Draws parallel with Lehman Bros; demands investigation of LIC, institutional investors; suggests widespread reforms
Parliamentary Standing Committee on Finance has criticised the credit rating agencies for overrating the debt-ridden Infrastructure Leasing & Financial Services (IL&FS) and has demanded probes into their role as well as of Life Insurance Corporation (LIC) and other institutional investors as part of an overall investigation into the IL&FS crisis.
In its report titled, 'Strengthening of Credit Rating Framework', the parliamentary panel has sought a comprehensive inquiry into IL&FS, also covering the governance failures, indecision and indiscretion on the part of the IL&FS Board. The panel headed by former Congress minister Veerappa Moily tabled the report in Lok Sabha on Wednesday.
"The Committee would recommend a comprehensive commission of enquiry into the whole gamut of the episode, which will inter-alia probe the role credit rating agencies that had over-rated the (IL&FS) entities sometime before the crisis and the role of the largest institutional stakeholder in IL&FS, LIC as well as other institutional stakeholders," the report said.
Drawing a parallel with the collapse of Lehman Brothers in the US where the rating agencies' role came under scanner, the committee observed that the credibility of the rating agencies has once again come under question in the case of Il&FS. In the US, the rating agencies were forced to downgrade their own prior credit ratings on complex mortgage backed securities.
Similarly, due to lack of due diligence, the credit rating agencies here, while ignoring the rising debt levels, had given IL&FS an AAA rating, which indicates the highest level of creditworthiness, the committee said. The rating agencies had downgraded IL&FS multiple notches only after it defaulted on a series of loan payments in September 2018, it said. The IL&FS has a debt obligation of about Rs 91,000 crore, the majority of which is from the public sector banks and financial institutions. The majority of the capital invested in IL&FS is by public financial institutions like LIC, State Bank of India (SBI), Central Bank of India besides UTI AMC.
The time has come for the fresh evaluation of the credit rating framework in the country with a view to restoring public confidence and ensuring the accountability of the credit rating agencies, the report said.
To address conflict of interest, the committee has suggested the capital markets regulator Securities & Exchange Board of India (Sebi) and the finance ministry to consider the 'investor pays model' or 'regulator pays model'. Currently, as per the 'issuer pays model' followed by the rating agencies involves the entity issuing the financial instrument pays them upfront to rate the underlying securities.
The panel has also recommended mandatory rotation of rating agencies on the lines of the statutory auditors to avoid pitfalls of long association with the issuer, considering the recent failures in sensing trouble in their client-entities. It has also suggested to the finance ministry to consider dual rating involving one more rating agency, particularly for debt instruments or bank credit involving large amounts of more than Rs 100 crore. In this light, the existing threshold for registration of rating agencies should be lowered to promote competition, it has said.
To avoid another area of conflict of interest, the panel has recommended changes in the regulatory framework which allows the rating agencies or their subsidiaries to also do advisory work apart from rating.
The disclosures being made by the rating agencies should, henceforth, include extent of promoter support, linkages with subsidiaries, liquidity position for meeting near-term payment obligations among others, the committee said.
It has asked the finance ministry to seek a report from the two regulators – Sebi and Reserve Bank of India – about the action taken by them against the ratings agencies that have been giving stable ratings to IL&FS.
INDIA'S LEHMAN MOMENT
- Credit rating agencies gave IL&FS an AAA rating, which indicates the highest level of creditworthiness
- The companies downgraded IL&FS multiple notches only after it defaulted on a series of loan payments
WHAT THE COMMITTEE PRESCRIBES
- Wants investor or regulator to pay for rating rather than the issuer of securities now
- Mandatory rotation of rating agencies in line of statutory auditors
- Dual rating, particularly for amounts exceeding more than Rs 100 crore.
- Lowering existing threshold for registration of rating agencies
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Similarly, due to lack of due diligence, the credit rating agencies here, while ignoring the rising debt levels, had given IL&FS an AAA rating, which indicates the highest level of creditworthiness, the committee said. The rating agencies had downgraded IL&FS multiple notches only after it defaulted on a series of loan payments in September 2018, it said. The IL&FS has a debt obligation of about Rs 91,000 crore, the majority of which is from the public sector banks and financial institutions. The majority of the capital invested in IL&FS is by public financial institutions like LIC, State Bank of India (SBI), Central Bank of India besides UTI AMC.
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