For a long time, the credit raters have been in the news for the wrong reasons; both in India and abroad. In India, the issue first came up back during Lehman crisis but Indian rating agencies really came under fire for downgrading Amtek Auto in a single stroke. Later, the same case was repeated with IL&FS as well as DHFL. The recent SEBI proposals for rating agencies need to be seen in this light. Here is why!

Where raters faltered?

Over the last few years, the rating agencies have been criticized for various reasons. There have been allegations that the same rating agency offering rating services and consultancy to the corporates created a conflict of interest. Secondly, rating agencies had been quite impulsive in their actions. For example, in the case of bonds of IL&FS and DHFL, the downgrade from “A” rating to “Default” rating happened in a matter of days. The need of the hour was to build a better early warning system. Lastly, there was a major issue of data availability. Most rating agencies get the default data from the banks and that tends to come out after a certain time lag. Hence, by the time the actual news is factored into ratings, it is just too late. In the case of debt instrument the impact on yields and prices due to a shift in ratings is huge and that is why the responsibility on the rating agencies is a lot higher. SEBI is trying three ways to address this ratings challenge.

Probability of default

Under the new norms, rating agencies will also have to assign probability of default to each instrument with separate such probabilities to short term and long term instruments. This will be subjective but such a numerical expression of probability of default will make the rating agencies more accountable and also enable finer pricing. In fact, the rating agencies may now be a lot more cautious about assigning AAA ratings to bonds. That could be the takeaway.

Sensitivity to triggers

Another key disclosure that the rating agencies will have to make is the extent to which the ratings are sensitive to triggers. Such triggers could be macro based, sector based, stock based or market risk based. This sensitivity disclosure gives investors an idea as to when they can expect upgrades in the bonds and when they can expect some downgrades as a response to stimuli.

Bond spread deviation

An important rule now will be that rating agencies will have to treat any sharp shift in bond spreads / yields as a material event. It becomes more of a cause than just an effect and rating agencies will have to factor this into their calculations. It is hoped that these 3 shifts will make the functioning of raters more meaningful! ©