Why a group of investors should pay ratings agencies to end bias

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Published: February 15, 2019 4:05:57 AM

Instead of firms, a group of investors should pay for them.

sebi, investorsNews reports suggest SEBI wants investors to pay for the ratings, rather than the companies, which is the practice at present.

It is a fact that ratings agencies haven’t exactly covered themselves with glory; their assessments have often been way too optimistic, to put it mildly. And their alerts and rating changes usually come way too late, leaving investors like sitting ducks. In some instances—like with IL&FS—the agencies seem to have had no idea whatsoever of the goings-on in the company or they simply decided to look the other way.

Some of the blame for this must lie with the regulator since there seems to be no penalty whatsoever for the poor assessments or the delayed alerts. But it is not as though the investors are completely blameless; dishonesty among fund managers is not exactly unknown. Which is why, the system needs to be revamped and it is good news that SEBI is looking to make some changes. News reports suggest SEBI wants investors to pay for the ratings, rather than the companies, which is the practice at present.

Conspiracy theories say this won’t work either because bankers and fund managers typically want to embellish the quality of the rating so that they can set aside less capital against the loan exposure or report a better NAV (net asset value), as the case may be. That is not hard to believe, going by the track record of both bankers and fund managers.

One suggestion is that companies continue to pay for the ratings and that a pool of funds be created from the fees; the rating agencies would then be paid from this corpus, but the amount to be paid would be decided by an accredited panel of investors. To be sure, ratings agencies will say this is unworkable since they will have no control whatsoever over their revenues. That is a valid point because, to ensure that the quality of ratings doesn’t drop, an agency must invest and, in order to do that, it must have visibility on its revenues. Also, there is no guaranteeing the investors will be altogether unbiased while allocating the fees to the ratings agencies. What this system does achieve is that it breaks the nexus between the company and the rating agency since the fees cannot be negotiated between them and, therefore, the rating outlook cannot be influenced. Perhaps investors—bankers, insurance companies, mutual funds, EPFO—should commission ratings assessments and pay for them jointly. That would ensure that no one fund manager influences the rating and, at the same time, the ratings agency would be assured of its fee. Also, since the costs would be shared, it would not burden a single investor. The companies can also contribute to this pool—a flat amount perhaps—which could also be paid out to the ratings agencies as a flat fee. It is important to free the system of biases.

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