Credit Rating Agencies reforms

Context:

SEBI has released a consultation paper seeking feedback on a new set of rules drafted to improve “market efficiency” and enhance “the governance, accountability and functioning of credit rating agencies

New Rules:

Provisions to restrict cross-shareholding between rating agencies without regulatory approval to 10%
Increase the minimum net worth requirement for existing and new agencies from ₹5 crore to ₹50 crore
There should be at least five years’ experience for promoters of rating agencies
SEBI has proposed disclosure norms to improve investor awareness about the operations of rating agencies
It is to prevent rating agencies from resorting to collusion in reaching decisions.

Criticism

The present business model of rating agencies allow considerable room for issuers of securities to shop for a favourable rating or avoid negative ratings by severing their ties with these agencies.
Prudential regulation is thus justified to tackle this problem. This criticism, however, ignores the reputational damage these agencies suffer after each corporate default
But repeated failures have not affected the business of rating agencies, primarily due to the lack of alternative service providers who can help out investors.
Individual creditors have thus had to trust the ratings of the existing rating agencies at their own peril, even after repeated crises
Indian credit rating market is an oligopolistic one due to the high barriers to entry.
SEBI’s proposed move to impose further quality requirements on rating agencies is unlikely to change things for the better, or raise further barriers.

Way forward

Make it easier for new players to enter the credit rating space and compete against incumbents.
This will make credit rating agencies actually serve creditors rather than borrowers.

BRICS Rating Agency:

India has pressed the BRICS (Brazil, Russia, India, China and South Africa) nations to set up an independent credit rating agency of the five-member group.
India had first mooted the idea of having such an agency for the BRICS grouping to solve impediments for the emerging market economies posed by present credit rating agency market that is dominated by S&P, Moody’s and Fitch. These three western rating agencies hold over 90% of the sovereign ratings market.
Emerging economies claim that western ratings firms are biased, pessimistic on the developing countries and optimistic on developed nations.
They also have concerns over methodologies of the three global agencies.