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Monday, May 29, 2023

Regulations for regulators

Credit rating agencies (CRAs) and merchant bankers (MBs) play a crucial role in an economy that is market driven. When rated corporates go bankrupt suddenly, or a corporate entity whose shares are highly valued but continues to make operational losses, CRAs and MBs are subjected to criticism in the public domain. 

In the Bharatiya context in the recent past the credibility of credit rating has come into question in the crisis involving the Infrastructure Leasing and Financial Services Limited (IL&FS), a major infrastructure development and finance company which was an entity with systemic importance, with a debt obligation of Rs 91,000 crore. A systemically important financial institution is one which would pose a serious risk to the economy if it were to collapse. The credit rating agencies turned a blind eye to the rising debt levels at IL&FS, and continued rating it AAA, indicating the highest level of creditworthiness. The Standing Committee on Finance (Chaired by Dr. M. Veerappa Moily) which submitted its report on ‘Strengthening of the Credit Rating Framework in the country’ on February 13, 2019 rightly recommended that the regulators (such as SEBI and RBI) should review their regulations and suitably modify them to ensure greater objectivity, transparency and credibility in the whole credit rating framework.

The Committee also recommended that the Ministry of Finance should seek a factual report from the concerned regulators regarding the enforcement of the regulations with regard to the IL &FS crisis and evaluate the same. The committee said that the role of the Life Insurance Corporation of India, the largest institutional stakeholder in IL&FS to be part of the factual report. 

The committee further suggested that the disclosures being made by credit rating agencies should also include important details like: (i) extent of promoter support, (ii) linkages with subsidiaries, and (iii) liquidity position for meeting near-term payment obligations.

Under the current framework, there is no provision for the rotation of credit rating agencies.  The Committee recommended that mandatory rotation of rating agencies should be explored as there was no such provision in the extant guidelines. This would ensure avoiding any collusion/ nexus between the rating agencies and the rated corporate entities.

Multiple regulators 

In Bharat, the Securities and Exchange Board of India (SEBI) primarily regulates credit rating agencies and their functioning. SEBI is among the few regulators globally to mandate public disclosure of rating criteria and methodology by the agencies. However, certain other regulatory agencies, such as Reserve Bank of India (RBI), Insurance Regulatory and Development Authority, and Pension Fund Regulatory and Development Authority also regulate certain aspects of credit rating agencies under their respective sectoral jurisdiction.
The matter becomes more complex when CRAs also do consultancy or advisory services as this leads to conflict of interest. In the IL &FS crisis, critics have pointed out their fingers at RBI since IL &FS is a NBFC that primarily comes under RBI regulations. 

There are several instances of jurisdictional overlap between regulators when the regulated corporate entities come under multiple regulations and regulators. In order to avoid the jurisdictional overlap and ensure that the multiple regulators act in tandem, in CCI vs Bharti Airtel (2018), the Supreme Court in its judgement laid down a two-step process. While the sector specific regulator would complete its findings on the jurisdictional aspect, other regulators would thereafter proceed to exercise their powers. Drawing inference from this it can be said that the issue of financial irregularities and the quality of asset portfolio in IL&FS comes under RBI’s purview whereas the credit rating related issues come under SEBI. This requires smooth coordination and consultative approach between the multiple regulators.

Need for mandatory consultative approach

If the regulators adopt a confrontational approach or keep quiet assuming the other regulator would initiate action, then the issue becomes complex. Bharat follows a non-mandatory consultation approach which means that the regulatory bodies have the discretion to engage themselves in consultation with each other or not. Many a times, this results in regulatory vacuum when the multiple regulators do not initiate action on their own and refrain from consultation with one another. Therefore, there is a need for removing this regulatory vacuum by bringing suitable legislation/ amendment to existing Acts, making consultative approach among the multiple regulators as mandatory. This will remove the jurisdictional tussle whenever there is one sectoral regulator like e.g., SEBI and on the other hand a non-sectoral regulator for example; CCI (Competition Commission of India). 

Yes Bank fiasco involves financial irregularities, poor asset quality and corporate governance. In other words, along with RBI, MCA and SEBI are equally responsible for regulatory vacuum in the case of Yes Bank crisis, which could have been resolved better through mandatory consultative approach. 

Valuation issues in corporate entities

Valuation of any stock, share, debenture, security, Goodwill, asset, liability or net worth of the company are governed by the Companies Act. Similarly, valuation of shares debentures for the purpose of transfer or acquisition that come under ODI, FDI are governed by FEMA guidelines. Valuation issues of listed corporate entities come under SEBI guidelines. Valuation issues of corporates that are under liquidation come under IBC, 2016. Since multiple regulators are involved in the valuation issues in corporate entities as mentioned above, there is a need for consultative approach among the regulators. Making consultative approach among the multiple regulators as mandatory will remove the regulatory vacuum with regard to valuation issues in corporate entities. (Ruchi Soya Industries, Paytm, to quote a few examples) 

Corporate governance issues 

Post liberalization, Bharatiya corporates expanding their activities into different sectors, promoters of business organizations taking active part in public life by choosing political path has led to conflict of interest and overreach of corporate sector through political system to exercise influence on the regulators. 

Needless to mention that regulators must have functional independence as well as financial autonomy. Also, the heads of regulators must have fixed tenure. This will insulate the regulators from political influence and empower them to act with freedom. In this context it is worth mentioning what the Supreme Court said on 2nd March, 2023 while delivering its judgment on the appointment of Election Commissioner, “the means to gain power in a democracy must remain pure and abide by the constitution and the laws. EC cannot claim to be independent then act in unfair. A person in a state of obligation to the State cannot have an independent frame of mind. An independent person will not be servile to those in power.” The above observation of supreme court is equally applicable for all the regulators. Therefore, let us hope that the parliament will deliberate on this issue and make appropriate laws to ensure that the regulators function with autonomy and independence, more importantly without fear or favour which is essential for a vibrant democracy.  

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Dr. B.N.V. Parthasarathi
Dr. B.N.V. Parthasarathi
Ex- Senior Banker, Financial and Management Consultant and Visiting faculty at premier B Schools and Universities. Areas of Specialization & Teaching interests - Banking, Finance, Entrepreneurship, Economics, Global Business & Behavioural Sciences. Qualification- M.Com., M.B.A., A.I.I.B.F., PhD. Experience- 25 years of banking and 16 years of teaching, research and consulting. 200 plus national and international publications on various topics like- banking, global trade, economy, public finance, public policy and spirituality. One book in English “In Search of Eternal Truth”, two books in Telugu and 38 short stories 50 articles and 2 novels published in Telugu. Email id: [email protected]


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