In the recent two decades, credit ratings have become increasingly crucial among investors and...
To reduce the risk to investors over structured financial assets, the SEBI, on 28th September 2022, issued a framework for credit rating agencies on ratings of securities for Credit Enhancement. The framework provides that the credit rating agencies shall involve explicit credit enhancement features along with security credit ratings.The framework is issued to provide transparency and an improved rating process so the investor can make an informed decision.
A credit rating is generally allocated to security. It is the process of analysing the Credit Risk of any financial instrument or an entity. The rating is given to an entity or the security based on its past borrowing and lending performances in the market. It is a detailed report based on the previous borrowing and lending activities of any financial instruments and is used to determine the creditworthiness of any financial entity. The credit rating helps determine any financial entity’s ability to meet its debt obligations.
Credit Enhancement is a technique the company uses to improve their credit ratings in the market. It can be done through external and internal sources to enhance their creditworthiness in the market and determine the capacity to repay the debt.
The Framework on Credit enhancement rating shall be effective from 1st January 2023, and it shall be applicable on the securities that are:
The framework has stated that the Credit Rating agencies shall, within one quarter from 1st January 2023, submit the report of the compliance with SEBI.
The framework has provided that credit ratings for securities that are listed and are proposed to be listed on the Recognised Stock Exchange shall carry the suffix “CE” if a third party does the credit enhancement, provided that the security rated is not bankruptcy remote of the issuer or originator.
The framework aims to provide transparency in the rating process of security. It provides that wherein any specified support considerations for Suffix “CE” mentioned below is used for the credit rating shall have to follow measures specified in the framework.
The measures adopted by the credit rating agencies for Credit Enhancement are:
The framework provides that there shall be a half-yearly Internal Audit of the Credit Rating Agencies to monitor whether the provisions of the framework are followed or not.
The current framework is established to determine the credit enhancement ratings of the security and provides for a transparent and improved rating process. The credit rating agencies are required to independently conduct the examination of any credit enhancement by the third party and shall appoint an external legal consultant when warranted. The framework aims to provide security to the investors so they can make an informed decision about the financial entity and any financial instrument. It is also necessary that the Credit Rating Agencies shall, while rating the security, also suffix “CE” when the third party determines the rating.
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