Credit rating agencies ask RBI to come out with default recognition criteria – The Economic Times

Clipped from: https://economictimes.indiatimes.com/news/economy/finance/credit-rating-agencies-ask-rbi-to-come-out-with-default-recognition-criteria/articleshow/97232916.cms

Synopsis

With the central bank and the capital market regulator, the Securities and Exchange Board of India (Sebi), parting ways on how different kinds of debts would be rated in the financial market, the rating companies want the RBI to come out with a public statement on recognition of default.

Credit rating agencies ask RBI to come out with default recognition criteria

Credit rating agencies have asked the Reserve Bank of India (RBI) last week to spell out the ‘default recognition’ criteria, which determines how missed or delayed payment in one kind of debt impacts the rating of other debt raised by a borrower.

With the central bank and the capital market regulator, the Securities and Exchange Board of India (Sebi), parting ways on how different kinds of debts would be rated in the financial market, the rating companies want the RBI to come out with a public statement on recognition of default.

Even a single-day delay or non-payment of even a rupee by a corporate borrower pulls down the agency’s credit rating on a bank term loan to ‘default grade’ or ‘D’. Under the present practice, this automatically triggers a downgrade of non-convertible debenture (NCD) to ‘C’ (which indicates high risk of default in timely servicing of financial obligations). The NCD downgrade happens even if the company which issued the security (and defaulted on its term loan from the bank) does not miss payment to investors of the NCD. In case of default on cash credit or working capital loans given by a bank, the downgrade takes place if the account remains irregular for 30 days.

Bank loans are regulated by the RBI while corporate debt securities listed on stock exchanges come under Sebi. Over the past one year, the two financial market regulators have voiced their differences on credit rating principles and stuck to their respective positions despite repeated representations by the rating firms amid fears that divergent ratings on two kinds of debts of the same company could confuse investors. After Sebi came out with the operational guidelines on rating of securities a fortnight ago, it has become abundantly clear that rating companies would simply follow the market regulator’s norms while rating debt securities and strictly abide by the RBI’s directives when rating bank loans.

With clearly demarcated credit rating rules between loans and securities — as laid down by the two regulators — rating companies are looking for clarity on how rating movement in one debt (under one regulator) would influence another debt (under the other regulator). “RBI should put it in the public domain that the default recognition rule which is applicable now would continue under the current framework. This is important. And RBI should announce this by January 31 as Sebi’s new operating guidelines come into effect from February 1,” said an industry person.

The old turf tussle between the two regulators sharply came to the fore in early 2022 when RBI in a guidance note to rating firms said that ratings given on loans to a company cannot be notched up on the back of “diluted and non-prudent support structures” such as letter of comfort, letter of support or undertaking, and other covers like pledge of shares. Such support from the parent or promoters enabled companies to reduce the cost of borrowings — as higher the rating, lower the interest charge on debt.

RBI also asked them to refrain from giving higher rating on the back of ‘obligor-co-obligor structures’ — common arrangements by infrastructure companies where multiple special purpose vehicles housing separate projects pool in their cash flows to create a mechanism where funds of one SPV can be used to service debt of another vehicle which runs out of cash. Thus, any support to a bank loan must be backed by a firm and legally enforceable guarantee.

However, with Sebi allowing rating firms to factor in support from structures in rating debentures, the differences between the two regulators were apparent.

“Rating agencies may seek more clarifications from the two regulators to sort out operational issues. Another aspect where clarity may be required is whether standalone rating of companies would have to be separately given where the rating factors in ‘implicit guarantee’ or support from the parent,” said another person.

There are companies which enjoy higher ratings as their parent or promoter group has demonstrated in the past of stepping up to help group companies avert default. “So even if there is no guarantee in black and white, the common brand, group reputation, synergies, and past experience come in to give the rating a ‘parent notch-up’. It’s difficult to segregate and give the standalone rating in such cases,” said another person. “Also, Sebi should clarify that its rules apply to unlisted debt securities as well,” he said.

There can be six broad kinds of debts: plain vanilla listed and unlisted securities; listed and unlisted securities with support or credit enhancement structure; and bank loans (with or without firm guarantees). Almost 90% of the 50,000 debt ratings are on bank loans. Banks prefer rated loans that carry a lower risk and reduce capital requirement.

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