Sebi has asked credit rating agencies to share information on all corporates whose ratings are propped up with promoter or parent guarantees and pledge of shares. The capital market regulator has also sought details on companies which have been refusing, often for years, to share data with rating firms.
The Securities and Exchange Board of India (Sebi) has asked credit rating agencies to share information on all corporates whose ratings are propped up with promoter or parent guarantees and pledge of shares. The capital market regulator has also sought details on companies which have been refusing, often for years, to share data with rating firms.
Companies lower cost of borrowings on bank loans and bonds through mechanisms like ‘letter of comfort, ‘letter of undertaking’, and stock collaterals which improve credit ratings by a few notches. Sebi would analyse the data in the wake of the Reserve Bank of India (RBI) voicing its reservations on these arrangements – describing them as “diluted and non-prudent support structures”.
According to the central bank, even the apparently more enforceable supports and widely used structures like ‘corporate guarantee’ from the parent holding entity or group flagship can be used to enhance credit rating only if there is a strict timeline on the invocation of guarantee by lenders.
“The rating companies have already submitted the data on the number of companies having ‘credit enhancement’, the nature of support taken for the purpose, and the names of the companies. The RBI directive is to banks which it regulates while the rules on ratings of other tradable debt instruments such as debentures are framed by Sebi which has allowed rating improvements through supports...So, this has created a situation where two regulators have divergent stands on ratings based on which thousands of crores of debt are raised by companies,” a senior industry official told ET.
ET had reported on May 19, 2022 that rating agencies have sought the intervention of their primary regulator Sebi due to the contradictions that have surfaced following RBI’s directive. Left unaddressed, this causes a confusing situation in the market where a company’s listed debentures (regulated by Sebi) would command a higher credit rating than bank loans (which are under RBI’s purview).
A corporate guarantee is a promise by the parent to assume the debt obligation of a group company if the latter fails to repay or service a loan. (ET had first reported on April 27, 2022 on the RBI’s communique to banks.) RBI in an April 22 letter to CEOs of rating companies had observed that a review has revealed there was a “wide variation among credit rating agencies in the nature of support considered, evaluation mechanism and methodology while assigning such ratings”.
Corporate borrowers as well as rating firms have sensed that rules of the game (to enhance ratings through support structures) would change very soon. “I feel the differences between Sebi and RBI are temporary, and would soon be sorted out with a common set of rules on credit enhancement for loans as well as debentures. But it’s now apparent that a company which is unable to furnish watertight corporate guarantee that stands the scrutiny of legal due diligence of rating companies cannot reduce its borrowing cost – something they have been doing for years,” said the compliance head of a large private bank.
Rating agencies also expect Sebi to deal with the pitfalls of rating companies which do not cooperate in sharing their financials and other information. “It’s a problem particularly for unlisted companies that don’t have to make periodic disclosures on numbers and sensitive information to stock exchanges. Not only do such companies hold back information from rating agencies, even their bankers protect them and are reluctant to talk about a loan default which only consortium banks are aware of,” said an official with a rating company. Close to 90% of the 50,000 debt ratings are on bank loans. Banks prefer rated loans because a lower regulatory risk weightage on such rated assets allows them to earmark a little less capital and improve capital adequacy ratio.
A few years ago, rating companies told regulators that they should be allowed to withdraw ratings of about 15,000 companies which are not co-operating. “The problem is rating agencies need a ‘no-objection certificate’ from lending banks before they remove the ratings, and banks typically drag their feet on this. This was raised a few years ago. Hopefully, some solution would be found now that Sebi has a new chief and a lot of changes have happened within Sebi,” said an official with a debenture trustee.