New Delhi: The BRICS grouping of the five largest emerging economies—Brazil, Russia, India, China and South Africa—is planning to challenge the existing credit rating system through a new credit rating agency where it is the prospective investor that will pay for the rating of an issuer of a debt instrument.
The proposal originally mooted by India is expected to be fast-tracked at the upcoming 8th BRICS Summit at Goa on 15-16 October, by setting up a working group and a technical group, a government official involved in the process said, requesting anonymity.
Under the present pricing model of rating agencies, the company or institution issuing bonds pays the rating agency to be rated, known as issuer-pays model. Under the new BRICS rating agency, it is the investor who is planning to invest in the company that will pay for the rating of the company—an investor-pays model.
“What we are saying is a shift to investor-pays model from issuer-pays model. There is a moral hazard in the existing model of rating. There is an ethical issue. Before 1970s, ratings were funded by the investors, not the issuers. We think there is space for the rating model to shift to the earlier model followed,” the official quoted earlier said.
In preparation for the BRICS rating agency, Exim Bank had prepared a concept paper and rating agency Crisil Ltd had conducted a study for India. Later, the concept paper was shared with the other four members of BRICS. “There was a knowledge workshop in Mumbai where Securities and Exchange Board of India (Sebi) which is the regulator of rating agencies in India, was there. The other members submitted their views on the concept paper. It was also discussed at the BRICS sherpas meeting in Bhopal in August,” the official said.
Just as the BRICS New Development Bank (NDB) contributes new financing to existing financing available through other multilateral institutions, the new rating agency will also contribute to existing knowledge of rating systems, the official said. “Currently, the rating is from one perspective, which is not an emerging market perspective. The granularity is not there. For example, SBI (State Bank of India) is an AAA rated institution, but when it raises bonds in the international market, it is capped at India’s sovereign rating, which is BBB minus. India has never ever defaulted—how do you give India a BBB minus rating?” the official asked.
The official said BRICS could look at rating companies, institutions as well as sovereigns. “One proposal is that the right to rate should be auctioned off. So, the five BRICS countries will auction off to some private entity which will take minimum subsidy for some years because this rating agency will not start making profit from the beginning. There can be different private entities chosen for different ratings such as companies, institutions and sovereigns,” he added.
Amit Tandon, founder & managing director of Institutional Investor Advisory Services and former managing director of Fitch Ratings, said BRICS has to get its credit rating model right—just because there are problems with the issuer-pays model it does not mean the investor-pays model will work. “Investors also could push rating agencies for higher rating of the companies they are investing in because it will mean lower capital charge for them. Also, the new model may reduce the universe of rated companies as currently in India around 10,000 companies are rated because they pay for themselves while only about 150 investors subscribe for it. There should be more rating agencies but it should not lead to rating inflation or rating agencies assigning higher rating under pressure,” he added.
For the new rating agency to succeed, a legal framework has to be built to decide under which country’s legal jurisdiction this rating agency should operate. “It’s a challenge. If it is based in one of the five countries, then will the laws of that country apply? Our view is it should be somewhere out of these five countries or it could even have a virtual headquarter,” the official said.
Tandon said though the reputation of rating agencies was temporarily hit after the Lehman Brothers collapse at the beginning of the global financial crisis in 2008, their revenues are now higher than in the pre-crisis days. “It means the market is willing to pay them for their rating and services,” he added.
India has long held that the methodology of the existing three major rating agencies — S&P Global Ratings, Fitch Ratings and Moody’s Investors Service — is biased against developing countries, reflected by their poor rating of these economies. Currently, all the three global rating agencies rank India at the lowest investment grade, which is just a notch above junk status.
On Thursday, Indian finance ministry officials ticked off a visiting team of Moody’s that indicated on Tuesday that it is unlikely to upgrade India’s credit rating anytime soon, ahead of a meeting with Indian government officials.
“Due process has to be followed and you cannot jump the gun. If you are reaching a conclusion before interaction with the finance ministry and the other ministries, then somewhere we see the entire rating process, the methodology, was deficient,” economic affairs secretary Shaktikanta Das said on Thursday.