I. Introduction
SEBI had passed a circular on November 1, 2016, bearing no. SEBI/HO/MIRSD/MIRSD4/CIR/P/2016/119 “Enhanced Standard for Credit Rating Agencies (CRAs)”. It had been decided that any person who has a business responsibility should not be a part of the rating committee. However, an MD/CEO of a credit rating agency earlier could be a member of a rating committee. The positions have now been changed with the introduction of the Circular dated November 4, 2019, bearing no. SEBI/HO/MIRSD/CRADT/CIR/P/2019/121 (the “Circular”).
II. Guidelines under the Circular
Following are the changes introduced in the guidelines in comparison with the position earlier:
There was no such provision earlier.3Composition of Independent DirectorsIndependent Directors should be 1/3rd if the board is chaired by a non-executive director. However, if the board is chaired by the executive director, the independent directors should be at least half.
There was no specific provision to have independent directors on board. There are 7 credit rating agencies out of which 3 are listed and some of them did not have a single independent board of directors on board.4Constitution of the committeesThe Board shall constitute (i) the ratings subcommittee; and (ii) nomination and remuneration committee.
The nomination and remuneration committee must be chaired by an independent director.
The subcommittee and the nomination and remuneration committee did not exist earlier.5Recording of minutes of the meetingCRA is required to record the minutes of the meetings with the issuer management in rating committee notes.
While there was a provision of reviewing the ratings annually, there was no provision for recording minutes6Meetings with the issuerThe CRA is required to meet the audit committee of the issuer at least once a year in order to discuss issues related to (i) related party transactions; (ii) internal financial control; (iii) other material disclosure which have bearing on the rating of the listed Non-Convertible Debentures (NCDs)
No such provision existed earlier.
[1] SEBI/HO/MIRSD/MIRSD4/CIR/P/2016/119
III. Recent Events which led to the Introduction of the Circular
The main event which led to regulators like SEBI and RBI to open their eyes in amending the existing regulations for credit rating agencies was the IL&FS ratings. It is not disputed that many companies in the past have paid to get good ratings. In the case of IL&FS, the ratings only dropped from the highest rating i.e. AAA to one notch below AA+ in August 2018. IL&FS was downgraded nine notches in September 2018 at once. This raised doubts about the credibility of the credit rating agencies. The regulators have since deliberated upon strictly regulating the credit rating agencies.
Currently, we follow the ‘issuer pays’ model. This essentially means that the companies which have to be rated pay the rating agencies to be graded. The alternative models are ‘investor pays’ and ‘regulator pays’. However, these models are not feasible and may raise further complications and hence, the ‘issuer pays’ model was considered to be suitable. Therefore, in order to ensure that the ratings are not bought with the ‘issuer pays’ model, the above-stated amendments have been made. The changes that have been incorporated by the circular helps in avoiding any conflict of interest from high-level management and ensures transparency in credit rating procedures.
IV. Functions of the Nomination and Remuneration Committee
The main functions of the Nomination and Remuneration Committee (NRC) are to identify persons who may be appointed to senior management positions. This is more likely to now change since MD/CEO has been excluded from being part of the CRAs. The NRC would also identify an independent director to serve as a chairman of the committee. It would be the function of the NRC to attract members to management positions by developing appropriate compensation packages.
[1] SEBI/HO/MIRSD/MIRSD4/CIR/P/2016/119
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