Regulation Of Credit Rating Agencies In India
Updated: Jan 22
An effective regulation to regulate the conduct of Credit Rating Agencies (CRA), is essential so that accountability and efficiency in the credit rating system can be maintained. Credit rating determines the risk that may be associated with the timely payment of principal amount and interest on a debt instrument. It is an opinion of a recognized entity that determines the ability of a debtor to pay his debts and the likelihood of default. It allows the investors to form an educated decision by relying on such ratings as it reduces the headache of processing and analyzing extensive information regarding the debt instrument.
Credit Rating Agencies are usually involved in the rating of the following instruments:
· Debt securities
· Fixed deposits
· Structured debt obligations
· Short term debt instruments, like commercial papers.
In India, credit rating agencies are regulated by the Securities and Exchange Board of India (SEBI) through the SEBI (Credit Rating Agencies) Regulation, 1999, and periodical circulars issued thereunder.
Regulation of Credit Rating Agencies
The main features of SEBI (Credit Rating Agencies) Regulation, 1999 include:
Registration of CRA: Chapter II of the CRA Regulations lays down the provisions related to registration of credit rating agency with the Securities Exchange Board of India (hereafter referred to as Board). It mandates any credit rating agency to obtain a certificate of registration from the Board. It requires the applicant to have a minimum net worth of rupees five crores, with adequate infrastructure. It is essential that the applicant possesses professional competence, financial soundness, and a general reputation of fairness and integrity in the business transactions to the satisfaction of the Board. In the interest of the promoters, it is required that the applicant, his promoter, or any director should not be involved in any proceeding relating to the securities market, nor should they be convicted of an offence involving moral turpitude or any economic offence.
Obligations of the Credit Rating Agencies: Chapter III of the Regulations lay down the general code of conduct to be abided by the Credit Rating Agencies. Section 14 requires that the CRA should enter into an agreement with the client whose securities it proposes to rate, and the agreement should include the rights and liabilities of each party. The agreement should also include the fee to be charged by the CRA. The client should agree that the credit rating agency shall periodically review the rating during the tenure of the rated instrument. The provision imposes an obligation on the client that he shall provide full disclosure of the rating assigned to the client’s listed securities by any credit rating agency during the last three years.
Restriction on the rating of securities by promoters: Chapter IV of the Regulation imposes a certain obligation on the credit rating agencies not to rate any security that is issued by its promoter. Section 25 of the Regulation defines promoter as any person who holds ten per cent or more of the shares of the credit rating agency. Any security issued by an entity who is a borrower, a subsidiary or an associate of its promoter shall not be rated by such credit rating agency.
Inspection and investigation: The Securities Exchange Board of India (SEBI) under Regulation 29 has the right to appoint one or more persons as inspecting officers to undertake inspection or investigation of the books of account, records and documents of the credit rating agencies. Under Regulation 30, the Board is required to give a notice of at least ten days to the credit rating agency. Regulation 31 imposes an obligation on the credit rating agency whose affairs are being inspected to produce such books, accounts, and other documents in its custody or control and furnish such information and statements related to its rating activities as required by the investigating officer.
Valuation of MLDs not to be done by CRA
In September 2011, SEBI issued a circular on “Guidelines for Issue of Market Liked Debentures” (MLD Circular). Para 4(f)(1) of the circular stated that for the purpose of valuation of MLD, a third-party valuation agency shall be appointed which shall be a credit rating agency. However, pursuant to an amendment to CRA Regulations on May 30, 2018, a credit rating agency cannot carry out the valuation of instruments other than securities after May 30, 2020. Therefore, on July 13, 2020, SEBI introduced another circular regarding the valuation of Market Linked Debentures which states that the valuation for MLDs shall be carried out by an AMFI appointed agency, and not a credit rating agency.
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