SEBI Penalises 3 Credit Rating Agencies – Misleading Ratings of IL&FS

Securities and Exchange Board of India (SEBI) has found that credit rating agencies are lacking in conduct while rating the non-convertible debentures (NCDs) of Infrastructure Leasing and Financial Services Ltd. (IL&FS).

Consequently, the regulator has issued orders and levied a penalty of Rs.25 lakh on each of ICRA Ltd, India Ratings & Research, and CARE Ratings Ltd for not being diligent, not taking timely action while publishing ratings, and lapsing on their duties towards investors.

During the past three years, SEBI has changed the CRA-related regulations for a minimum of six times. However, this case seems rare as SEBI had either increased regulatory compliances or let them settle the issue via consent in the past. In contrast to the usual behaviour, SEBI had rejected their settlement applications on 3 July 2019. Otherwise, the CRAs could settle the lapses against a fee without having to admit the guilt.

The matter dates back to September 2018 when IL&FS had defaulted on its debt obligations. The incident triggered a liquidity crisis in the financial services market. The amount owed by IL&FS and its subsidiaries has made Rs.99,354 crore damage in the financial system. 

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The problem arose when the three credit rating agencies gave the highest rating of AAA even when the subsidiary, IL&FS Transport Networks, defaulted in June this year. An unexpected downgrade was seen in the ratings of bonds sold by IL&FS and its entities when they defaulted on their payment obligations in the month of September. Credit rating agencies had downgraded the bonds from the highest rating to default/junk.

CRAs let the investors lay excessive reliance on assertions of IL&FS management and did not apply the required assessment. Therefore, SEBI found the CRAs guilty for getting comfort from the parentage. The agencies were also found guilty for not identifying the disparities in public disclosures made by IL&FS. Despite displaying stress in the balance sheets, lack of cash flow, and inability to monetise assets, the agencies had not modified the ratings.

The rating agencies argued that the rating is just an opinion and reliance on companies for facts is the pathway as specified in the regulations. However, this argument was not entertained.

For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in