When an investor purchases the shares of a company, they rely on various factors like the financial statements of such company, their products, management representation, etc. to determine if investing in such a company is a good bet. Such analysis of companies is further backed by validation from the credit rating agencies when they provide a positive rating for the entity in question. Therefore, the presence of credible CRAs in the stock markets is essential. But what happens when these CRAs do not meet their responsibilities? SEBI comes into action. In a similar case, SEBI has recently asked Brickworks Rating Agency to wind up their operations within 6 months from the issue of the order dated 6th October 2022. Given below are the reasons for such drastic steps and other relevant details.
What are Credit Rating Agencies (CRA) and why are they important?
Let us first begin with the basic meaning of a Credit Rating Agency (CRA). There are 7 credit rating agencies presently in India that are registered with SEBI that are charged with rating the companies and their ability to honour their debt commitments. It is their responsibility to review the affairs of the company with due diligence and provide a fair rating that can help in determining its relative position in the industry and with its peers.
The highest credit rating provided by these agencies is AAA and the lowest is D depending on their evaluation. These ratings are reviewed by relevant stakeholders like lenders, investors, creditors, etc. while initiating any transactions or investments in the company. A company with a higher rating will find it fairly easy to have access to borrowed funds and will also have room to negotiate the rate of interest. This lower cost of borrowing will further add to the bottom line of the organization ultimately benefiting the company and the shareholders.
Brickworks Rating Agency
Brickworks Rating Agency (BWR) was registered with SEBI in 2008 and has been a leading name as one of the 7 credit rating agencies in the country. The agency has assigned over 9000 credit ratings to various companies since its inception and is backed by Canara Bank which is also a strategic partner in the agency. The agency was directed by SEBI, in a first-ever decision, to close its operations within a period of 6 months. The decision was backed by the SAT (Securities Appellate Tribunal) and the financial hearing on the matter will be on November 15th, 2022.
Why did SEBI ask BWR to shut shop?
The crackdown on Credit Rating Agencies was initiated by SEBI after the collapse of IL&FS in 2018. The regulator had stated that the agency failed to carry out due diligence on the risk build-up and the overleveraging of the company which were the initial warning signs.
SEBI then pulled up the records of the agency for the period April 1, 2014 – September 30, 2015, April 1, 2017 – September 30, 2018, and October 1, 2018 – November 30, 2019. These records showed that the agency had defaulted on various occasions regarding its consistency in issuing ratings and exercising due diligence while discharging its obligations. Some cases of default include the delay or failure in delivering the credit ratings or taking suitable action on Bhushan Steel Ltd, Reliance Capital, Diamond Power Infrastructure Ltd., Zee Entertainment Ltd., and Gayatri Projects Ltd.
On another occasion, Sintex declared in 2019 that they were unable to meet their financial obligations and had also violated the terms of the loan contract. This incident was in March 2019 but BWR declared the default of Sintex only in August 2019. Furthermore, they claimed that the delay on their part was only for 7 days and tried to wash their hands off the debacle. But SEBI did not allow BWR to escape its shortcomings and cited that the revelations from multiple investigations have shown that the recommendations made to ensure optimum governance as well as the penalties levied for previous defaults did not have much impact on the agency.
Therefore, in the face of such multiple defaults, SEBI ordered the Brickworks Rating Agency to close down its operations in order as of 6th October 2022.
What is the impact of this decision?
Although the responsibility of the CRAs is to provide credit ratings to the companies that can help investors make informed decisions, they are paid by the companies to give them their ratings. This creates a direct conflict of interest and therefore, SEBI mandates that CRAs should adhere to high levels of transparency and integrity in fulfilling their duties. The direct and immediate effect of this order by SEBI is that Brickworks Rating Agency will not be able to take any new assignments till the time of the final hearing which is scheduled for November 15th, 2022. With BWR closing its operations, many companies who were using its ratings will have to find alternatives and get fresh ratings for their businesses.
The defaults of Brickworks Rating Agencies have not been overnight but upon investigations have been found on many occasions. Therefore, SEBI had to take this one-of-a-kind drastic decision and direct them to wind up their operations. With such a step, SEBI has also sent a clear message to all the remaining agencies to ensure all the necessary compliances and the discharge of their duties without any bias and maintain the highest standards of due diligence.
A. The remaining 6 credit rating agencies in India are
1.Acute Ratings & Research Ltd.
2.Crisil Ratings Ltd.
4.Care Ratings Ltd.
5.India Ratings and Research Ltd.
6.Infomerics Valuation and Ratings Ltd.
A. Brickworks Rating Agency registered with SEBI in 2008.
A. The credit rating agencies have to be duly registered with SEBI and have to adhere to all the regulations set by them to ensure transparency of the rating process and its functioning as well as standardize the disclosure requirements for the securities.
A. The highest rating provided by CRAs is AAA which represents the highest creditworthiness for the company and can open doors for easier access to borrowed funds for such an entity.