Sebi mulls checks on 'rating shopping' by companies

Concerned over companies keeping under wraps their bad credit ratings and publicising only the favourable ones, market watchdog the Securities and Exchange Board of India (Sebi) is mulling how to curb this ‘rating shopping’ menace.

Sebi is considering making it mandatory for credit rating agencies (CRAs) to make public even those ratings that are not acceptable to the companies getting rated, sources close to the development said.

At the same time, the CRAs, which are paid by the companies themselves for assigning them a rating, may be asked to put in place clear and effective ‘Chinese Walls’ between their analytical and business development teams, sources said. Other steps being considered include allowing CRAs to offer unsolicited ratings, asking the companies to get themselves or their securities rated from two or more competing agencies, and enhancing disclosure on relationships between CRAs and clients. However, CRAs would have to make it clear to investors whether the ratings were rejected by the companies and/or were unsolicited, sources said.

CRAs are organisations that rate credit worthiness of companies or their debt instruments after conducting due-diligence of their financial accounts. The current regulations in India give companies an option to accept or reject a rating assigned by CRAs, which in turn disseminate only the accepted ratings. If a rating is not accepted, CRAs keep it confidential. However, a panel constituted by Sebi for revising the regulations governing CRAs found the current practice might be leading into ‘rating shopping’ by many companies.

It discovered that companies which don’t get a favourable rating from a CRA approach their rivals, seeking more positive assessment.

Subsequently, the panel suggested Sebi could make it mandatory for CRAs to disseminate all ratings issued by it, regardless of their acceptance or rejection by clients.

Sources said however that mandatory publication of rejected ratings might not be immediate but should be done within a year of the rating.

In the past, concerns have been raised that mandatory disclosure of all ratings could lead to the companies avoiding CRAs with uncompromising reputation.

However, it was felt that compulsory dissemination of unaccepted ratings would protect investors and help conscientious CRAs gain in the long run, as market would eventually reject the CRAs compromising on quality.

Sources said that Sebi might also ask the CRAs to completely separate their analytical and business development teams — the two divisions which are engaged in assigning ratings and getting clients, respectively.

Rating agencies globally follow an ‘issuer-pays’ rating model, despite it having a structural conflict of interest, as the entity being rated itself pays for the exercise.

In order to help investors know the relationship between the rating agency and the rated company, Sebi is considering tightening the disclosure norms for the CRAs.

Regulators in the US and Europe have recently cracked whip on ‘rating shopping’, as the failure of over-rated financial institutions and securities is believed to be a key reasons for the recent global financial meltdown, from which the world economy is yet to recover fully.

The US regulator Securities and Exchange Commission (SEC) recently decided to amend its rules for better oversight of CRAs and to improve the quality of credit ratings.

To curb the menace of ‘rating shopping’ the SEC has also allowed competing credit rating agencies to offer unsolicited ratings, by granting them access to the necessary information for the underlying information.