HYDERABAD: Coming down heavily on the lax regulatory framework for Credit Rating Agencies (CRAs), the Parliamentary Standing Committee on Finance, headed by M Veerappa Moily, favoured a unique ‘investor pays’ or ‘regulator pays’ model for rating firms. Besides, it also suggested mandatory rotation of CRAs and considering ratings carried by dual or multiple firms.
The move comes in the backdrop of IL&FS debt default fiasco; its securities were backed by CRAs until the crisis unfolded. Currently, there are seven registered CRAs, of which three are listed.
In line with global practices, currently credit ratings are initiated by the borrower under the ‘issuer pays’ model. Here, the entity issuing the financial instrument pays CRAs upfront to rate the underlying securities, potentially leading to a ‘conflict of interest’ and compromise the quality of analysis or the objectivity of the ratings. “The Committee would therefore suggest that the Ministry/Regulator may consider other options as well, such as ‘investor pays model’ or ‘regulator pays model’ after weighing the relevant pros and cons,” it noted. Alternately, it suggested regulators SEBI and RBI to determine in consultation with CRAs an appropriate rating fee structure, payable by the issuer.
This is a departure from the previous committee recommendations, most notably by the Krishnan Committee on Comprehensive Regulation for Credit Rating Agencies (2009), which favoured the ‘issuer pays model’ saying other alternatives aren’t desirable or feasible as they lead to greater problems. However, it recommended transparency regarding disclosure of conflict of interest and the fees received.
Incidentally, the role of CRAs in advance economies too was questioned following the collapse of Lehman Bros and other institutions of repute, raising concerns about the level of due diligence by CRAs.
Meanwhile, the committee suggested exploring the mandatory rotation of rating agencies along the lines of statutory auditors to avoid the pitfalls of long association between the issuer and the CRA and particularly considering the recent instances of failure of CRAs in sensing simmering ‘trouble’ in their client-entities and eliminate complacency. It also suggested making rating compulsorily carried out by more than one agency (dual or multiple), particularly for debt instruments/bank credit involving large amounts, say more than `100 crore.
“This will help the investors to access different positions/viewpoints for an informed decision. On the same premise, the committee would also suggest that the existing threshold for registration of CRAs may also be suitably lowered/ modified with a view to encouraging more entities, particularly start-ups with the requisite capability and expertise to become part of the industry,” the committee noted.