Standardisation of Rating Scales used by Credit Rating Agencies: SEBI

Nikhil Mogha

01 Jun, 2024

Credit rating agencies or CRAs are the SEBI-registered body responsible for rating any entity’s securities. The agency evaluates an entity’s financial score and determines its ability to pay off the debt based on credit risk. Henceforth, the evaluated score is termed as the rating of a security of an entity listed on the stock exchange. The credit rating agencies are set up to provide independent evidence and research-based opinion on the ability of the issuer to pay off its obligations.

It has been observed by SEBI that credit rating agencies are using different rating symbols and definitions. Therefore, to simplify the rating scales all over the country, the SEBI issued guidelines on “Standardisations of Rating Symbols and Definitions” on 15^th June 2011. Further, through a circular dated 16^th July 2021, the SEBI has standardised the rating scale of securities based on Expected Loss, which also includes the provisions of standardisation of rating scales by CRAs. Therefore the SEBI, in order to provide detailed guidelines on the standardisation of rating scales, has issued the current guidelines.

What is the previous guideline on the Standardisation of Rating Scales?

The SEBI, to standardise the rating scales in the securities market, issued a circular on 16^th July 2021 wherein it was stated that:

• The Credit rating agencies are required to undertake the activity of rating the financial instruments under the guidelines of different financial sector authorities or regulators and according to Regulation-9(f) of SEBI (Credit Rating Agencies) Regulations, 1999.
• The Credit rating agencies must align their rating scales with the rating enumerated under the guidelines of financial sector authorities and regulators to standardise the rating scale’s usage.

Standardised Rating and Symbols for Issuer Rating or Corporate Credit Rating

The circular of standardisation of rating scales has standardised the symbols and provided the definitions for Issuer rating or Corporate Credit Rating. An issuer rating or corporate credit rating determines the degree of safety of a rated entity or the issuer in regard to its ability to timely pay off all its debt obligations.

Moreover, below-mentioned is the list of new symbols or ratings that the CRAs shall use for issuer rating or corporate credit rating.

AAA- Issuers with this rating have the highest degree of safety in terms of paying off all their debt obligations and carry the lowest debt risk.

AA- Issuers with this rating have a high degree of safety in terms of paying off all their debt obligations and carry very low credit risk.

A- Issuers with this rating have an adequate degree of safety in terms of paying off all their debt obligations and carry low credit risk.

BBB- Issuers with this rating have a moderate degree of safety in terms of paying off all their debt obligations and carry moderate credit risk.

BB- Issuers with this rating have a moderate risk of default in terms of paying off all their debt obligations.

B- Issuers with this rating have a high risk of default in terms of paying off all their debt obligations.

C- Issuers with this rating have a very high risk of default in terms of paying off all their debt obligations.

D- Issuers with this rating are in default or expected to be in default.

Note: – The new rating symbols shall contain CRA’s first name as a prefix.

Standardised descriptors for Rating watch and the Rating Outlook

The circular of standardisation of rating scales specifies the standard descriptors for “Rating Watch” and “Rating outlook”. The step of standardising the descriptors has come from the guidelines of “Enhanced Standards for Credit Rating Agencies” dated 1^st November 2016, wherein it is mandated by the Credit Rating agencies to assign a rating outlook and publish the same in the press release. Therefore, in furtherance to the above guidelines, the following standard descriptors are issued by the current guidelines:

• Rating Watch: A rating watchdescribes the credit rating agency’sviews on the expected direction of the rating movement in the short term. The standard descriptors which should be used when security is placed on “Rating watch” shall be:
  • Rating watch with Positive Implications
  • Rating Watch with Developing Implications
  • Rating Watch with Negative Implications
• Rating Outlook: A rating watchdescribes the credit rating agency’sviews on the expected direction of the rating movement in the near to medium term. The standard descriptors which should be used when security is placed on “Rating outlook” shall be:
  • Stable
  • Positive
  • Negative

Ratings of Capital Protection Oriented Scheme

Based on the consultation with the stakeholders, it is stated in the circular that the credit rating agencies shall rate the Capital protection Oriented scheme, and it shall use a rating scale for the “Structured Finance” instrument in accordance with the circular “Standardisations of Rating Symbols and Definitions” dated 15^th June 2011.

Applicability of the Circular

The provisions of the circular of standardisation of rating scales shall be complied with by the Credit rating agencies. They shall also send a compliance report to SEBI within the first quarter from the applicability date of this circular, which is 1^st January 2023.

Monitoring of the Circular

The circular on the standardisation of rating scales specifies that this circular shall be monitored by way of internal auditing of Credit Rating Agencies on half yearly basis.

Conclusion

The SEBI is the regulatory body that manages the security market in the country. The current circular is issued to provide a standardised rating scale. It further provides that due to diversification in the different rating scales of the Credit rating agencies, it becomes imperative to provide a scheme of standardisation of rating scales which will help the investor to understand the credit risk^[1] of any security in a stock exchange. Henceforth, to maintain scrutiny over the rating scale of the CRA, it is required that a compliance report be submitted to the SEBI within a quarter and internal auditing be held on half yearly basis.

Read Our Article: How to Set Up a Credit Rating Agency in India?