Conflict of interests playing havoc with credibility of credit raters
Every time global credit rating agencies downgrade India’s sovereign ratings, investors used to react sharply causing market indices to drop.
By Gireesh Chandra Prasad, ET Bureau |
Every time global credit rating agencies downgrade India���s sovereign ratings, investors used to react sharply causing market indices to drop. Now, stories from the US market about how they cut corners and tried to please their clients while rating securities, have raised serious doubts about their credibility.
For the Indian government, which is making an effort to move away from highly prescriptive financial regulations, this has posed a new challenge. Should the authorities make more regulations to address the conflicts of interests gripping the rating industry or, instead, encourage market competition so that good governance and best practices find a place in this industry as it grows?
Conflict of interests are inherent in the business model of rating agencies as they accept fee for gauging the credit worthiness of an organisation from the very same clients. Rating agencies do not get their fee from the investors who purchase the securities they have rated. Besides, they also provide ancillary services to the same clients and industry observers say that other revenue streams from the same clients may affect the independence of rating.
At a recent roundtable finance ministry officials, experts and the capital market regulator discussed if it would be prudent to encourage competition among rating agencies so that the industry would evolve best business practices on its own.
As more players come in, corporate governance would get more emphasis in an industry which survives on credibility. Many experts said that the fact that only a few rating agencies operate in India, is itself market-determined .
Unless the market needs more, there can be little that the government can do.
In India , Standard and Poor ���s has more than 43% stake in leading credit rating agency Crisil, while Moody���s Investment Company India Private Limited holds 28.5% in Icra. The Fitch Group has a 100% subsidiary here called Fitch India. CARE Ratings is a domestic player with IDBI Bank, Canara Bank and SBI as major shareholders.
Rajya Sabha member and former RBI governor Dr C Rangarajan said that instead of more regulations to tackle the conflict of interests in the industry, what we need is ���more appropriate��� regulations. Burdening the industry with more and more regulations is not the right approach .
The government and the regulators are now studying the business model of rating agencies . Rating agencies in India claim that their affiliates are separate legal entities manned by different CEOs operating on an arms-length basis. However, in any holding-subsidiary relationship , the majority shareholder can assert his rights covertly and overtly in the subsidiary.
For the Indian government, which is making an effort to move away from highly prescriptive financial regulations, this has posed a new challenge. Should the authorities make more regulations to address the conflicts of interests gripping the rating industry or, instead, encourage market competition so that good governance and best practices find a place in this industry as it grows?
Conflict of interests are inherent in the business model of rating agencies as they accept fee for gauging the credit worthiness of an organisation from the very same clients. Rating agencies do not get their fee from the investors who purchase the securities they have rated. Besides, they also provide ancillary services to the same clients and industry observers say that other revenue streams from the same clients may affect the independence of rating.
At a recent roundtable finance ministry officials, experts and the capital market regulator discussed if it would be prudent to encourage competition among rating agencies so that the industry would evolve best business practices on its own.
As more players come in, corporate governance would get more emphasis in an industry which survives on credibility. Many experts said that the fact that only a few rating agencies operate in India, is itself market-determined .
Unless the market needs more, there can be little that the government can do.
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Prominent economists in rating agencies told ET that it would not be prudent to subject rating agencies to more pressures of competition as it would only force them to be aggressive in soliciting business and not to focus on conflicts of interest. In India , Standard and Poor ���s has more than 43% stake in leading credit rating agency Crisil, while Moody���s Investment Company India Private Limited holds 28.5% in Icra. The Fitch Group has a 100% subsidiary here called Fitch India. CARE Ratings is a domestic player with IDBI Bank, Canara Bank and SBI as major shareholders.
Rajya Sabha member and former RBI governor Dr C Rangarajan said that instead of more regulations to tackle the conflict of interests in the industry, what we need is ���more appropriate��� regulations. Burdening the industry with more and more regulations is not the right approach .
The government and the regulators are now studying the business model of rating agencies . Rating agencies in India claim that their affiliates are separate legal entities manned by different CEOs operating on an arms-length basis. However, in any holding-subsidiary relationship , the majority shareholder can assert his rights covertly and overtly in the subsidiary.
The government also has the intention of adopting principles-based regulations instead of making over-prescriptive rules for the financial sector as it is increasingly becoming evident from the Wall Street���s collapse that the industry would be one step ahead of regulators when prescriptive regulations are in place.
One option could be to subject rating agencies to greater disclosures and not preventing them from exploring new business opportunities. Disclosure of fees for different services from the same client would let the investor know whether he should take the rating with a pinch of salt or a generous helping of it.
As Dr Rangarajan pointed out, the problem also lies in blindly following the ratings given by these agencies.
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