NISM study calls on credit ratings agencies to tweak operations

The present study by NISM is another attempt to assess the performance of CRAs, particularly in the light of the recent significant events in the global financial system and the criticism being faced by CRAs in the USA

The National Institute of Securities Markets (NISM) has called upon credit ratings agencies (CRAs) in India to tweak their operations so that the ratings can be more useful for investors.

In a report titled, 'Assessment of Long Term Performance of Credit Rating Agencies in India', the Institute said that there is a need for a framework to be agreed upon by all CRAs and regulators to have a standardised and operational definition of default.

CRAs have been operating in India since 1988. CRISIL, ICRA and Fitch India have collaborative arrangements with S&P, Moody’s and Fitch, respectively. CARE is promoted by IDBI and Canara Bank. Brickworks, the latest entrant, was established in 2008. Thus, a total of five major CRAs operate in India at present. Most of the ratings by CRAs relate to bank loans, on account of ascertaining the credit-related capital adequacy.

For a market like India, where financial literacy is at a nascent stage, multiple rating symbols could confuse the investing community and it could result in 'rating inaction' and foster unhealthy competition. Rating scales, brought under comparable bands, need to be hosted on the websites of the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA) and also on the sites of investors' associations, the NISM said.

Talking about the timeliness of ratings and its outlook, the report said since 'Rating Outlooks' (both positive and negative) and `RatingWatch' have a limited life, it must be replaced by a firm rating within a reasonable span of time, say a month.

Terming the policy of some CRAs to stay away from services other than credit ratings as a 'healthy sign', the NISM said that it needs to be ensured that the registered CRA, as a corporate entity, must not engage in any services other than ratings.

The report said that the presence of External Committee Members (ECM) brings with it a whole baggage of conflict of interest. Some CRAs have demonstrated that it is possible to develop the expertise either with full-time employees from domestic CRAs or in collaboration with overseas CRAs. Alternately, ECMs could be deployed for providing inputs, leaving the final ratings to an Internal Committee at the CRA, it added.

To curb the unhealthy practice of 'shopping for ratings', the NISM said that it is necessary to come to a stage where all ratings, including unaccepted ratings are published. In the 'shopping for ratings', issuers attempt to seek informal ratings from various CRAs and pass the final rating mandate to the agency that could offer the highest ratings, it clarified.

It said that young potential employees tend to gravitate towards merchant banking and investment management, leaving a paucity of talent in accounting, audit and credit appraisal, which are actually the backbone of financial systems. Calling for specialised training for due diligence review (DDR) and accounting & auditing systems, the report said that these skills, especially the DDR skill, are needed to assess the overall credit-worthiness of an entity. India is only two years away from the implementation of International Financial Reporting Standards (IFRS) and the preparedness is woefully lacking, amongst professionals as well as academics, the report noted. {break}

Along the lines of the compulsory Internal Audit for Stock Brokers, NISM said it is found necessary to stipulate an Operational Audit to ascertain that the rating processes leave a documentary trail. This could cover details of site inspections, management meetings, rating committee meetings, dissent notes, surveillance, monitoring schedules and minutes of the appeal process, it said. The audit will address the basic issue of good housekeeping and could be performed twice in a year. Some CRAs have taken the initiative to appoint a person with the task of Quality Control, and he is involved in all rating exercises, the report said.

Calling for inclusion of debt to equity ratio in interim financial reporting, the NISM said that there is a need to amend the accounting standards (AS25) and the listing agreement that can provide details of total debt alongside net worth and would help in computation of the debt to equity ratio at quarterly (90-day) intervals.

The report said that there is a need to educate people on the usage of ratings since there lies a danger of the rating being accepted blindly without a self-check or giving due importance to the time gap between two review dates. There is also the practice of issuers using ratings for marketing purposes—exhibited on all their business literature and office stationery. Hence people should use rating as one of the inputs in the decision-making process and not as a guarantee. Of course, this does not absolve the responsibility of the CRAs for negligence, the NISM report said.

There could be information gaps that arise due to factors beyond anybody’s control. In line with the Risk Factors highlighted on various products, CRAs also need to mention a disclaimer on all rating announcements as well as on the website. This is to bring to the mind of the reader (user) of ratings the fact that credit-related information is dynamic and subject to changes. Rating disclosures could also mention the latest review date, the report said.

The NISM report said that it is important for the members of the public to know that the relationship of the CRA is at arm’s length with that of the rated entity, in letter and spirit and hence, shareholding ownership patterns of all CRAs need to be made public.

There have been instances in the USA where S&P and Moody’s have deliberately given low ratings to various issues on an unsolicited basis. This was used as a means of arm-twisting the issuers. This is a classic instance of abuse of independence provided to CRAs. The NISM said that unsolicited ratings must not be permitted, in case the CRA community makes a representation to this effect in the future.

The NISM report said that bad governance can contaminate financial statements, and hence annul the entire credit-rating exercise. It is sad to know that CRAs heavily depend on the audited financial statements and do very little to gain the maximum from cross-verification from formal and informal sources. While this is a lacuna on the part of auditors and CRAs, much needs to be done on corporate governance, since a governance code works only on paper, it added.

Today, the entire edifice of corporate finance—shareholder wealth maximisation—is under question. The focus is shifting towards stakeholder satisfaction and societal wellbeing. Auditors and CRAs are the watchdogs of society as also the conscience-keepers of the nation; hence corporate governance is even more relevant as the first filter. It is often said, in credit wisdom, that balance sheets do not repay loans, it is the people behind the organisation (who do so), the NISM report concluded.

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    In a strong uptrend

    Selling pressure and weak global cues weighed heavily on Indian markets

    Indian markets saw selling pressure throughout the day and investors also remained cautious about Greece’s fiscal position as they waited for interest rate decisions from two of Europe’s top central banks. At the end of the day, the Sensex declined 28 points from the previous day’s close to 16,972, while the Nifty closed at 5,080, down 8 points. We expect the Indian bourses to continue their uptrend. However, wait to buy at a dip.

    Subex Ltd has announced the launch of Nikira V7.2, a fraud management component of the Revenue Operations Center (ROC). The stock ended flat.

    Hinduja Foundries announced that the company’s unit at Hyderabad will have an additional weekly holiday on Thursday due to non-availability of power with immediate effect, till further notice. The stock plummeted 6%.

    Suzlon Energy shot up 4% after the company won a major order from Gujarat State Petronet Ltd (GSPL) to set up, operate and maintain its 52.5-MW wind energy project in the Rajkot and Porbandar districts of the state.

    Marg Ltd announced that, in continuation of the subsisting term sheet, Karaikal Port Pvt Ltd (KPPL), a wholly-owned subsidiary of the company, has on 1 March 2010, entered into a Shareholders’ Agreement and Share Subscription Agreement with India Infrastructure Fund for a proposed investment of Rs150 crore in KPPL. The stock was up 5%.

    Strides Arcolab, as part of its strategy to focus on its core specialty injectable business, has entered into an understanding with Aspen to acquire a facility in Campos, Brazil with related products and IPs. The stock ended flat.

    CESC Ltd’s subsidiary, Dhariwal Infrastructure, has issued a letter of intent to Punj Lloyd for an EPC project for a value of Rs1,023 crore in connection with its 2x300MW thermal power project undertaken at Tadali village, near Chandrapur in Maharashtra. The stock remained flat whereas Punj Lloyd plunged 2%.

    During trading hours, the government released data that showed that the food price index rose 17.87% in the 12 months to 20 February 2010, faster than the annual rise of 17.58% in the previous week. The fuel price index was up 9.59%. The primary articles index rose 15%. As per market expectations, higher inflation is likely to add pressure on the central bank to raise interest rates in April 2010. However, finance minister Pranab Mukherjee said today that India’s economic recovery is still being driven by public spending and is not yet broad-based, further clouding the debate on the timing of rate hikes by the central bank.

    During the day, Asia’s key benchmark indices in Hong Kong, South Korea, Singapore, China, Japan and Taiwan were down by between 0.26%-2.38%.

    On Wednesday, 3 March 2010, the Dow Jones Industrial Average was down 9 points while the Nasdaq Composite and the S&P 500 remained flat.

    The Beige Book survey of economic conditions released Wednesday by the Federal Reserve gave mixed signals about the prospects for the US economy. The economy again improved modestly in February, the survey said, but loan demand remained weak and there were no signs of improvement in the labour market.

    As per reports, Greece announced further austerity measures designed at getting its fiscal deficit down to levels acceptable to the rest of the EU. Ongoing worries about Greek debt are expected to be one reason for the European Central Bank’s policymakers to keep rates on hold.

    In premarket trading, the Dow was trading 4 points higher.

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    Birla MF targets FD holders through its capital protection fund

    In an SMS to distributors, Birla Sun Life MF has asked IFAs to compare its new scheme with NRE deposits which fetch returns of 3.5%

    Mutual funds (MFs) eye fondly lakhs of crores lying in savings accounts and term deposits of banks but have never found a way to get even a tiny fraction of this money. Birla Sun Life MF is making one more attempt with its capital protection scheme. It has recently sent a text message to some Independent Financial Advisors (IFAs) saying: "NRE Deposits earn 3.5% interest v/s Birla Sun Life Capital Protection offering deposits plus returns. This category is a very big target segment for this fund. Please speak to all your deposit holders as this product offers safety and returns which will attract every investor class."

    The message was in connection with the fund house’s new fund offer (NFO), ‘Birla Sun Life Capital Protection Oriented Fund Series I’. The company has denied sending any such message on its part. According to trade sources and competitors, Birla Sun Life is targeting to mop up Rs600-Rs700 crore from this NFO.

    The fund allocation is about 90% in bonds and 10% in equity. The fund aims to expand the investment by the end of 27 months. “It has a clear objective to protect capital because many people are hesitant to enter such products because their capital is at risk. It is difficult to commit a target for the NFO at this time,” said A Balasubramanian, chief executive, Birla Sun Life Mutual Fund.

    “It is targeted towards fixed deposit investors who are keeping their money in fixed income where they earn 3%-4% interest,” said Mr Balasubramanian.

    The fund is rated ‘AAA’ by Credit Rating Information Services of India Ltd (CRISIL). No TDS is applicable except for NRIs. The fund aims to further reduce tax liability by triple indexation method. The NFO closes on 10th March.

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    v n purav

    1 decade ago

    most of the investor are not aware that investing in capital protection fund is lockin of 27 months as no exit optionis available.further it has come to my knowledge that mutualf und agent are purshing this product becasue they are getting 3 to 4% immediate commission plus foreign trip in reward for recommendingt this scheeme to gullible investors.
    What will happen to a retired person who invest huge investment in hope of gettting higher return than 3.5%


    1 decade ago

    what about local investors ?

    V swamy

    1 decade ago

    I am regularly reading your articles on mutual fund indstry.
    i congratulate you for writing bold facts.other publications are paints rosy picture of mutual fund becasue they may be influenced by advertisement support given by corprote houses.
    i think common man should keep out from mutual fund investments for another atleast 1 year as everyday new irregularity is unearthed.

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