Regulation of Credit Rating Agencies – A Comparative Analysis across India, US and EU

Credit rating agencies (CRA) provide independent assessments of credit risk for various debt instruments and borrower institutions using established frameworks for the same in return for a fee. CRAs have recently been in the news for their role in triggering large scale defaults of IL&FS, and this has prompted calls for an overhaul of CRA regulation design and supervisory processes. In this post, we compare regulatory approaches that CRAs are subjected to across 3 jurisdictions (India, the United States and European Union) and contrast major differences, if any, and provide some commentary on what India can consider.

Key lessons for India

SEBI was one of the first few regulators to put in place an effective and comprehensive regulation for CRAs, unlike in the US and Europe, which saw CRA regulations only recently[1]. The comparison above brings out a few areas where the regulations need to be strengthened further to ensure that the CRAs’ credit rating actions are timely, consistent, independent, objective, and of the highest quality.^[2]

1. Conflict of interests – Many regulations have been put in place to ensure that the conflicts of interest arising out of issuer-pay compensation model do not affect the quality of ratings provided by the rating agencies. However, there are no regulations which directly address the issue of a long term relationship being developed between the CRA or its employees and the issuer.^[3] Restriction on the contractual duration between the CRA and the issuer and rotation of employees involved in the rating process periodically has been seen as one way to address this issue in the US and EU which is currently missing in the Indian regulatory regime. However, there have been news reports suggesting that SEBI is already considering mandating the rotation of CRAs[4].
2. Ratings shopping – Ratings shopping has been identified as a problem where the issuer selects rating agencies that will assign the highest rating to their issues.^[5] A number of regulations have been adopted to address this issue, including enhanced disclosure norms and the prohibition on engaging in certain activities. While SEBI requires the rating agencies to disclose all ratings regardless of whether the issuer accepted them, there is no common platform on which these ratings published by different rating agencies on the same issuance can be found. Such a platform, as required to be established by ESMA in EU, can enable investors to make informed decisions in addition to deterring the issuers from ratings shopping.^[6]
3. Accountability to investors – In India, currently, where CRAs contravene any of the provisions of the regulations, SEBI is empowered to penalise as per the provisions of Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.^[7] However, unlike in the US and the EU, where the CRAs can be held accountable through a civil liability regime, there is no direct remedy available to persons aggrieved by the actions taken by the CRAs in India.^[8]
4. Timeliness – Rating action (upgrade, downgrade, affirmation) can be mandated on the occurrence of endogenous corporate events such as potential M&As, large capex & new projects (criteria to be defined), capital structure changes etc. and exogenous corporate events like short seller attacks, whistleblower reports and wherever applicable, sustained (to be defined) divergence of bond implied ratings and those assigned by CRAs. In other words, when material information gets presented, and if the CRA’s views on the rating remain unchanged, an onus can be placed on CRAs to explain their position within a given timeframe.

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References

• Congressional Research Service. (2006). Credit Rating Agency Reform Act of 2006.
• European Securities and Markets Authority. (2018). CRA Authorisation.
• European Union Law. (2006). Communication from the Commission on Credit Rating Agencies (2006/C 59/02). Official Journal of the European Union.
• European Union Law. (2006). Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (recast). Official Journal of the European Union.
• European Union Law. (2009). Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies. Official Journal of the European Union.
• European Union Law. (2011). Regulation (EU) No 513/2011 of the European Parliament and of the Council of 11 May 2011 amending Regulation (EC) No 1060/2009 on credit rating agencies. Official Journal of the European Union.
• European Commission. (2013). New rules on credit rating agencies (CRAs) enter into force – frequently asked questions.
• European Union Law. (2013). Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies. Official Journal of the European Union.
• Ministry of Finance, Capital Markets Division. (2009). Report of the Committee on Comprehensive Regulation for Credit Rating Agencies. Securities and Exchange Board of India.
• Prakash, Shreya, Aditya Aditya & Shreya Garg. (2017). Regulations of Credit Rating Agencies in India. Vidhi Centre for Legal Policy.
• Securities and Exchange Board of India. (2018). Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 [Last amended on September 11, 2018].
• Securities and Exchange Board of India. (2018). Registered intermediaries as on date Dec 21, 2018).
• Securities and Exchange Board of India. (2018). Master Circular for Credit Rating Agencies.
• Securities and Exchange Board of India. (2018). Guidelines for Enhanced Disclosures by Credit Rating Agencies (CRAs).
• U.S Government Publishing Office. (2006). Dodd-Frank Wall Street Reform and Consumer Protection Act.
• U.S Government Publishing Office. (2018). Electronic Code of Federal Regulations.
• U.S. Securities and Exchange Commission. Current NRSROs.
• U.S. Securities and Exchange Commission. (2006). PUBLIC LAW 109–291—SEPT. 29, 2006.

[1] Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, December 2009, Ministry of Finance, GoI

^[2] European Union Law. (2006). Communication from the Commission on Credit Rating Agencies (2006/C 59/02). Official Journal of the European Union.

^[3] Prakash, Shreya et al. (2017). Regulations of Credit Rating Agencies in India. Vidhi Centre for Legal Policy.

[4] https://economictimes.indiatimes.com/markets/stocks/news/ilfs-fallout-sebi-plans-major-overhaul-in-role-of-rating-agencies/articleshow/66439260.cms – Retrieved on 31st Dec 2018

^[5] Ministry of Finance, Capital Markets Division. (2009). Report of the Committee on Comprehensive Regulation for Credit Rating Agencies. Securities and Exchange Board of India.

^[6]Regulation (EU) No 462/2013 of the European parliament and of the council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies, available at: https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:146:0001:0033:EN:PDF

^[7] Securities and Exchange Board of India. (2018). Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 [Last amended on September 11, 2018].

^[8] Prakash, Shreya et al (2017). Regulations of Credit Rating Agencies in India. Vidhi Centre for Legal Policy.