Judging IPOs: Rating cos tread cautiously

A new homegrown rating product will soon be tested out in the Indian market. Indian credit rating agencies are almost ready to rate initial public offerings of local firms after the capital markets regulator has made it a mandatory requirement.

There are just a handful of countries which encourage rating of equity which intrinsically spells risk. In neighbouring Bangladesh, it is limited to one segment while in some Latin American countries, pension funds go in for rating to protect their investments. Local rating agencies who compete hard otherwise for business have now put their heads together to work out broad terms for rating equity offerings.

There is agreement on the methodology to be adopted and the rationale for the rating awards. The agencies will cover the projects the company which is seeking to raise funds from the public market has on hand. They will run a check on the promoters, the financials of the firm, do the valuation, how the issuer has utilised funds and so on.

What would be distinct however is the rating scale. The rating scale is expected to be from one to five with five signalling top quality offering. Each rating agency would be free to come to its own conclusion on the scale of rating just as it does in debt offerings. But this does not imply that firms can get away by shopping for better ratings.

There is a difference in the new equity rating landscape unlike what the practice has been in rating debt. It may well be that a firm which is aggrieved with the rating assigned to it by one agency may well approach another rating agency. But the Indian capital markets regulator has been one up on them. It has made it clear that the issuer would have to disclose in the offer document the fact that it had approached another rating agency and had been assigned a lower rating.

Perhaps, investors may have to go to the website of the issuer or the regulator or the rating agency to check out such details. Those are matters of detail and no one is quibbling about it now. But in India where politicians swear by the “poor small investor” rating agencies would certainly need to cover their backs.

This band of investors are the kind who would gloss over any disclosures even if printed in thick typeface and then go on moaning if they lose money. Netas have been quick to jump in to seize political capital and many perceive the exercise of rating of equity offerings as one prompted by policymakers to insulate themselves from trouble in the future.

It is obvious that rating agencies see the risks involved in the new rating product. Legal disclaimers are sure to be attached alongside the rating report which they are expected to put out saying that they have done the best based on the data they have been provided with.

After all, it is not that they were keen on this product, fully aware as they are of the reputational risks associated with such ratings. The revenues aren’t also very promising, at least to start with. But when it is the regulator which wants this to be done, seldom can a ratings firm decline.

In a month or two, the first rating of an IPO is expected to be assigned. The big offerings such as ICICI Bank or SBI which are slated for launch later will not have such ratings as they are follow on offers. Over a period of time, the latest rating product should evolve. If it does, Indian rating agencies will be closely watched.