Last week, SEBI penalized ICRA and CARE Rs.25 lakhs each for laxity in due diligence in the IL&FS case. Some of the proxy advisories were of the view that the penalty was too small considering the magnitude of the default by IL&FS. But that is not the point. The point is that the regulator has sent across a clear message to the rating agencies that they will be held accountable for their ratings, their downgrades, their upgrades as well as misplaced ratings.
Making CRAs accountable
Even at the peak of the financial crisis in 2008, most of the world’s leading rating agencies got away under the pretext that it was a systemic crisis which could never predicted. It was not clear how the likes of Lehman and Bear Sterns enjoyed AAA ratings just a few weeks before they imploded. Even in India, SEBI has rarely questioned, leave alone penalized the CRAs. One of the common refrains of most rating agencies was that there were information delays from the side of the banks and the companies and hence the rating agencies came to know about defaults very late. That has been resolved with SEBI instructing all listed companies to share default information with CRAs within 24 hours. The need to make CRAs accountable was also felt after it emanated that a handful of employees of these CRAs were hand-in-glove with the IL&FS top management in taking the shareholders and lenders down the wrong path.
IL&FS was the last straw
In a way, the regulator had little choice other than penalizing the CRAs in IL&FS case. There were too many flagrant violations. Firstly, the ratings agencies were clearly in cahoots with the former board of IL&FS, as is evident from the top management dismissals. Secondly, the rating agencies did not even sound as much as a warning even as IL&FS was gradually and inexorably imploding before the crisis became public in mid 2018. Had the money markets not tightened, the IL&FS story would have continued for some more time. CRAs were also guilty of drastically cutting IL&FS ratings from AAA to default rating. This resulted in huge losses for the small and retail investors exposed to IL&FS debt via the mutual fund route.
SEBI has sent right signals
The proxy advisors need to realize that the onus was on SEBI to make it clear that the rating agencies were partially, if not wholly, responsible for the mess at IL&FS. That purpose has been served. Rating agencies will now put internal checks and balances in place to ensure investors are adequately forewarned if not forearmed. That issue will certainly be addressed by this penalty. For a long time, rating agencies and auditors came for the least amount of flak by the capital markets regulators. That is changing; and it is good for the health and integrity of capital markets! ©