From time to time, Sebi has released circulars to make a set of rules which govern the criteria for credit rating agencies. The regulator has now released a master circular to enable the investors to have access to all the directions at one place.
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.
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.
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.
Frequently asked questions
What does a credit rating actually mean?
A credit rating is an agency's opinion on the relative likelihood that an issuer will service its debt in full and on time. It is a measure of relative credit risk — not a recommendation to buy, sell or hold the instrument.
Who regulates credit rating agencies in India?
Credit Rating Agencies (CRAs) are regulated by SEBI under the SEBI (Credit Rating Agencies) Regulations. The major Indian CRAs include CRISIL, ICRA, CARE, India Ratings, Acuité and Brickwork.
What is a rating action?
A rating action is any change an agency makes to a rating: an initial assignment, an upgrade, a downgrade, a placement on 'rating watch', an outlook change, a reaffirmation, or a withdrawal. Each is published with a rationale.
How should an investor use ratings?
Treat the rating as one input, not the whole analysis. Read the rationale and rating-action report for the assumptions and sensitivities behind the letter, watch for outlook and 'rating watch' signals, and understand where the rating sits on the AAA-to-D scale.
Key terms
- Investment grade
- Ratings from AAA down to BBB- that signal relatively low credit risk. Below BBB- (BB+ and lower) is considered 'speculative' or sub-investment grade.
- Outlook
- The agency's view on the likely direction of a rating over the medium term — Positive, Stable or Negative — without yet changing the rating itself.
- Rating Watch
- A flag that a rating may change in the near term due to a specific event (e.g. an acquisition or covenant breach), pending more information.
- Notch
- A single step on the rating scale (e.g. AA to AA-). A 'multi-notch' downgrade signals a sharp deterioration in credit quality.
- Default (D)
- The lowest rating, indicating the issuer has missed a payment or is otherwise in default on its obligations.