Credit ratings play a very important
role in providing guidance about the financial credibility of companies seeking
public funds. Therefore, Credit Rating Agencies (CRA) bear a heavy
responsibility to come out with credible credit ratings. Ratings dispensed by
CRAs have the ability to garner / manipulate the trading and financial
transactions contemplated through instruments by the companies in the capital
markets.

Given such pivotal role of the ratings
issued by CRAs and the bearing such ratings will have on the concert of the
capital market – the Securities Exchange Board of India (SEBI) has issued a
directive to the CRAs not to pull out instruments ratings brusquely and be more
diligent in their evaluation / assessment.

The directive is issued in the light
of unforeseen downgraded ratings of certain companies in the last few years due
to the reason of CRAs either suspended or downgraded ratings of such companies
brusquely.

The underlying intent of the directive
is that no CRA will be allowed to suspend the ratings of an instrument unless
and until the CRA rated the said instrument for a minimum period of 5 years or
50% of the instrument tenure.

SEBI also issued the following
directives in relation to CRAs:

·    Net worth
requirement for rating agencies is increased to Rs 25 crore from the current Rs
5 crore.

·    Promoter
entity needs to preserve at least 25 percent stake in the rating agency for a
period of three years.

·    No CRA is
allowed to hold more than 10% stake in peer CRA.

·    Segregation
of non-core activities from core activities (rating of financial instruments
and economic/ financial research) to a separate entity to avoid conflict of
interest.

SEBI has also alerted fund houses
about investment in debt instruments at their own risk and not to rely on
ratings issued by CRA.

The directives are dispensed with the
objective to prevent the abrupt credit ratings and make CRA more responsible
and accountable for the ratings issued by them – ultimately to safeguard the
stability of the capital markets and interests of the stakeholders involved.

Research and inputs by Paruchuri
Bawanth Mohan

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About the author :

Bhumesh Verma is a lawyer with over 2 decades of experience in advising domestic and international clients on corporate transactions (M&A, Venture Capital, Private Equity, Startups, corporate advisory, etc.) and features in “The A-List – India’s Top 100 Lawyers” by India Business Law Journal. He keeps writing frequently on FDI, M&A and other corporate matters and is a guest faculty as well. He can be reached at [email protected].