidity crisis brewing at the debt-ridden Infrastructure Leasing and Financial Services (IL&FS). 

Icra, Care and India Ratings are among agencies that have been asked to provide reasons for missing out early signs of the crisis at the infrastructure financier. 

These rating agencies have been monitoring the activities of IL&FS, the group’s holding company and its subsidiaries. Moreover, the markets regulator had called a meeting with senior officials of rating agencies last week to discuss measures to strengthen rating standards and disclosures.

In a response to an email query, Icra said it is cooperating with the regulatory agencies. “Being a responsible organisation, we are providing full support to regulatory agencies in this matter.” Icra, however, denied receiving a show-cause notice by Sebi.

Care Ratings spokesperson, in its response, said, “The company is in constant dialogue on various issues relating to ratings in a proactive way with the regulators and other authorities. Under these circumstances, we do think it is improper to comment on any specific issue.”

India Ratings and Research declined to comment on the matter.

People in the know say that rating agencies have responded to the regulator, explaining their stance on why they failed to act on time.

An official from a rating agency said the regulator sought feedback on how to avoid a repeat of this situation and measures needed to improve detection.

“The role and mandate of a rating agency is limited. Most of the agencies are performing their functions according to the regulatory framework,” the person added.

These rating agencies had rated IL&FS debentures as AAA, its highest level of creditworthiness, until its subsidiary IL&FS Transportation Networks defaulted in June.

Sebi is of the view that rating agencies should be able to pick up early signs of a crisis and issue a rating watch, followed by rating action. The regulator felt that they have failed to act in an apt manner in the IL&FS case. The rating for the IL&FS group had gone straight from AAA to default.

In a recent speech, Sebi chairman Ajay Tyagi said the default at IL&FS had severely impacted the trust and confidence of investors. He added that the IL&FS episode highlighted how complex subsidiary structures can mask the end use of funds.

Sources said at last week’s meeting that Sebi told rating agencies to explicitly disclose the kind of back up a company enjoys from the promoter group – whether it is government or private.

Moreover, rating agencies have been directed to be more vigilant and conduct periodic reviews of companies when their bond prices see unusual movement or changes in spreads.

Sources said the regulator may soon announce more changes to the regulatory framework for rating agencies.

Last year, Sebi had taken similar action against rating agencies over their decision to suspend ratings of beleaguered Amtek Auto without following the due process.