IL&FS Crisis: SEBI Imposes Rs 25-Lakh Penalty On CARE, ICRA And India Ratings

The market regulator imposed a Rs 25 lakh-penalty on CARE Ratings Ltd., ICRA Ltd.,and India Ratings and Research Private Ltd., for their failure to exercise skill, care and due diligence in rating the non-convertible debentures of Infrastructure Leasing & Financial Services Ltd. and its non-bank lending unit.

“Brazen failure” of the credit rating agencies clearly defeated the objective of investor protection and orderly development of securities market, the Securities and Exchange Board of India said in an order. It concluded that the rating agencies violated the provisions of SEBI Act, 1992, and the its code of conduct.

The credit rating agencies should have anticipated the stress in IL&FS’ balance sheet and mounting credit risks, and must have awarded credit ratings to alert the market regarding its deteriorating financial position, the regulator said.

The order stems from SEBI’s investigation into the rating agencies’ role following the defaults by IL&FS and IL&FS Financial Services Ltd. on their debt obligations in September 2018. That collapse rattled the credit markets, prompting the government to take over the group and appoint a board led by veteran bank Uday Kotak.

The new board appointed Grant Thornton to investigate the role of credit rating agencies in the entire process. The report flagged instances where gifts and undue benefits may have been used to try and influence rating agencies. The probe also highlighted a potential conflict of interest as IL&FS Financial Services owned an equity stake in CARE Ratings.

SEBI initiated its probe in December last year and, after preliminary investigation, concluded that there were sufficient grounds to conduct an inquiry into the violation of credit rating regulations.

Here are the key findings of the order....

Allegations Against ICRA

Excessive reliance on representations of IL&FS management: ICRA failed to conduct independent due diligence to ascertain accuracy of management updates on status of various projects and deals. It assigned a ‘AAA’ rating to the non-convertible debentures of IL&FS despite the stressed balance sheet and negative debt-to-equity ratio.

Failure to change rating outlook: ICRA maintained a “stable” rating outlook on NCDs issued by IL&FS despite slow progress in asset monetisation and deleveraging. It retained the outlook despite having knowledge of several factors like non-completion of projects and delays.

Not considering latest financials in the Oct. 27, 2017 rating note: ICRA failed to provide details of IL&FS’ ballooning debt to its rating committee. It didn’t exercise prudence and proper due diligence by failing to obtain latest asset-liability mismatch figures from IL&FS.

SEBI relied on the central bank’s observation: RBI had observed in its report that a standalone evaluation of the governance systems in IL&FS Financial services wasn’t carried out by the rating agency.

Allegations Against CARE Ratings

Excessive reliance on management’s representations on NCDs and rights issue: CARE Ratings failed to exercise due diligence as it was aware that IL&FS would receive funds after the deadline to pay its obligations on commercial papers.

Failure to change the rating outlook or placing the rating under credit watch: CARE kept the credit rating of IL&FS as “stable” throughout the rating period despite certain observations and only placed it under “rating watch negative” in August 2018.

RBI’s observations on the rapid rating downgrade of IFIN commercial papers: CARE Ratings downgraded the IL&FS Financial Services’ commercial papers from A1 to A4 in a single instance in September 2018. It relied on the support extended by IL&FS’ group entities while assigning credit ratings without evaluating the financial strength of the supporting entity.

Allegations Against India Ratings

• India Ratings placed excessive reliance on the representations made by the management of IL&FS.
• It failed to keep a track of disparity in the stock exchange disclosures made by the infrastructure developer and didn’t exercise proper due diligence as it failed to obtain independent confirmation of the claims made by IL&FS.
• It relied on figures as on March 31, 2017 for a rating committee note issued in February 2018.
• It failed to adequately caution investors regarding the high leverage at IL&FS.

SEBI’s Findings

For CARE Rating:

• It failed to exercise due diligence to ensure true, fair and adequate rating to instruments issued by IL&FS.
• Didn’t apply independent professional judgment, objectivity and independence in the rating process.
• Failed in doing due diligence while discharging responsibilities as a credit rating agency.

For ICRA:

• It’s failure in the credit rating process is blameworthy and serious.
• Default by IL&FS occurred due to the ICRA’s indifference and laxity in the process.
• It’s brazen failure defeated the purpose of the SEBI regulations and their objective of investor protection.

For India Rating:

• India Rating’s failure in the credit rating process is vivid and obvious.
• While it highlighted concerns about deteriorating IL&FS’ financial conditions, it failed to act upon them while rating the non-convertible debentures issued by IL&FS.
• Failed to exercise proper skill and due diligence in the credit rating process.