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The extent of independence of the ratings committee and quality of analysis warrant close watch
The IL&FS saga has brought the spotlight back on credit ratings agencies for all wrong reasons. The last time such a situation arose was in late 2015, when auto ancillary company Amtek Auto defaulted on the repayment of its bonds. The aftermath of the Amtek episode witnessed a series of measures from SEBI aimed at strengthening the ratings process and enhancing the standards of credit ratings agencies. While this has helped in standardising the processes across the agencies and plugging some obvious loopholes like suspension of ratings (to avoid a downgrade) and lack of timely updates, the IL&FS episode reminds us that there are issues that still need to be addressed before reliance on credit ratings can increase further. Among other things, there are two elements that warrant a close examination, given their susceptibility to impact the quality of a rating. These are (a) the extent of independence of the ratings committee and (b) quality of the analysis. It may also be useful to clearly delineate the bond rating and bank loan rating businesses, as the users of these two products are different. The investor who uses the bond rating product does not have any window into the issuer’s business, whereas the banker who uses the bank loan rating has a more detailed view of the borrower’s business — in most cases a view which is better and deeper that the ratings agencies themselves. Credit ratings is a business where the better you perform professionally, it is more likely that your client (read the entity that is rated) may not be too happy! It is therefore essential to incentivise rigorous analysis so that the pressure of improved financial performance does not force them to cut corners. This may be done by standardising the fee structure at least in the case of bond ratings.
Having external experts on the ratings committee for large issues and bringing in safeguards to ensure that the analytical rigour is not diluted are some steps that could help rating agencies regain their credibility.
Source : https://www.thehindu.com/todays-paper/tp-business/of-credit-rating-agencies-and-credibility/article25533908.ece
