With an aim to bring in a greater level of transparency in the way credit rating agencies work, the capital markets regulator Sebi is working on a new set of guidelines to address conflict of interest in the functioning of such entities.
Through the new guidelines being considered by it, the markets watchdog is seeking to ensure a greater level of compliance by the rating agencies to the norms regarding adherence to 'Chinese Walls' like structures between their sales and research teams, a senior official said.
Sebi is working on measures that are required to tackle the issue of any possible manoeuvring by CRAs (credit rating agencies) in favour of their major or preferred clients while assigning ratings tho them, he added.
At the same time, fears have also been raised in the recent past that CRAs might assign bad ratings to the entities that have either fallen out of favour, the official said.
The regulator is also looking to instill a greater level of confidence among the investors through its new guidelines to address conflict of address in case of CRAs, he said, while adding that framing of these norms figures among the top-agenda of Sebi in the coming months.
The regulations require credit rating agencies to keep their sales and research functions completely separated by 'Chinese Walls' like structures, so that income received from their clients do not affect the ratings being assigned to them.
Credit ratings are indicative of the creditworthiness and potential credit risks associated with the entity being rated. The CRAs are regulated by Sebi in India, while ratings assigned by them are depended upon by both the borrowers and the lenders, when it comes to raising of funds from the capital markets.
The functioning of CRAs has always been a matter of debate for possible regulatory violations, as the business model of such entities involves income realisation from the companies being rated by them.
The role of rating agencies become much more important during times of slowdown in macroeconomic scenario, corporate earnings and the capital markets.
Industry experts say that Sebi already has a very strong set of regulations for CRAs and the regulator has been very futuristic while framing these norms. However, changing business dynamics and the trends being witnessed in global markets have led to Sebi giving a fresh look at its CRA regulations, they believe.
In the developed markets of the US and Europe, a lot of regulatory thinking has gone into the potential safeguards against any possible manipulations by the CRAs since the financial crisis of 2007-2008.
The CRAs had faced the brunt in a big way when many banks rated highly by them went bust during the crisis, resulting into the regulators across the world tightening their norms for such entities.
Most of the developed markets did not have effective regulations for rating agencies till 2008 or so, but Sebi has had a strong set of norms to govern the functioning of CRAs since way back 1997.
The need for a strong set of norms for CRAs was also felt at the last board meeting of International Organisation of Securities Commissions (IOSCO), a body of capital markets regulators including Sebi from across the world.
As per an IOSCO report on rating agencies, CRAs continue to play an important role in most modern capital markets, despite concerns about their performance during the 2008 crisis.
The corporates use their credit ratings to raise capital, while lenders and investors use credit ratings to assess the likely risks they face when lending money to, or investing in, securities of a company.
Institutional investors and fiduciary investors also use credit ratings to help them allocate investments in a diversified risk portfolio, while laws and regulations use credit ratings to distinguish creditworthiness.