THE GIST of Editorial for UPSC Exams : 19 JUNE 2019 (Time to crack the whip (The Hindu))

Time to crack the whip (The Hindu)

Mains Paper 3 : Economy
Prelims level : Not Much
Mains level : Highlighting the additional disclosures by SEBI

Context

  • Strict enforcement may work better than higher disclosures in disciplining rating agencies.

Background

  • Rating agencies, or rather their propensity to lock the stable doors after the horses have bolted, have been at the centre of the recent credit crisis in the debt market.
  • Investors in bonds have been frequently jolted by instances of NBFCs rated ‘high safety’ (ILandFS, DHFL and Reliance Home and Commercial Finance, for instance) running into a crunch situation and delaying or defaulting on their repayments.
  • Rating agencies have handed out multi-notch downgrades after their difficulty in servicing debt became well-known. This makes ongoing attempts by the Securities Exchange Board of India (SEBI) to hold rating agencies accountable for their opinions quite welcome.
  • But SEBI’s expectation that investors will take rating agencies to task based on increasingly elaborate disclosures in rating reports, appears unrealistic.

Three key sets of additional disclosures

  • SEBI has asked credit rating agencies to make three key sets of additional disclosures that put their credit opinions in context.
  • One, it has asked them to reveal the cumulative default rates on rated securities over one, two and three-year time frames so that investors can assess their hits and misses.
  • Two, they will be required to stick their neck out on the probability of default for each type of rating, so that investors can gauge the credit risk they’re taking on when buying bonds. SEBI has also laid down the tolerance level of defaults for each rating category.
  • For instance, it expects AAA rated securities to carry a zero-default rate for one and two years, with a tolerance of 1 per cent for three years.
  • Three, SEBI wants rating agencies to give their opinion on the liquidity situation of the issuer while taking note of sudden spikes in bond spreads that can be a precursor to default.

Outcomes of these disclosures

  • While all these disclosures will no doubt add to the utility of rating reports, it is doubtful if retail investors will be able to derive much value from them.
  • Retail investors in NCDs and public deposits tend to take third-party credit ratings at face value and seldom delve into the rating rationales put out by agencies.
  • if they do, it is doubtful if they can decipher the implications of such jargon-filled qualifiers on their investments.
  • While institutional investors may be able to make sense of such disclosures, they should in any case be relying on in-house expertise for independent credit assessment to justify their fees.

Conclusion

  • After multiple rounds of changes to disclosure norms, it is time SEBI turned to stricter enforcement actions to discipline rating agencies.
  • Writing new regulations or calling for more disclosures post facto cannot substitute for SEBI promptly hauling up rating agencies when they are found to be negligent.
  • Now that it has a probability of default framework in place, SEBI must consider measures such as clawing back rating fees or even revoking licences for rating agencies who frequently fail in their fiduciary duty to warn investors off risky debt.

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Prelims Questions:

Q.1) With respect to “The World Population Prospects 2019”, consider the following statements:
1. By 2027, India is projected to surpass China as the world’s most populous country.
2. Following the India-China re-ordering in 2027, the ranking of the five largest countries is projected to remain the same until the end of the century.
Which of the statements given above is/are correct?

Which of the statements given above is/are correct?
A. 1 only
B. 2 only
C. Both 1 and 2
D. None

Answer: C
Mains Questions:
Q.1) What are the three key sets of additional disclosures as SEBI has asked credit rating agencies to follow?

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