MUMBAI: To make credit ratings more relevant to assess in-built risks, markets regulator Securities and Exchange Board of India (SEBI) has directed Credit Rating Agencies (CRA) to put out ‘Probability of Default’ (PD) benchmarks, set standard procedures for computation of default rates, liquidity position and mandated disclosure of rating sensitivity. In addition, the agencies have also been asked to disclose the probability of defaults based on the default record for all financial instruments rated.
“In order to enable investors to discern the performance of a CRA vis-a-vis a standardised PD benchmark scale, CRAs, in consultation with SEBI, shall prepare and disclose standardised and uniform PD benchmarks for each rating category on their website, for one-year, two-year and three-year cumulative default rates, both for short-run and long-run,” SEBI said in a circular issued on Thursday. CRAs have been asked to review their rating methodologies in order to align the same with the proposed PD benchmarks.
In November 2018, after the IL&FS crisis triggered a debate on overnight downgrade of highly rated paper to junk, SEBI had tightened the norms for credit rating agencies and asked them to track the liquidity position of the companies rated, the market indicators available from bond spreads etc., Further to that, now SEBI has asked CRAs to indicate companies as ‘Superior/Strong’, ‘Adequate’, ‘Stretched’, or ‘Poor’ in terms of their liquidity profile based on their liquid investments, unutilised credit lines, liquidity coverage ratio etc.,
Apart from tracking liquidity position, SEBI had also asked CRAs to track the bond market movement of rated instrument to gauge the risk perception from the sharp deviations in bond spreads of debt instruments vis-a-vis the benchmark yield. CRAs have been directed to devise a model to track such deviations in bond spreads.
Moreover, CRAs have been asked to have a specific section on ‘Rating Sensitivities’ to explain the performance levels and the trigger for rating change, upward or downward. Disclosure of factors to which the rating is sensitive is critical for end users to understand the factors that would impact the credit worthiness of the entity, the regulator said. “Such factors shall be disclosed in quantitative terms to the extent possible, discernible to the investors, and should not read like a general risk factor,” SEBI added.
Making rating agencies transparent
In order to improve transparency, the credit ratings agencies shall have a specific section on ‘Rating Sensitivities’ in the press release which shall explain the broad level of operating and/ or financial performance levels that could trigger a rating change, upward and downward, Sebi said in a circular on Thursday