Mumbai: India’s capital market watchdog is likely to act against two rating companies, following an investigation of ratings assigned to debt securities of troubled auto parts maker Amtek Auto Ltd and a subsequent redemption crisis at JP Morgan Asset Management Co., said two people familiar with the matter.
The action would mark the first time the Securities and Exchange Board of India (Sebi) takes rating companies to task.
Sebi is in the final stages of its investigation, said the two people cited above, on condition of anonymity. The regulator will decide the nature of action to be taken once the investigation is complete.
“The investigation is against rating agencies Credit Analysis and Research Ltd (CARE Ratings) and Crisil Ltd in the matter of rating Amtek Auto’s debt paper and rating JP Morgan’s corporate debt fund,” said one of the two persons.
Sebi launched the probe after the redemption crisis faced by JP Morgan India Treasury Fund and JP Morgan India Short Term Income Fund in August 2015. The crisis was brought on by a sharp downgrade and withdrawal of ratings on bonds of Amtek Auto, which was on the verge of defaulting on Rs.800 crore in bond repayments.
The crisis drew attention to the conduct of the rating agencies in assigning a credit rating to the Amtek Auto bonds and the JP Morgan schemes.
CARE Ratings chose to suspend its rating on Amtek Auto on 7 August 2015. The agency had given Amtek Auto an AA- rating. ‘AA’ signifies a high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk. The ‘minus’ with the rating signifies a low standing within the category.
As per Sebi regulations, a credit assessor cannot suspend its rating on an outstanding debt security. A rating can be suspended only if the security is clubbed with another security or in the case of a company merging with another one.
“Suspension of rating is a violation as per Sebi regulations. Even if a company is not disclosing relevant information pertinent to the rating, an agency is required to assign a rating based on available information, with a caveat that there is lack of information. The regulator is looking into that aspect,” said the second person cited above.
In response to an email, CARE Ratings said it had not received any communication from Sebi on the investigation or on possible action.
“Credit rating is assigned to any instrument based on data that is publicly available as well as detailed discussions with the company. The latter is a crucial part of the rating process, to better understand the past financials, current trends and projections on which the future debt servicing capability hinges on,” said a spokesperson for CARE Ratings.
“Suspension becomes unavoidable at times as we may not be in a position to take a call on the credit profile of the company in the absence of cooperation from the company’s end. You may note that the policy of ratings suspension is a market practice and is also done by other rating agencies too,” the spokesperson added.
Crisil Ltd had assigned a rating of AAAmfs (signifying the highest portfolio credit quality) to the JP Morgan India Treasury Scheme in May 2015. A rating is based on the ratings of debt securities held in the portfolio of the scheme. Subsequently, Crisil revised the rating for the scheme in three stages over two months. On 1 September, it downgraded the scheme from AAAmfs to A+mfs. On 29 September, the scheme was downgraded to BBBmfs, which meant an eight notch downgrade within a month. Finally, on 15 October, Crisil placed the scheme on “notice of withdrawal”.
Given the sequence of events,Sebi is examining whether the agency failed in its fiduciary responsibility by not issuing a timely warning to investors.
A Crisil spokesperson, in an emailed response, said it hadn’t received any communication from Sebi on the probe.
While Sebi is investigating individual agencies, it is also in the process of tightening rules and disclosure norms for rating agencies in general.
In January, Mint reported that Sebi is likely to ask rating agencies to set up independent internal assessment teams, which will be required to determine whether the rating assigned to a company is appropriate or not.
This will be over and above the team which assigns the initial rating. Sebi may also ask rating agencies to give clear reasons if they choose to withdraw their rating on a company.
Tougher norms for rating agencies have become necessary in the light of recent developments. Apart from the Amtek Auto episode, there have been other cases where sharp and sudden downgrades have left investors in the lurch.
On 15 February, Crisil downgraded Jindal Steel and Power Ltd’s debt rating to BB+/A4+ from BBB+/A3+. On 9 March, it cut the rating further to D. The downgrades hit funds such as Franklin Templeton Asset Management (India) Pvt. Ltd which held these securities.
Another recent example has been the case of Ricoh India Ltd. While the case was one of suspected fraud, it highlighted the inability of a credit assessor to act as an early warning system for investors.
Ricoh India saw its revenues and liabilities jump sharply between fiscal 2011 and fiscal 2015 without any corresponding increase in fixed assets or profits. The company also delayed declaring its September 2015 quarter earnings until last month.
The curious case of Ricoh India’s balance sheet
Despite this, India Ratings and Research Pvt. Ltd, in January 2016, upgraded the company’s non-convertible debentures. In March, it put the company on ‘Negative Watch’ but did not downgrade the securities. India Ratings explained this by saying that its ratings “were largely reflecting the operational linkages and financial support from Ricoh Japan”.
“This is clearly a first that a regulator is looking at the action of the rating agencies. There has been enough noise made on the non-performing asset levels of banks but… rating agency actions have so far not been examined,” said Amit Tandon, founder and managing director of Institutional Investor Advisory Services, a proxy advisory firm.
“With Sebi examining the role of rating agencies, it will be a signal to the market that the credit-rating firms will be held accountable for their actions,” he added. According to Tandon, the regulation barring creditors from suspending the rating on debt securities requires a relook.
“Suspension of rating has become a market practice as it is a viable option when relevant data is not available. The regulator must factor in that suspension of ratings is an option and relook at the regulations accordingly,” added Tandon.