The capital market regulator has told credit rating agencies — some of which were blindsided by the aura and size of IL&FS — to review borrowers as soon as their bond prices crash, and even place such securities on ‘rating watch’ if prices continue to languish. Baffled by the rapid downgrades of IL&FS debt paper — from triple-A to ‘D’ (or, default) in less than two months — Sebi wants rating agencies to take cues from the market in evaluating bond issuers.
The strategy to track widening bond spreads — the difference between a corporate bond yield and that of a government bond of similar maturity — was emphasised by Sebi officials at a recent meeting with large rating agencies, two persons familiar with the development told ET. The move assumes significance with the financial market currently displaying a sudden risk aversion to debt securities of businesses like non-banking finance companies whose importance and valuation had risen in the last two years as banks shirked lending to manufacturers and often choosing to lend to NBFCs. Bank loans to NBFCs rose 40% between July 2017 and July 2018. “Bond spreads would now be an element in future ratings. According to the discussions between Sebi, rating agencies would carry out reviews for the next six months and based on the findings, they would prepare a model,” said a source.
Audit of Rating Companies
A rating agency is supposed to put in place a material review mechanism to factor in a range of developments such as change in management, new ventures, as well as developments in financial markets which could have a potential impact on the company.
“While prices of securities should ideally be a part of such a mechanism, rating agencies rarely consider high bond spreads in contemplating rating action. If bond spreads continue to widen or stay high, it’s a hint that there’s something worrying the markets. The regulator wants agencies to pick up these signals and review the company, even though it may not necessarily lead to a rating action,” said an official with one of the agencies. About 25,000 companies are rated in India, of which half are estimated to be below investment grade. Provident funds, one of the largest investment groups, do not buy bonds with less than double-A ratings.
Sebi’s instruction follows a few months after Reserve Bank of India’s decision to conduct regular audit and inspection of rating agencies whose actions can significantly influence the borrowing price of companies. While communicating its decision in July, the central bank had told rating agencies to avoid sharp downgrades that rattle investors, and exercise caution when corporates fish around to shop for a better rating.
Rating agencies would play an important role in the current environment where creditors have dragged companies to the bankruptcy court. Agencies have the mandate to rate debt instruments based on the resolution plan prepared with the consent of lenders and bankruptcy court for reviving a company. “What has surprised markets in the IL&FS crisis is the default on commercial paper (CP), which is a liquid money market instrument and not a typical bond. A CP default is a serious event in any financial market,” said a senior fund official. Besides long-term debt paper, rating agencies evaluate bank loans, CP as well as nonfund facilities.
The Economic Times, 25th September 2018
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