SEBI’s New Norms Require More Disclosures From Rating Agencies
SEBI’s new rating norms seek disclosures on cumulative default rates, probability of default benchmarks and liquidity indicators.
Credit rating agencies will now have to make more disclosures about the quality of debt instruments they rate as the market regulator looks to streamline processes in the wake of a series of defaults.
The new guidelines require disclosures on the cumulative default rates, probability of default benchmarks and liquidity indicators, according to a circular uploaded on the website of the Securities and Exchange Board of India.
Rating agencies came under scrutiny after the surprise defaults of AAA-rated IL&FS group in September. The spotlight on the sanctity of their rating actions increased after a rise in defaults by stressed companies.
SEBI has now enhanced the disclosure framework. The requirements include:
Cumulative Default Rates: Every year, rating companies have to disclose the average one-year, two-year and three-year cumulative default rates. These disclosures will have to be made on a consolidated bases for all finance instruments that are rated by an agency and the historical data on default rates for the last 10 years will have to published on their website.
Crisil, in a statement, said the methodology to compute default rates is the much-needed step and it aligns with globally followed standards. While SEBI said that withdrawn ratings can be included the computation of default rates till the completion of the cohort or the maturity of the instrument, the rating agency said this could be counter-intuitive and erroneous as it could result in a three-year default rate being lower than one-year default rate.
“With monthly static pool concept, any ratings that see quick mortality will also get captured in the default stats and rightly so,” Crisil said. “For instance, a company rated in June 2018 and defaults in September 2018 will not appear in default stats that consider annual pools of period ended March. However, such defaults will get reflected in the stats in monthly pool method.”
Probability of Default Benchmark: In consultation with the regulator, the rating agencies need to disclose on their websites by Dec. 31 a standardised and uniform probability of default benchmark for each rating category for one-year, two-year and three-year cumulative default rates. This would be for both short- and long-term instruments.
Such a benchmark has not been tested anywhere globally by rating agencies or suggested by any regulator, Crisil said. Therefore, the regulator and the rating agencies will need to evaluate this new criteria over the next few months before it becomes a standard part of ratings disclosures, it said.
Credit Enhancement Symbol: Since many rating agencies are assigning the ‘SO’ or structured obligation suffix to ratings of instruments other than securitised or asset-backed transactions, they will now assign a ‘CE’ suffix to a rating if there is an explicit credit enhancement. They will have to assess whether a credit enhancement structure is adequate, under various scenarios, including stress, and disclose it in ratings press releases. The agencies will have to disclose the new symbol and definition on their websites.
Crisil said this suffix will provide more clarity to investors in structured finance instruments.
Standard Operating Procedure: In consultation with SEBI, the rating agencies will need to frame a uniform SOP when it comes to tracking debt defaults and their timely recognition.
Liquidity Indicators: While SEBI had last year mandated the inclusion of a specific section on the liquidity position of an issuer, it has now mandated the rating agencies to publish a standardised liquidity indicator, indicating poor, stretched, or adequate to superior/strong classifications.
The disclosures on liquidity descriptor and rating sensitivity factors that have to be issued in the ratings press releases will provide better quality information to the investors to make informed decisions, according to Crisil.
The market regulator had earlier told the rating companies they may treat a sharp deviation in the bond spreads of debt instruments from the benchmark yield as a material event. It reiterated the need to develop a model to track such deviations.