The global financial crisis has triggered a yet-inconclusive debate over how to regulate rating agencies and make them more accountable. The crux of the issue is who pays the rater and how to evolve a system where companies can no longer shop for the most benign rating agency. Nobel Prize-winning economist Paul Krugman, in a recent column, wrote about how the US government (probably deliberately) is focusing on emails from Goldman Sachs’ employees instead of those of credit-rating agencies that deliberately “skewed their assessments to please their clients.” He says, “Of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent—93 percent!—have now been downgraded to junk status.” The solution? Prof Krugman talks about two possible proposals to prevent companies from shopping for the most pliable rater. Issuers of financial paper must not pay for the ratings; or that they pay for the ratings, but the Securities and Exchange Commission would decide which agency gets the business.
We, in India, had argued for a similar structure for IPO ratings. India fortunately has large chunks of investors’ money sitting in several big pools—the Investor Education and Protection Fund with the ministry of company affairs (nearly Rs400 crore) and several hundred crores each with the Bombay Stock Exchange and the National Stock Exchange. Investor associations strongly argued that IPO ratings must be paid for through these funds and that there must be a cap on what the rating agency could charge. Between them, there is already enough money to pay for rating every IPO that is likely to hit the capital market for the next few decades. The best part is that this money belongs to the investors and would have been used for their protection—it is not a dole from the government.
Yet, the SEBI board overruled such a recommendation by the primary market advisory committee and allowed companies to pay for ratings (the cost is substantially higher, because raters can name their price) and also shop for the most convenient rating agency.
Ironically, the same people who, as part of the SEBI board, refused to experiment with a different fee model, even in a tiny segment like IPO ratings, have since commissioned multiple reports on regulating the raters. One of the reports requisitioned by the High Level Coordination Committee through SEBI has primarily concluded that there is no pressing need to tighten the regulation of rating agencies. Instead, it proposes a little tinkering with disclosures and payment receipts. It suggests better reporting of revenues from a particular issuer and from non-rating businesses, such as advisory services, and recommends having fewer rating symbols to make ratings more comprehensible. Given that the two global majors, namely, Standard & Poor’s and Moody’s control CRISIL and ICRA, respectively, account for a bulk of the business distributed among five firms, the report seems rather too complacent. If regulation of rating agencies in India is admittedly weak, how can they be unaffected when the basic issue, of who pays the fees and conflict of interest created by a growing advisory services business, remains untouched? This when the SEBI report admits that companies seek informal rating from multiple agencies and give the final mandate to the one that is most favourable. It also points out that raters rely excessively on audited financial reports, instead of doing an independent investigation, although it is known that governance reports are largely an eyewash. — Sucheta Dalal