Credit rating agencies (CRAs) would soon have to be more open about their various sources of income and the way they assess the credit worthiness of companies. This is because the regulatory mechanism for CRAs are being reinforced.

The finance ministry along with financial sector regulators like RBI, Sebi and Irda have examined if mandatory credit rating can altogether be done away with due to the conflicts of interests that increasingly affect the raters? credibility but have finally chosen the second best option of tightening their regulation, according to official sources.

In fact, a committee of the ministry and the regulators have reached a near consensus that mandatory credit rating could be dispensed with. What made it to rethink is the fact that multilateral norms like that of the Swiss-based Bank of International Settlements (BIS) are reliant on credit rating tools and so national regulations can?t be contradictory. As per BIS? Basel II norms for capital adequacy, the risk-weighting for AAA-rated banks is 20% while that for unrated banks is 100%.

The committee has recommended sweeping changes in the way credit rating agencies should behave. Accordingly, capital market regulator Sebi?s Credit Rating Agencies Regulations, 1999 and a 2003 code of conduct would be amended, said an official privy to the development, who asked not to be named.

The panel has taken the view that Sebi would remain the lead regulator for CRAs. While Sebi will set the minimum behavioural standards, the banking, insurance and pension regulators can impose higher discipline on CRAs for their respective sectors, depending on their requirements and capacities, the official said. Thus, the RBI, Irda and the Pension Fund Regulatoxry Development Authority (PFRDA) can even accredit raters for meeting their rating requirements, if need be.

The existing regulation and the code of conduct do not restrict credit raters from accepting juicy advisory work from the same client, whose debt securities they endorse for investors to bet on. Insurance firms and pension funds that rely on possibly motivated credit rating may be heading for trouble. The panel?s solution to this problem is to make CRAs disclose the income they get from rating and advisory work separately so that investors can decide whether they should take the rating with a pinch of salt.

CRAs will also have to disclose their ownership structure. During discussions with the panel, raters had argued that their rating and advisory businesses are organized under separate legal entities with different CEOs. But the panel did not consider this arrangement foolproof as such firewalls may be breeched by raters when they are in a difficult situation. In any holding-subsidiary relationship, the majority shareholder can assert his rights covertly and overtly in the subsidiary, the panel felt.

CARE Ratings, a domestic CRA, however, had shut down its corporate advisory business when the conflicts of interests plaguing the segment became a subject of debate. CARE?s deputy managing director DR Dogra told FE the firm had recently stopped accepting new advisory contracts as it is difficult for any rating agency to maintain a Chinese wall between rating and advisory activities.

The panel also suggested that CRAs should be asked to reveal how they arrived at a particular rating for a company?s or a nation?s securities. ?The rating methodology should be made public insofar as there is a public requirement.? Disclosing the assumptions and the methodology used in rating other than proprietary information will dispel doubts about the accuracy and credibility of rating.

Global rating agencies have presence in India with Standard and Poor?s holding more than 43% stake in Crisil, while Moody?s Investment Company India Private Limited has about 28.5% in Icra. The Fitch Group has a 100% arm called Fitch India . CARE Ratings is owned by IDBI Bank, Canara Bank and SBI.