Before opting for a debt instrument, investors are often recommended to check the credit rating. Higher the rating, the safer the instrument and conversely, the lower the rating, the riskier the investment.
However, one may wonder what are the criteria based on which these agencies such as CRISIL and ICRA rate the financial products. Each agency may have different criteria to judge the instrument’s credibility. What if one agency is more liberal, while the other is more stringent in its evaluation criteria?
In order to reconcile these differences, rating agencies are supposed to reveal the framework based on which they judge their credit ratings.
From time to time, capital markets regulator Securities and Exchange Board of India (Sebi) has released circulars to make a set of rules which govern these criteria.
And while taking another step in this direction, Sebi has now released a master circular on credit rating agencies. This is aimed to enable the industry and other users to have access to all the applicable circulars/ directions at one place.
Th master circular is the combination of all circulars released till date.
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Some of the key features of the master circular:
I. How are rating criteria determined?
Each credit rating agency is told to frame detailed rating criteria including the same in its operations manual/ internal governing document and disclose the same on its website.
Periodicity will be disclosed on the website of credit rating agencies. While disclosing the criteria on their website, agencies will also provide a reference to the original criteria to enable investors to discern the change made to the same.
II. What is the rating process?
Each credit rating agency is mandated to have in place a proper rating process and disclose the same on its website.
Each agency is also told to frame detailed guidelines on the following and disclose them on its website:
1 FAQs on ratings
2 General nature of compensation arrangements with rated entities.
3. Policy for placing ratings on credit watch
4. Guidelines on what constitutes non-cooperation
5. Gift policy
6. Confidentiality policy
7. Policy on outsourcing of activities
Any change in the rating process or policies shall be disclosed on the CRA’s website.
III. Why to check the repayment schedule?
Credit rating agencies are meant to be proactive in early detection defaults or even delays in making payments. So, these agencies are supposed to track the servicing of debt obligations of each security rated by them.
They are meant to monitor different indicators such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), deterioration in liquidity conditions of the issuer, unusual increase in issuer’s borrowing cost and other details which may indicate decrease in credit quality of the issuer.
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While carrying out monitoring, these agencies are also supposed to analyse the deterioration in the liquidity conditions of the issuer and consider any mismatch in the asset-liability.
They are also instructed to monitor the stock exchange websites for disclosures made by the issuer which may affect their liquidity conditions.
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Published: 17 May 2024, 06:18 PM IST