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CREDIT RATING AGENCIES

EXECUTIVE SUMMARY

Credit rating is slowly being recognized in India as a significant measure towards investor

protection and self check for the corporate enterprises of their financial and operational

strength. Credit rating provide s indicative guidance to the prospective investor in the fixed

income securities or fixed deposit programs on the degree of risk involved in the timely

repayment of principal and interest . A rated company is placed higher in the estimation of

the investor than a an unrated company irrespective of better financial standing of the latter

or the reputation attached as a familiar group company of a big business houses. This makes

a transition in the corporate culture in this country. So far, the finding show that company is

shy enough to opt for credit rating unless it is made mandatory under the government

directives.

With the commencement of CRISIL (1998) and ICRA in (1991) about 400 companies have

under compulsion or voluntary gone for the rating for different debt instrument or fixed

deposit programs issued by them.

It is the need of an hour to create a deeper understanding of the rating process, procedure,

practices & information requirements particularly in the minds of the persons managing the

corporate enterprises. A lot of efforts are needed to educate the people in general and the

corporate executive in particular on the systems, methodology and practices followed by

them in rating the credit instrument and debt obligations.


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INTRODUCTION TO CREDIT RATING

The Ratings industry in India has been built up to its present position over a period of fifteen

years. Over the years, credit ratings have evolved into a 90-crore market, with four agencies

providing rating services, and significant pull from investors for the product. The ratings

business in India has seen three phases. During the first of these phases, as described above,

there was no experience of credit ratings, and virtually no awareness, on the part of investors

and issuers.

The second phase saw the advent of regulatory support for credit ratings, with the

introduction and increasing rigor of regulations covering primarily the markets for public

issue of debt and for fixed deposits. Aimed at protecting smaller investors, these measures

also amounted to regulatory recognition of the role of credit ratings and the quality of the

effort put in till then, in estimating credit quality. With these measures, credit ratings rapidly

passed out of the arcane realm of high finance, and into the lexicon of the individual market

participant. This phase also saw the arrival of competition, in the form of other domestic

agencies entering the market.

Recent years have seen a third phase of the markets development with public issues of debt

reducing in volume; the focus has shifted to the market for private placements. Almost all the

privately placed debt issued in the Indian market is rated, even though this is not a regulatory

requirement. This shift is entirely driven by investors in these securities, who typically tend to

be highly sophisticated financial sector entities. We are looking therefore at a qualitative

maturing of the market, where a rating is required not as a compliance issue or a mandatory

requirement, but as an opinion on credit quality demanded by discerning buyers.


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Going forward, following trends are expected to intensify in the Indian market:

- More intensive use of ratings by investors.

- Increasing sophistication in use of ratings.

These two trends will result in credit ratings not being used only as a go- no-go input, as is

currently often the case. We expect the major use of credit ratings to be in the pricing of debt

instruments. The correlation of yields and ratings, already strong, will deepen as the bond

market evolves further. Measures increasing the sophistication of the market, such as the

introduction of credit derivatives, will add a further dimension to the use of ratings.

Credit rating is also known as SECURITY RATING in India. It is mandatory for the issuance

of debt instruments, debentures, commercial paper issued by corporate and public deposits of

all NBFCs (Non Banking Financial Companies).

LIST OF SOME TOP CREDIT RATING AGENCIES OF INDIA

India CRISIL (1987)

India ICRA (1991)

India CARE (1994)

India Duff & Phelps Credit Rating India (P) Limited (Now Fitch Ratings India Private

Ltd.)(1996)

India SME Rating Agency of India Limited (SMERA) (2005)

India Brickwork Ratings India Pvt. Ltd (BWR) (2007)


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ORIGIN

The concept of Credit Rating originated in the United States. The first Credit Ratings were

published by John Moody during 1909 in his analysis or rail road investments. This evolved

into the rating company, Moodys Investors Services Inc, a division of Dun and Bradstreet

Inc.

Moody was followed by Poors publishing Company in 1916 and the Standard Statistics

Company in 1922, which merged, into Poor to become the largest bond rating concern,

Standard and Poors corporation, a subsidiary of McGraw Hill, Inc. The third is Fitch

publishing company of New York, which was established in 1924. The fourth agency is Duff

& Phelps of Chicago, which was recognized by Securities and Exchange Commission in

1982. It acquired Crisanti and Maffei Inc. of New York in 1991. These four security raring

agencies are the only ones with Securities and Exchange Commission recognition as national

bond rating agencies. There are other services that rate securities especially stock, like Value

Line Investment Survey.

The recognition of rating agency by Securities and Exchange Commission in U.S.A does not

constitute approval. Actually, such recognition is not necessary to enter the security rating

business. SEC uses the ratings of recognized agencies for evaluation of bong assets of

brokers and dealers registered with it.

In India there are 5 credit rating agencies. First, Credit Rating Information Services of India

Limited (CRISIL) set up by ICICI AND UTI in 1988. Secondly Investment Information and

Credit Rating Agency of India limited (ICRA) set up by IFCI in 1991. Thirdly, Credit

Analysis and Research Limited (CARE) promoted by IDBI in 1993 in association with

financial institutions. Fourthly, Duff and Phelps Credit Rating India Private Limited (DCR

India) for rating non-banking financial companies for fixed deposits.


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DETERMINANTS OF CREDIT RATINGS

Credit rating is a symbolic indicator of the current opinion of a rating agency of the

willingness and relative of an issuer debt instrument to pay interest and repay principal as per

the terms of the contract. A rating agency assigns quality ratings that measures the default

risk of a security and sells rating to their subscribers. The default risks primarily determined

by the amount of work available to the issuer relative to the amount of funds to be paid to the

security holders. The ability to pay is evaluated by financial ratios. Ratio analysis is done to

analyze the present and future earning power of the company issuing the security. Ratio

analysis of the issuers financial statements yields insights about the strength and weaknesses

of the company. The credit rating agencies have written guidelines about what values

particular ratios should have in order to earn each different quality ratings.Credit rating

appraises the default risk which is a combination of business risk and financial risk.

Business Risk: Business risk relates to the market position of the company, operating

efficiency and management quality. The key factor taken into consideration are: the nature of

the industry the company is in, the demand-supply position, cyclical/ seasonal factors and

government policies vis--vis the industry; and the competition its facing within the industry.

Market Position: The market share the company enjoys, it is competitive advantages and

selling and distribution arrangements.

Operating Efficiency: Locational advantages, labor relationships, cost structure,

technological and manufacturing efficiency as compared to its competitors.


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Legal Position: Terms of prospectus, systems for timely payment, and for protection

against fraud.

Financial Risk: Financial risk is a function of the profitability, debt leverage flexibility

and adequate cash flow. The assessment of financial risk is done on the basis of:

a) Financial analysis, including accounting quality: accuracy of statement of profit,auditors comments, valuation and depreciation policies.

b) Earnings protection: Sources of future earning growth, profitability ratios andearnings in relation to fixed income charges.

c) Adequacy of cash flow: Sustainability of cash flows and working capitalmanagement.

d) Financial flexibility: Ability to raise funds.

Management: An evaluation of the management, which is qualitative in nature and

imparts certain amount of subjective element, is done on the basis of track record of the

management; planning and control system, depth of managerial talent, succession plans.

Evaluation of capacity to meet adverse situations, goals, philosophy and strategies.

Environment: An analysis of environment covering regulatory and operating

environment, national economic outlook, pending litigation and unpaid taxes are also

attempted.

Rating thus is not based on a predetermined formula which specifies the relevant variables

and as well as weights attached to each one of them. Further the emphasis on different

aspects varies from agency to agency. Broadly the rating agencies assure itself that there is


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good congruence between assets and liabilities of a company and downgrades the rating if the

quality of the assets depreciates.

The rating agencies employ qualified professionals to ensure consistency and reliability. The

agencies also ensure the integrity of rating by insulating rating from conflicts of interest. The

rating agencies employ nearly identical symbols. They examine the above factors before

assigning a grade. The symbols are A, B, C and D and each symbol is graded with associated

risk by adding two or one of the same symbol, like AAA, AA and A; BBB, BB and b; and so

on.

MEANING AND DEFINITION

Credit rating is the opinion of the rating agency on the relative ability and willingness of tile

issuer of a debt instrument to meet the debt service obligations as and when they arise. Rating

is usually expressed in alphabetical or alphanumeric symbols. Symbols are simple and easily

understood tool which help the investor to differentiate between debt instruments on the basis

of their underlying credit quality. Rating companies also publish explanations for their

symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper

understanding.

In other words, the rating is an opinion on the future ability and legal obligation of the issuer

to make timely payments of principal and interest on a specific fixed income security. The

rating measures the probability that the issuer will default on the security over its life, which

depending on the instrument may be a matter of days to thirty years or more.

In fact, the credit rating is a symbolic indicator of the current opinion of the relative

capability of the /issuer to service its debt obligation in a timely fashion, with specific


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reference to the instrument being rated. It can also be defined as an expression, through use of

symbols, of the opinion about credit quality of the issuer of security/instrument.

INDIAN CREDIT RATING AGENCIES DEFINE CREDIT RATING AS

FOLLOWS:

According to CARE: Credit ratings are essentially, the opinion of the rating agency on the

relative ability and willingness of the issuer of a debt instrument to meet the debt service

obligation as and when they arise.

According to CRISL: Credit rating is an unbiased, objective and independent opinion to an

issuers capacity to meet financial obligation, it is the current opinion as to the relative safety

of timely payment of interest and principal on a particular debt instruments. Thus, rating

applies to a particular debt obligation of the company and is not a rating for the company as a

whole

According to ICRA: credit rating is a simple and easy to understand symbolic indicator of

the opinion of the credit rating agency about the risk involved in a borrowing program of an

issuer with reverence to the capability of the issuer to repay the debt as per terms of issues.

This is neither a general purpose evaluation of the company nor the recommendation to buy,

hold or sell a debt instrument.

Credit rating does not indicate market risks or predict prices or yield of credits instrument. It

evaluates only a specific instrument and indicates risk associated with such instrument only.

It is general purpose evaluation of the issuer business or operations.


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IMPORTANCE OF CREDIT RATING

Credit ratings establish a link between risk and return. They thus provide a yardstick against

which to measure the risk inherent in any instrument. An investor uses the ratings to assess

the risk level and compares the offered rate of return with his expected rate of return (for the

particular level of risk) to optimise his risk-return trade-off.

The risk perception of a common investor, in the absence of a credit rating system, largely

depends on his familiarity with the names of the promoters or the collaborators. It is not

feasible for the corporate issuer of a debt instrument to offer every prospective investor the

opportunity to undertake a detailed risk evaluation. It is very uncommon for different classes

of investors to arrive at some uniform conclusion as to the relative quality of the instrument.

Moreover they do not possess the requisite skills of credit evaluation.

Thus, the need for credit rating in todays world cannot be over- emphasised. It is of great

assistance to the investors in making investment decisions. It also helps the issuers of the debt

instruments to price their issues correctly and to reach out to new investors. Regulators like

Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) use credit

rating to determine eligibility criteria for some instruments. For example, the RBI has

stipulated a minimum credit rating by an approved agency for issue of commercial paper. In

general, credit rating is expected to improve quality consciousness in the market and establish

over a period of time, a more meaningful relationship between the quality of debt and the

yield from it. Credit Rating is also a valuable input in establishing business relationships of

various types. However, credit rating by a rating agency is not a recommendation to purchase

or sale of a security.

Investors usually follow security ratings while making investments. Ratings are considered to

be an objective evaluation of the probability that a borrower will default on a given security


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issue, by the investors. Whenever a security issuer makes late payment, a default occurs. In

case of bonds, non-payment of either principal or interest or both may cause liquidation of a

company. In most of the cases, holders of bonds issued by a bankrupt company receive only a

portion of the amount invested by them.

Thus, credit rating is a professional opinion given after studying all available information at a

particular point of time. Such opinions may prove wrong in the context of subsequent events.

Further, there is no private contract between an investor and a rating agency and the investor

is free to accept or reject the opinion of the agency. Thus, a rating agency cannot be held

responsible for any losses suffered by the investor taking investment decision on the basis of

its rating. Thus, credit rating is an investor service and a rating agency is expected to maintain

the highest possible level of analytical competence and integrity. In the long run, the

credibility of rating agency has to be built, brick by brick, on the quality of its services

provided, continuous research undertaken and consistent efforts made.

The increasing levels of default resulting from easy availability of finance, has led to the

growing importance of the credit rating. The other factors are:

i. The growth of information technology.ii. Globalisation of financial markets.

iii. Increasing role of capital and money markets.iv. Lack of government safety measures.v. The trend towards privatisation. vi. Securitisation of debt.


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FACTORS AFFECTING ASSIGNED RATINGS

The following factors generally influence the ratings to be assigned by a credit rating agency:

1. The security issuers ability to service its debt. In order, they calculate the past andlikely future cash flows and compare with fixed interest obligations of the issuer.

2. The volume and composition of outstanding debt.3. The stability of the future cash flows and earning capacity of company.4. The interest coverage ratio i.e. how many number of times the issuer is able to meet

its fixed interest obligations.

5. Ratio of current assets to current liabilities (i.e. current ratio (CR)) is calculated toassess the liquidity position of the issuing firm.

6. The value of assets pledged as collateral security and the securitys priority of claimagainst the issuing firms assets.

7. Market position of the company products is judged by the demand for the products,competitors market share, distribution channels etc.

8. Operational efficiency is judged by capacity utilisation, prospects of expansion,modernisation and diversification, availability of raw material etc.

9. Track record of promoters, directors and expertise of staff also affect the rating of acompany.

NATURE OF CREDIT RATING

1. Rating is based on information: Any rating based entirely on published informationhas serious limitations and the success of a rating agency will depend, to a great

extent, on its ability to access privileged information. Cooperation from the issuers as


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well as their willingness to share even confidential information is important pre-

requisites. The rating agency must keep information of confidential nature possessed

during the rating process, a secret.

2. Many factors affect rating: Rating does not come out of a predeterminedmathematical formula. Final rating is given taking into account the quality of

management, corporate strategy, economic outlook and international environment. To

ensure consistency and reliability a number of qualified professionals are involved in

the rating process. The Rating Committee, which assigns the final rating, consists of

specialised financial and credit analysts.

3. Rating by more than one agency: In the well developed capital markets, debt issuesare, more often than not, rated by more than one agency. And it is only natural that

ratings given by two or more agencies differ from each other e.g., a debt issue, may be

rated AA+ by one agency and AA orAA- by another.

4. Monitoring the already rated issues: A rating is an opinion given on the basis ofinformation available at particular point of time. Many factors may affect the debt

servicing capabilities of the issuer. It is, therefore, essential that rating agencies

monitor all outstanding debt issues rated by them as part of their investor service.

5. Publication of ratings: In India, ratings are undertaken only at the request of theissuers and only those ratings which are accepted by the issuers are published. Thus,

once a rating is accepted it is published and subsequent changes emerging out of the

monitoring by the agency will be published even if such changes are not found

acceptable by the issuers.


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6. Right of appeal against assigned rating: Where an issuer is not satisfied with therating assigned, he may request for a review, furnishing additional information, if any,

considered relevant. The rating agency will undertake a review and thereafter give its

final decision.

7. Rating of rating agencies: Informed public opinion willbe the touchstone on whichthe rating companies have to be assessed and the success of a rating agency is

measured bythe quality of the services offered, consistency and integrity.

INSTRUMENTS FOR RATING

Rating may be carried out by the rating agencies in respect of the following:

Equity shares issued by a company. Preference shares issued by a company. Bonds/debentures issued by corporate, government etc. IV. Commercial papers

issued by manufacturing companies,

Finance companies, banks and financial institutions for raising short-term loans. Fixed deposits rose for medium-term ranking as unsecured borrowings.

Rating Other than Debt Instruments Credit Rating has been extended to all those activities

where uncertainty and risk is involved. Now-a-days credit rating is not just limited to debts

instruments but also covers the following:


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I. COUNTRY RATING

A country may be rated whenever a loan is to be extended or some major investment is to be

made in it by international investors to determine the safety and security of their investments.

A number of factors such as growth rate, industrial and agricultural production, government

policies, inflation, fiscal deficit etc. are taken into consideration to arrive at such rating.

II. RATING OF REAL ESTATE BUILDERS AND DEVELOPERS

CRISIL has started assigning rating to the builders and developers with the objective of

helping and guiding prospective real estate buyers. CRISIL thoroughly scrutinises the sale

deed papers, sanctioned plan, and lawyers report government clearance certificates before

assigning rating to the builder or developer.

III. CHIT FUNDS

Chit funds registered as a company are sometimes rated on their ability to make timely

payment of prize money to subscribers. The rating helps the chit funds in better marketing of

their fund and in widening of the subscribers base. This service is provided by CRISIL.

IV. RATING OF STATES

States of India have also approached rating agencies for rating. Rating helps the State to

attract investors both from India and abroad to make investments. Investors find safety of

their funds while investing in a state with good rating. Foreign companies also come forward

and set up projects in such states with positive rating. States like Maharashtra, Madhya

Pradesh, Tamil Nadu, Andhra Pradesh and Kerala have already been rated by CRISIL.


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V. RATING OF BANKS

CRISIL and ICRA both are engaged in rating of banks based on the following six parameters

also called CAMELS.

CStands for capital adequacy of banks.

A - Stands for asset quality.

M - Stands for management evaluation.

L - Indicates liquidity position.

S - Stands for Systems and Control.

FUNCTIONS OF A CREDIT RATING AGENCY

A credit rating agency serves following functions:

1. Provides unbiased opinion:An independent credit rating agency is likely to providean unbiased opinion as to relative capability of the company to service debt

obligations because of the following reasons:

a. It has no vested interest in an issue unlike brokers, financial intermediaries.b. Its own reputation is at stake.

2. Provides quality and dependable information: A credit rating agency is in aposition to provide quality information on credit risk which is more authenticated and

reliable because:


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a. It has highly trained and professional staffs that have better ability to assessrisk.

b. It has access to a lot of information which may not be publicly available.

3. Provides information at low cost: Most of the investors rely on the ratings assignedby the ratings agencies while taking investment decisions. These ratings are published

in the form of reports and are available easily on the payment of negligible price. It is

not possible for the investors to assess the creditworthiness of the companies on their

own.

4. Provide basis for investment: An investment rated by a credit rating enjoys higherconfidence from investors. Investors can make an estimate of the risk and return

associated with a particular rated issue while investing money in them.


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ROLE OF CREDIT AGENCIES IN INDIA


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THE ROLE OF CREDIT RATINGS AGENCISES

Credit rating agencies assess the risk of investing in corporations and governments and

provide credit opinions on the ability of companies and countries to meet their debt

obligations. They also provide a wide array of financial data and information on bonds,

equities and mutual funds.

They bridge the information gap between issuers and investors and a source of credit

surveillance for investors by monitoring and disseminating credit opinions in a timely and

efficient manner. They also provide outlook on government securities, like positive, negative,

stable, etc. Opinions and views of credit rating agencies are vital to investment decisions

made by banks, pension funds and other financial institutions.

Bondholders and shareholders rely on the advice of the three big credit rating agencies. Their

views can stroke millions of bond and share prices and can move markets in an unpredictable

ways, creating a strong riffle effect.

CRAs' role has expanded with financial globalization and has received an additional boost

from Basel II which incorporates the ratings of CRAs into the rules for setting weights for

credit risk. Credit rating agencies (CRAs) specialize in analyzing and evaluating the

creditworthiness of corporate and sovereign issuers of debt securities. Issuers with lower

credit ratings pay higher interest rates embodying larger risk premiums than higher rated

issuers. Moreover, ratings determine the eligibility of debt and other financial instruments for

the portfolios of certain institutional investors due to national regulations that restrict

investment in speculative-grade bonds. In making their ratings, CRAs analyze public and

non-public financial and accounting data as well as information about economic and political

factors that may affect the ability and willingness of a government or firms to meet their

obligations in a timely manner. However, CRAs lack transparency and do not provide clear

information about their methodologies. Ratings tend to be sticky, lagging markets, and then

to overreact when they do change. This overreaction may have aggravated financial crises in

the recent past, contributing to financial instability and cross-country contagion. The failure

of big CRAs to predict the 19971998 Asian crisis and the bankruptcies of Enron, WorldCom

and Parmalat has raised questions concerning the rating process and the accountability of the

agencies and has prompted legislators to scrutinize rating agencies.


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A. Role of Credit Rating Agencies in the Evaluation of Issuers of Securities

1. General Procedures for Evaluating Issuers:

The larger credit rating agencies engaged in traditional, fundamental credit analysis generally

approach the rating process with similar procedures and organizational structures, and these

are described below. Rating procedures at these firms are designed to facilitate analytical

consistency and capitalize on area expertise. Organizationally, the larger rating agencies

divide the rating universe into separate categories by industry (e.g., energy or banking) and

type of instrument (e.g., corporate debt, municipal securities, structured finance). At the core

of the rating process is the rating committee. Rating committees are generally formed ad hoc

to initiate, withdraw, or change a rating. They typically are composed of a lead credit analyst,

managing directors or other area supervisors, and junior analytical staff. Rating decisions are

made upon a simple majority vote of the committee and are, at their most basic level, an

opinion regarding the likelihood the issuer will repay its financial obligation.

Rating agencies generally designate ratings of long-term debt through some variation of an

alphabetical combination of lower and upper case letters. Fitch and S&P use the same

ranking designators: AAA, AA, A, and BBB are investment grade categories; BB, B, CCC,

CC, C, and D are considered speculative grade rankings. Moodys long-term rating

designators are: investment grade: Aaa, Aa, A, Baa, speculative grade: Ba, B, Caa, Ca, and

C. Rating agencies often attach modifiers to the grades to further distinguish and rank ratings

within each generic classification. S&P and Fitch generally use pluses and minuses to

modify their grades, while Moodys generally uses numerical modifiers 1-3, with 1 indicating

that a credit falls in the higher end of the generic rating category, 2 indicating mid-range, and

3 indicating the lower end of the ranking.


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2. Rating Committee Process

Rating committees typically convene at the behest of a lead analyst or sector supervisor to,

among other things: (a) rate a new issuer or instrument; (b) assess a major transaction or event

that might impact a current rating; or (c) consider putting a rating on review for change. The

lead analyst frames the issues and presents most of the dataunder consideration. Opinions of

all members are considered and vetted, and ultimately result in a nonpublic committee

memorandum that discusses its decision, rationale, assumptions, and underlying data.

Committee deliberations are preceded by regular on-going contacts with issuers and

information gathering. Ratings are based on a variety of public and nonpublic information.

Public information reviewed in the ratings process typically includes filings with the

Commission, news reports, industry reports, bond and stock price trends, data from central

banks, and proxy statements. Nonpublic information can include credit agreements,

acquisition agreements, private placement memoranda, and business projections and forecasts.

Nonpublic information is often provided pursuant to a confidentiality agreement between the

rating agency and the issuer, or is provided premised upon the rating agencys policy to keep

such information confidential. It is generally the responsibility of the lead analyst to gather

this information, frame issues for committee deliberations, and act as the primary point of

contact with an issuer. Annual and periodic meetings at issuer or rating agency headquarters

are common. Questionnaires and detailed document and information request letters also are

used to gather information from issuers. Rating agencies generally do not, however, conduct

audits or due diligence reviews of issuer-provided information.


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3. Rating Decisions and Publication

Rating agencies generally advise issuers in advance of an imminent rating action and allow

the issuers to appeal the decision. However, the right of appeal is limited both in time and to

the submission of new and important information. The time between a committee decision

and publication varies from a few hours to a few days, in order to minimize the inappropriate

and premature disclosure of information to the marketplace. Issuers may be allowed to review

and edit press releases to ensure factual accuracy and prevent the disclosure of confidential

information. Rating agencies do not, however, allow issuers to delete the primary basis of a

rating action if the disclosure of confidential information is not at issue.

In addition to rating actions, rating agencies may also publish rating outlooks. An outlook is

an opinion on the future direction of the rating, and may encompass a period from one to

several years. Outlooks are usually categorized as being positive, negative, or stable, and are

typically included in a rating action press release. Rating agencies generally surveil ratings

over time by reviewing corporate filings, monitoring industry trends, and maintaining a

dialogue with corporate management. Rating agencies communicate the results of this

surveillance on occasion to the marketplace through the use of watch lists. Watch lists

signal to the market that a rating is under active review for a change (in any direction) and are

typically in response to significant sector or issuer specific events. Typically, issuers or

instruments are kept on a watch list 90120 days, depending on the practice of a particular

rating agency. As with rating actions, issuers often are informed in advance if they are to be

placed on a watch list, so that they have an opportunity to provide additional information or

explain existing data.


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B. Importance of the Role of Credit Rating Agencies to Investors and the

Functioning of the Securities Markets

Credit ratings can play a significant role in the investment decisions of investors, and the

value investors place on such ratings is evident from, among other things, the impact ratings

have on an issuers ability to access capital. Set forth below is a brief description of how

various market participants use credit ratings, and the importance of rating agencies to their

market activities.

1. Issuers

Issuers seek credit ratings for a number of reasons, such as to improve the marketability or

pricing of their financial obligations, or to satisfy investors, lenders, or counterparties who

want to enhance management responsibility. Public or private credit ratings may be sought

from one or more rating agencies. In certain markets, such as the U.S. long-term corporate

debt market, a single-rated debt issue may

Be priced below an issue with similar ratings from two agencies, because the absence of a

Second rating is interpreted as the issuers inability to obtain another equivalent rating. In

Other markets, however, such as the asset-backed securities market, a single rating may

Be adequate confirmation of asset quality.

2. Buy-Side Firms.

Buy-side firms, such as mutual funds, pension funds, and insurance companies, are among

the largest owners of debt securities, preferred stock, and commercial paper in the U.S.

Retail participation in the debt markets generally takes place indirectly through these

fiduciaries. Most of the large buy-side firms active in the fixed income markets are


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4. Regulatory Use of Ratings

Credit ratings are used for regulatory purposes around the world, primarily in the context of

financial regulations. The regulatory use of credit ratings increases their importance to

certain market participants. For example, ratings play an important role in the commercial

paper market, where issuers find it difficult to sell paper that does not qualify for investment

by money market funds under Rule 2a-7 under the Invest ment Company Act. 28 The

regulatory use of credit ratings in the U.S. is described in detail in Section II.B. Above. In

addition, the regulatory use of credit ratings in foreign markets appears to be growing. A

recent survey by the Bank for International Settlements, for example, summarizes the various

ways financial regulatory authorities around the world use credit ratings in their regulations

today. That survey was undertaken in connection with the proposal of the Basel Committee

on Banking Supervision to permit banks to use ratings from credit rating agencies in

determining capital requirements under the new Basel Capital Accord.

5. Use of Ratings in Private Contracts

The extensive use of credit ratings in private contracts also has enhanced the importance of

credit ratings to the marketplace. For example, the widespread use of ratings triggers in

financial contracts recently has received considerable attention as a result of certain high-

profile bankruptcies, such as Enron and Pacific Gas and Electric Company (PG&E).In the

case of Enron, the use of credit ratings as triggers in trading and other financial agreements

gave counterparties the right to demand cash collateral, and lenders the right to demand

repayment of outstanding loans, once Enrons credit rating declined to certain levels. As a

result, the existence of ratings triggers contributed to Enrons financial difficulties. Similarly,

the impact of credit rating downgrades on PG&Es financial agreements limited its ability to


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borrow funds to repay its short term debt obligations. In case such as these, contractual

ratings triggers can seriously escalate liquidity problems at firms faced with a deteriorating

financial outlook. As noted in Section V below, because of the significant potential negative

impact of contractual ratings triggers on issuers, the Commission intends to explore whether

issuers should be required to provide more extensive public disclosure regarding such

triggers. In addition, credit rating agencies and others have been conducting intensive studies

to better understand the nature and extent of the use of credit ratings in financial contracts,

and their potential impact on a companys liquidity and creditworthiness.

C. HOW CREDIT RATINGS FULFIL THEIR ROLE

Credit ratings fulfill their role in the markets in several ways. The most obvious is by serving

as an unbiased, independent "second opinion" that an investor can use to confirm or refute his

or her own analysis. Beyond that ideal case, however, credit ratings may also mitigate

information asymmetry in some less obvious ways.

For example, some institutional investors include credit ratings in their investment policies

for fixed-income investments. Such an investment policy does not delve into the nuances of

different kinds of bonds, but rather uses credit ratings as screens to disqualify securities that

exceed a maximum threshold of credit risk. In such cases, the credit rating is a necessary

but not, in itself, sufficientcondition for investing in a given security. The investor is using

credit ratings to screen securities before conducting its own analysis and before examining

research and analysis from other outside sources. In such a case, credit ratings mitigate

information asymmetry in two ways. First, by providing the screen that helps the institution

to apply its analytical resources most effectively, and second, by supplying unbiased,

independent "second opinion" of the security's creditworthiness.


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In many cases, when an issuer obtains a credit rating on its own securities, it is trying to send

investors a signal about its creditworthiness. In the context of the used-car example, the issuer

wants to signal that it is not a "lemon." By reducing uncertainty about its creditworthiness, an

issuer may achieve lower costs of borrowing than it would otherwise have.

D. IMPLICATIONS OF THE ROLE AND HOW REGULATORY USE

OF CREDIT RATINGS CAN DISTORT IT

Rating agencies' role in the market is significant, but it is also specialized and somewhat

limited. The main flow of information in the capital markets is from issuers to investors. A

secondary flow of information comes from exchanges, data vendors, and trading desks in the

form of prices and trading flows. Rating agencies provide a third source of additional

information consisting of independent credit opinions. Credit ratings can contribute to an

investor's decision-making process, but they are not a substitute for the investor's own

analysis or for information from other sources.

Some market participants, however, perceive a larger role for credit ratings, in the form of

promoting financial stability or preventing asset bubbles and financial crises. They assert that

credit ratings can cause or exacerbate a bubble or a crisis. Examples include Arezki et al.

(2011), Coffee (2010), Deb et al. (2011), He et al. (2011), and Kiff et al. (2012). White

(2009) and others have argued that decades of regulatory use elevated credit ratings to a point

of amplified significance, giving them the "force of law." That point, however, ignores or

misconstrues the true role of credit ratings, focusing rather on distortions of their role that

regulatory or other unintended uses have caused.


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The regulatory use of credit ratings (and certain practices described in Part IV) can produce

unintended effects. These can include distorting the decision-making processes of market

participants and causing them to deemphasize or misunderstand the information that ratings

actually provide. Such distortions, in turn, can contribute to or exacerbate an asset bubble or a

financial crisis.

The regulatory use of private-sector gatekeepersincluding rating agenciesrests on the

notion that using gatekeepers helps to reduce improper behaviour among the market's

primary participants (issuers and investors). This assumption, in turn, relies on the premise

that a gatekeeper actually can influence the behaviour of an issuer's management (Tuch,

2010). Only when regulatory use distorts and amplifies a gatekeeper's role does its influence

start to overshadow the other motivations and considerations of the primary market

participants.

Policymakers around the globe have come to understand this mechanism and to respond

appropriately. For example, Section 939A of the Dodd-Frank Act directs U.S. regulatory

agencies to eliminate or minimize their use of credit ratings. The European Union has also

proposed legislation that includes a similar provision.

When used as intendedas independent "second opinions" to help investors make

investment decisionscredit ratings have no special ability to prevent or to cause asset

bubbles or financial crises. Indeed, rating agencies are no more able than other participants in

the capital markets to predict (much less prevent) financial bubbles or adverse

macroeconomic trends.


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MISUSES OF RATINGS AND OTHER CHALLENGES TO

FULFILLING THEIR ROLE

A. RATING SHOPPING

In certain cases, an issuer may actually use ratings to increase information asymmetry. This

occurs when an issuer engages in "rating shopping," or chooses the rating agency that will

assign the highest rating or that has the most lax criteria for achieving a desired rating. Rating

shopping rarely involves corporate, sovereign, and municipal bonds, but it is common among

securitization issues. Its impact is greatest when one rating agency's criteria are more lax than

its competitors'. Unless investors demand multiple ratings, certain issuers will tend to use

only ratings from the agency with the most lenient standards.

Rating shopping hinders the ability of ratings to fulfil their role of reducing information

asymmetry. Historically, rating agencies countered rating shopping by publishing unsolicited

ratings. Although unsolicited ratings on securitizations were out of fashion for a number of

years, recent public policy support for unsolicited ratingsas reflected in the motivation

underlying SEC Rule 17g-5suggests a push to preserve or enhance the continuing ability of

credit ratings to improve market function by reducing information asymmetry.

B. REGULATORY USE OF RATINGS

As we discussed above (in Part II, Section D), regulatory use of ratings is another challenge

to credit ratings' ability to perform their true role. In some instances, regulators have used

credit ratings as a way to "outsource" part of their regulatory functionsfor instance, by

tying securities disclosure regulations, legal investment standards, or bank capital standards

to credit ratings. When a regulation uses credit ratings in such a way, issuers or investors may

also end up using ratings for purposes other than understanding credit risk. They may


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Taxability of interest,

Markettechnical (supply and demand), and

General economic and business conditions and trends.

In addition, with respect to complex structured instruments, understanding the credit

dimension alone requires much more than simply noting the credit ratings. It requires

understanding the analysis behind the credit ratings and understanding the differences of

opinion that can result from competing analytic approaches. As complexity increases, so does

the likelihood of different results from different analytic methodologies. Thus, the "misuse"

of ratings as a full substitute for an investor's own analysis can produce the unintended result

of effectively increasing information asymmetry by causing an investor to assume that he

knows more than he really does.

D. Misinterpretation and mischaracterization of ratings

A fourth factor that sometimes hinders the ability of credit ratings to reduce information

asymmetries is misinterpretation and mischaracterization of the ratings. A common example

is when a market participant uses credit ratings to ascribe mathematical properties, such as

specific default probabilities or loss expectations, to the subject securities. Most rating

agencies do not define their ratings in mathematical terms. Standard & Poor's has repeatedly

emphasized that its rating system indicates a rank ordering of creditworthiness and that actual

default frequencies for all rating categories should be expected to rise and fall with changes

in economic conditions (Adelson et al., 2009). When users misinterpret or mischaracterize

credit ratings, the ratings can increase rather than reduce information asymmetry by creating

faulty assumptions and flawed decisions.


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Conclusion:-

Better Understanding Yields Stronger Markets

The real role of credit ratings in the financial system is to improve the functioning of markets

by reducing information asymmetry between issuers and borrowers who need funding and the

investors and lenders who can provide it. Credit ratings thus can help make markets more

efficient by putting all lenders and investors on more equal footing, thereby minimizing

variations in returns that can arise from differences in the ability to make sound credit

judgments.

Ratings are a type of information, in the form of independent opinions about the

creditworthiness of issuers and securities. They fulfil their role by adding to the mix of

information that investors and lenders can use when analyzing and trading securities.

Moreover, rating agencies sometimes differ in their assessments of a given issuer or security,

either because they calibrate their rating scales differently or ascribe greater or lesser weight

to different factors in their analyses. This is a natural result of the inherently complex nature

of credit analysisit is not a simple task with a single valid approach, and seasoned

professionals looking at the same facts may reasonably come to different conclusions.

Accordingly, the greatest reductions in information asymmetry come from the presence of

multiple ratings on a given issuer or security, in combination with other sources of

information and independent analysis.

Misuses of ratingsincluding "rating shopping" by issuers, the regulatory use of ratings,

and the use of ratings as a substitute for an investor's own analysishave all contributed to

distortions of a credit rating's true role. Indeed, in extreme cases, those activities can cause


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ratings to increase (rather than reduce) information asymmetry. And when such misuses are

widespread, the market may fail to realize the full value that credit ratings can offer.

Unsolicited ratings are the credit rating industry's primary response to rating shopping, and

Rule 17g-5 indicates growing regulatory support for unsolicited ratings, at least in the U.S.

The hope is that greater understanding of what credit ratings really are and what they aim to

do can benefit all market participants and create a stronger, more efficient financial system.

It is an undisputed fact that CRAs play a key role in financial markets by helping to reduce

the informative asymmetry between lenders and investors, on one side, and issuers on the

other side, about the creditworthiness of companies (corporate risk) or countries (sovereign

risk). An investment grade rating can put a security, company or country on the global radar,

attracting foreign money and boosting a nation's economy. Indeed, for emerging market

economies, the credit rating is key to showing their worthiness of money from foreign

investors. Credit rating helps the market regulators in promoting stability and efficiency in

the securities market. Ratings make markets more efficient and transparent.

Rating agencies have received a lot of criticisms in recent years for the quality of their

research. The value of such security ratings has been widely questioned after the 2007-09

financial crisis. Lot of critics complain the agencies have lost their ability to independently

judge the risk on certain investments especially in light of AAA ratings given to

mortgage-backed securities that collapsed when defaults on U.S. home loans shot up,

triggering the financial crisis. Critics also note that the agencies are paid by the very entities

they rate, raising questions about their trustworthiness. Many observers claim that they are

poor financial forecasters, too slow to spot negative trends in the issuers that they track, and

too late to revise their ratings.


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CRISIL

Credit Rating and Information Services of India Ltd. (CRISIL) (BSE: 500092, NSE:

CRISIL) is India's leading Ratings, Research, Risk and Policy Advisory Company based in

Mumbai. CRISILs majority shareholder is Standard & Poor's, a division of The McGraw-

Hill Companies and the world's foremost provider of financial market intelligence. CRISIL

pioneered ratings in India more than 20 years ago, and is today the undisputed business leader

with the largest number of rated entities and rating products: CRISIL's rating experience

covers more than 24654 entities, including 14,500 small and medium enterprises (SMEs).

CRISIL offers domestic and international customers (CRISIL Global Research and Analytics

consisting of Irevna and Pipal Research caters to international clients) with independent

information, opinions and solutions related to credit ratings and risk assessment; energy,

infrastructure and corporate advisory; research on India's economy, industries and companies;

global equity research; fund services; and risk management.

A CRISIL rating reflects CRISIL's current opinion on the relative likelihood of timely

payment of interest and principal on the rated obligation. It is an unbiased, objective, and

independent opinion as to the issuer's capacity to meet its financial obligations. So far,

CRISIL has rated 30,000 debt instruments, covering the entire debt market.

The debt obligations rated by CRISIL include:

Non-convertible debentures/bonds/preference shares Commercial papers/certificates of deposits/short-term debt Fixed deposits Loans Structured debt


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Microfinance institutions Insurance companies Mutual funds State governments Urban local bodies

SHORT-TERM RATING

A short-term rating is a probability factor of an individual going into default within a year.

This is in contrast to long-term rating which is evaluated over a long timeframe. In the past

institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings

are commonly used.

First, the Basel II agreement requires banks to report their one-year probability if they applied

internal-ratings-based approach for capital requirements. Second, many institutional investors

can easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis.

Therefore, some rating agencies simply report short-term ratings.

CORPORATE CREDIT RATINGS

The credit rating of a corporation is a financial indicator to potential investors of debt

securities such as bonds. Credit rating is usually of a financial instrument such as a bond,

rather than the whole corporation. These are assigned by credit rating agencies such as A. M.

Best, Dun & Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter

designations such as A, B, C. The Standard & Poor's rating scale is as follows, from excellent

to poor: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-,

CCC+, CCC, CCC-, CC, C, D. Anything lower than a BBB- rating is considered a

speculative or junk bond. The Moody's rating system is similar in concept but the naming is a


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C. Integrity of the Rating Process

1) CRISIL Ratings and its employees shall comply with all applicable laws and regulationsgoverning CRISIL Ratings' activities in each jurisdiction in which it operates.

2) CRISIL Ratings and its employees shall deal fairly and honestly with issuers, investors,other market participants, and the public.

3) Analysts shall be held to high standards of integrity, and CRISIL Ratings shall not employindividuals where there is evidence that they have compromised integrity.

4) CRISIL Ratings and its Analysts shall not, either implicitly or explicitly, give any assuranceor guarantee of a particular rating prior to the determination of the rating by the applicable

rating committee. This does not preclude CRISIL Ratings from developing prospective

assessments used in structured finance and similar transactions.

5) CRISIL Ratings Analysts are prohibited from making proposals or recommendationsregarding the design of structured finance products that CRISIL Ratings rates. In assessing

the credit risk of a structured finance transaction, however, Analysts may properly hold a

series of discussions with the issuer or its agents in order to

(i) understand and incorporate into their analysis the particular facts and features ofthe structured finance transaction, and any modification, as proposed by the

issuer or its agents, a

(ii) Explain to the issuer and its agents the credit rating implications of CRISILRatings criteria and methodologies as applied to the issuers proposed facts and

features.


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5. CRISIL Ltd has separated, operationally (with the exception of certain shared services)and legally, its credit rating business and credit rating analysts, from its infrastructure

advisory business and its risk consulting business. CRISIL Ratings shall ensure that

ancillary business operations which do not necessarily present conflicts of interest with

the rating business have in place procedures and mechanisms designed to minimize the

likelihood that conflicts of interest will arise. CRISIL Ratings shall establish a firewall

policy governing firewalls and operations between CRISILs Ratings and Non-Ratings

Businesses to effectively manage conflicts of interest.

B. CRISIL Ratings' Procedures and Policies

1) CRISIL Ratings shall adopt written internal procedures and mechanisms to(1) Identify, and

(2) Eliminate, or manage and disclose, as appropriate, any actual or potential

conflicts of interest that may influence the opinion and analyses CRISIL Ratings

makes or the judgment and analyses of Analysts. CRISIL Ratings shall disclose

such conflict avoidance and management measures without charge to the public

on CRISIL's public website, www.crisil.com.

2) CRISIL Ratings prohibits its employees from engaging in any Securities trading presenting

actual conflicts of interest with CRISIL Ratings' rating activities.

3) In instances where rated entities (e.g., governments) have, or are simultaneously pursuing,

oversight functions related to CRISIL Ratings, CRISIL Ratings shall use different

employees to conduct its Rating Actions than those employees involved in its oversight


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3) CRISIL Ratings shall make available for public ratings the date of the most recentupgrade, downgrade, or Rating Watch action, if any, for issues and issuers. Each

announcement, if any, of a Rating Action shall also indicate that CRISIL Ratings

rating criteria are generally available without charge to the public on the CRISIL public

Web site, www.crisil.com. Each announcement, if any, of an initial rating, upgrade,

downgrade, or Rating Watch action for issues and issuers shall include a statement of

the analytic rationale for such action.

4)CRISIL Ratings shall make Rating Actions available to the public without charge.Rating Actions shall be disseminated via real-time posts on CRISIL's public website,

www.crisil.com and to the news media as well as via electronic or print subscription

services. The public shall be able to obtain a current public rating for any issuer or issue

without charge. Rating Actions and the short explanation of the basis for the Rating

Action, if any, shall remain on CRISIL's public website fora minimum of twenty-four

hours. Upon the request of an issuer, and in CRISIL Ratings' solediscretion, CRISIL

Ratings may agree to keep a rating confidential, and evidence this agreement in the

engagement letter with the issuer. If a rating is already public, a subsequent Rating

Action shall also be public.

5)CRISIL Ratings shall publish sufficient information about its procedures,methodologies and assumptions (including financial statement adjustments that deviate

materially from those contained in the issuer's published financial statements and a

description of the rating committee process, if applicable) so that outside parties can

understand how a rating was arrived at by CRISIL Ratings. This information will

include (but not be limited to) the meaning of each rating category and the definition of

default or recovery, and the time horizon CRISIL Ratings used when making a rating

decision


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B.The Treatment of Confidential Information

1) CRISIL Ratings shall use Confidential Information only for purposes related to its ratingactivities or otherwise in accordance with any confidentiality agreements with the issuer.

2) Employees shall take all reasonable measures to protect all property and recordsbelonging to or in possession ofCRISIL Ratings from fraud, theft or misuse.

3) Employees shall not engage in transactions in Securities when they possess ConfidentialInformation concerning the issuer of such Security.

4) Employees shall familiarise themselves with the internal securities trading policiesmaintained by CRISIL Ratings, and are required to periodically certify their compliance

as required by such policies.

5) Employees shall not disclose any(i) ofCRISILRatings ratings-related non-public information, or(ii) (ii) non-public information about Rating Actions or possible future Rating

Actions, except in the case of clause (ii) to related issuers and their designated

agents.

6) Employees shall not share Confidential Information entrusted to CRISIL Ratings withemployees of any Non-Ratings Business without the prior written consent of the issuer.

Except for legitimate business reasons arising in connection with the delivery of ratings

or related products, employees shall not share Confidential Information with other

employees ofCRISIL Ratings.

7) CRISIL Ratings' employees shall not use or share Confidential Information for thepurpose of trading Securities, or for any other purpose except the conduct of CRISIL

Ratings' business.


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