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
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 firstname.lastname@example.org.