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Context

Securities and Exchange Board of India has released a consultation paper and sought feedback on a new set of rules to improve “market efficiency” and enhance “the governance, accountability and functioning of credit rating agencies”.

Will SEBI’s proposed rules improve the quality of credit rating services?

Credit rating agencies may be in a tough spot as Securities and Exchange Board of India continues to tighten the screws on them.

What are the provisions?

• New set of rules were drafted to improve “market efficiency” and enhance “the governance, accountability and functioning of credit rating agencies”.
• Among them are provisions to restrict cross-shareholding between rating agencies without regulatory approval to 10%, and increase the minimum net worth requirement for existing and new agencies from Rs. 5 crore to Rs. 50 crore.
• Another mandates at least five years’ experience for promoters of rating agencies.
• SEBI has proposed disclosure norms to improve investor awareness about the operations of rating agencies.

Rationale of the proposed rules

• The spin-off of non-core operations of rating agencies will allow SEBI to focus on regulating just their credit rating operations.
• SEBI has spelt out its rationale for proposing each of the rules.
• SEBI’s predominant concern, apart from improving the information available to investors, seems to be to prevent rating agencies from resorting to collusion in reaching decisions.

What could be the possible impact of the new rules on credit rating services in India?

• The new rules may not have any substantial impact on the quality of credit rating in India.
• The intended effects of the rules sound convincing. What is unclear are their unintended effects on competition in the rating space.
• Also, how the rules will address the problem of “rating shopping” that plagues the business of credit rating in the country is unknown.
• The present business model of rating agencies is seen to allow considerable room for issuers of securities to shop for a favourable rating or avoid negative ratings by severing their ties with these agencies.
• Prudential regulation is thus justified to tackle this problem.
• This criticism, however, ignores the reputational damage these agencies suffer after each corporate default.
• Repeated failures have not affected the business of rating agencies, primarily due to the lack of alternative service providers who can help out investors.
• Individual creditors have thus had to trust the ratings of the existing rating agencies at their own peril, even after repeated crises.
• As is well-known today, the Indian credit rating market is an oligopolistic one due to the high barriers to entry.
• SEBI’s proposed move to impose further quality requirements on rating agencies is unlikely to change things for the better, or raise further barriers.

Way forward

• The way forward lies in making it easier for new players to enter the credit rating space and compete against incumbents.
• This will go a long way towards making credit rating agencies actually serve creditors rather than borrowers.