The credit crisis has exposed weaknesses in many financial intermediaries. How can rating agencies ensure their views are more accurate and unbiased? Despite due diligence, there is always scope for improvement. Credit rating agencies (CRA) do not carry out a separate audit but takes cognisance of the information available from annual reports, submissions from management, secondary sources and opinions from lenders/ investors.
As such, the quality of information plays an important role in the rating outcome. A CRA, however, might make necessary adjustments to reported figures to rate a company.
Nonetheless, the same cannot be construed as a substitute for an exhaustive audit or a fraud detection exercise. In a wider perspective, CRAs could consider avoiding potential conflict of interest generated by having ancillary business along with ratings business. At CARE we have stopped undertaking any advisory business. All new ratings are assigned by external rating committee.
Are the rating agencies facing a crisis of confidence after the significant default on AAA rated structured debt? Is the call for more competition justified?
At this point, it is pertinent to mention the relative stability of structured product ratings in India. Increased competition can help only to a limited extent beyond which the law of diminishing returns applies.
There are already five Sebi recognised CRAs in India compared to four main-line agencies in the US. Competition is welcome but we should see that it does not lead to `rating shopping’.
Would increased regulatory oversight be the answer?
CRAs are already regulated and subject to greater scrutiny than most other opinion providers. Increased regulatory oversight is not a panacea. The entire financial system, including intermediaries, has to graduate towards greater transparency. Nevertheless, we welcome any regulation to improve the rating standards.
Conflict of interest with issuers paying for credit rating has been a subject of raging debate. Would investor paid or a government-funded model work in India?
If the ratings could be linked to the fees paid by the issuer, only AAAs would dominate the rating list. All accepted ratings are in the public domain and disseminated on the CRA’s website.
Issuer-pays- model ensures that clients provide requisite information for the initial rating and especially during the surveillance. In the investor-pays model, it may be difficult for an investor to get requisite information from the issuer during the surveillance process.
Further, the issuer-pays model ensures that ratings are available to all lenders/investors. Conversely, in an investor-pays model, the investor may not want to share the rating outcome with others and there could be pressure to avoid downgrades to avoid mark-to-market losses for the investor.
The issuer-pays model has not prevented these downgrades — in the past one year, downgrades have outnumbered upgrades. Thus, the entire debate is misplaced.
Mandatory IPO grading has been criticised, as it is based on parameters such a short-term price performance. Are these investor concerns misplaced?
Investment decisions tend to be governed by the risk-return relationship and risk tolerance of an investor. Besides, valuation also plays an important role in determining the attractiveness of an investment proposition. IPO grading, being focused on the relative fundamentals, does not comment on the above.
It has to be necessarily seen as an opinion, which should be juxtaposed against the aforementioned factors like risk-return principle and risk tolerance of an investor.
Also, the short-term share performance is largely driven by market sentiments and not by long-term fundamentals. It should not be seen as an end in itself. It is too early to see the impact of IPO grading as it is hardly two years old. Some of the graded entities do not have even a one-year listing record.