Market regulator Securities and Exchange Board of India (SEBI) has increased its penalty to Rs1 crore each on India Ratings and Research Pvt Ltd, Care Ratings and ICRA Ltd for default committed in rating Infrastructure Leasing & Financial Services (IL&FS) and its subsidiary company IL&FS Financial Services Ltd (IFIN).
G Mahalingam, whole-time member (WTM) of SEBI, passed three separate orders, which state, "I find that the lapses on the side of the noticee, while rating the securities of IL&FS and IFIN have resulted in real and severe financial loss to investors. It has shaken up the investors’ faith in the reliability of credit ratings in the context of the corporate debt market. Had the noticee downgraded the ratings at the appropriate time and thereby forewarned the investors, the impact of the default on investors who invested in AAA rated instruments, could not have been this severe. Considering the above, I am convinced that the case merits imposition of exemplary penalty provided under Section 15HB of the SEBI Act."
"... having found the AO Order dated 26 December 2019 as erroneous to the extent it is detrimental to the interests of securities market, hereby impose a monetary penalty of Rs1 crore upon the noticee under Section 15HB of the SEBI Act," the orders say.
Mr Mahalingam further stated, "I note that substantial public interest was involved in the securities issued by IL&FS and the credit ratings thereon, which were relied upon by the investors to make investment decisions.
"However, the failure of the noticee to exercise adequate due diligence with respect to the assessment of the mounting credit risks of IL&FS in the light of its stressed balance sheet position and in turn, the failure to review and modify the ratings on time, so as to alert the market in advance, has resulted in abrupt downgrading of rating of these securities just before the default. In any case, a CRA cannot be heard to contend that its accuracy in ratings should not be relied upon by institutional investors."
Earlier in December 2019, the adjudicating officer (AO) had found that the credit ratings agencies (CRAs), while assigning their credit ratings to the non-convertible debentures (NCDs) of IL&FS, failed to exercise proper skill, care and due diligence while discharging their responsibilities as a CRA and thereby violated the provisions of Regulation 24(7) and clauses 4 and 8 of the code of conduct of the CRAs, read with Regulation 13 of the SEBI (CRA) Regulations, and had hence imposed a penalty of Rs25 lakh each on them.
Until July 2018, India’s credit rating companies had put out investment grade ratings on billions of dollars of corporate debt raised by the IL&FS group and its subsidiaries. The first signs of trouble came in June 2018, when the special purpose vehicles tied to IL&FS Transportation Networks Ltd (ITNL), a group subsidiary, defaulted on its debt obligations. More defaults in other parts of the empire followed in August and September. Finally, the rating agencies were forced to downgrade the rating status to default in September 2018.
In October 2018, the government was forced to dismiss the IL&FS board and replace it with six eminent persons of its choice led by the well-known and respected banker, Uday Kotak.
The IL&FS case is a prime example of locking the stable door after the horses have bolted. The credit rating agencies had clearly failed to discharge their prime responsibility.