Tighter disclosure norms for ratings firms to benefit structured products

Details about explicit guarantees will lead to higher transparency

Structured instruments, such as those involved in loans against share transactions that have led to turbulence in mutual funds, will have to follow tighter disclosure requirements under the proposed regulatory norms by the Securities and Exchange Board of India (Sebi).

The regulator on Thursday directed rating firms to put out additional information on structured finance instruments, which include such entities. 

Instruments with an underlying security (backed by loans or other assets), are currently classified together with those that do not have such backing. The reason for the similar classification is that the parent firm or a third party provides an explicit guarantee. 

These will have to explicitly carry a label on such ‘credit enhancement’. 

“The…rating to such instruments is based on some form of explicit credit enhancement from a third party/parent/group company, in the form of corporate guarantee/letter of comfort/ pledge of shares, etc. There is a need to differentiate ratings of such instruments from the ratings of securitised debt and asset-backed transactions,” said the note by Sebi. They will also have to provide information on the rating that would have been otherwise assigned without such support. 

“The CRAs (credit rating agencies) shall devise a model to assess the adequacy of credit enhancement structure under various scenarios, including stress scenarios. Such assessment shall also be disclosed,” it added.

Amit Tandon, founder and managing director of advisory firm Institutional Investor Advisory Services India, and former head of a rating agency, said the new norms will bring in more clarity to ratings and in their interpretation. Further, there will be greater consistency in the data that the various rating agencies publish.

“The fact that they have a separate credit enhancement suffix gives investors a better sense regarding the relationship between the entity being rated and the one offering support. Importantly, agencies will now communicate what the rating would have been, without such support,” he said.

The Essel Group had difficulty paying for loan against share instruments, in January.  Multiple MFs had exposure worth thousands of crores to the group. A March 2019 report from Crisil pegged the value of money through such loan against share instruments across companies at Rs 38,000 crore. 

“90 per cent of the rated pledge debt has transaction cover of less than 2x. This is in sharp contrast to the RBI’s prescription of a minimum collateral cover of 2 times for lending against shares by banks and NBFCs,” it said. 

Changes in the rule book

How ratings work for structured products now: Instruments with or without an underlying asset are clubbed in the same category

What will change: Instruments with external/parental support will be labelled as having credit enhancement

What else rating agencies need to do: Provide more information on defaults for various rating categories on a periodic basis, along with historical cumulative default rates

Benchmark to be followed: Regulator has mooted benchmarks for probability of default across categories, based on historic ratings

Other disclosures: Factors that could impact ratings (rating sensitivities) and liquidity indicators for the entity involved