“The rating of a company, an important task, is performed by an independent body. The trend in an industry is to get the rating done by a locally established company for effective results,” said former Lanka Ratings Head Adrian Perera at an interview with the Business Observer.
Excerpts:
Q. What is ‘rating of a company?’
A. Rating is an impartial opinion of the ability and willingness to honour debt commitments on time. It is important to note that both - ability and willingness must be there. During the 2008/09 financial crisis some institutions were willing but did not have the ability. Restructuring of debt, unless it is provided by the debt agreement, amounts to default. It is a medium and long term view.
Q. Why is it important to a company?
A. It is important for a company to give confidence to its stakeholders that it is a company that has honoured its commitments in the past and will continue to do so.
Q. What is the rating process?
A. Usually, a company requests for a rating and then enters into an agreement with the rating agency. Although there has been discussion on ‘the investor should pay for the rating’ for several decades, it has been found that the cost of rating increases significantly and is not practical.
Q. What are the challenges of the rating procedure?
A. This is a voluntary process by the company and so the rating agency relies on the information provided by the company. Rating is not an investigation or an audit. The company can always misrepresent or mislead the rating agency.
The rating agency has to take a medium to long term view and give its opinion based on existing and historical data and forecasted models. Its opinion can go wrong as the economic and business environment can change due to political, economic and other factors.
The rating depends on the rating agency analyst, rating committee’s view and business experience also. It is the analyst who recommends a rating to the rating committee and the committee decides on the rating. The more experience the rating committee members have on the business the better. Also the rating committee members’ experience in the said market brings in more insights to the rating process and rating becomes robust.
In order to ensure that ratings are robust for the debt capital market, domestic rating agencies were formed with local rating committee members of high integrity, experience in the capital market and also with a lot of business experience. This model is the most successful and has been adopted in India, Malaysia, China, Indonesia, Pakistan, Japan, Philippines, Thailand, Bangladesh and now in Europe also. The Association of Credit Rating Agencies and the Association of Credit Rating Agencies Asia (please refer websites) are all domestic credit rating agencies.They are more focused and professional than Standard and Poors, Moody’s and Fitch which have been directly responsible for the global financial crisises.
Retention of staff is the biggest challenge since rating agencies are niche market players.
Q. Who benefits from rating?
A. The beneficiaries are all stakeholders since a rating is an independent opinion. Starting from employees who get to know that their institution has honoured all its debt commitments while lenders and suppliers know the risk of their exposure.
India has a unique model which has been given thumbs up by International Financial Corporation, that is the SME rating.
This has helped the SME sector and the banks to uplift the SME sector. Rating agencies that do not do SME ratings, have been told to close up.
One multinational rating agency in India was forced by the regulators to change its name for misusing the global brand name and downgrading local companies.
A similar approach is adopted in China. SME rating is the way forward for a market like Sri Lanka where there is a large SME segment.
Q. How many companies have been rated in Sri Lanka?
A. Not even 200 and all of them are listed. A majority are financial services companies due to regulatory pressure.
Q. How often is rating done?
A. Review is annual. But for developed markets quarterly updates are mandatory. This is good.
Q. Are there special reasons to obtain ratings?
A. When issuing debt instruments such as debentures and bonds. In some jurisdictions when going for a listing.
Q. What benefits does the company get?
A. It is an independent opinion and an independent check on the company to the board of directors. Directors will take a business decision but due to sentimental reasons it might not be the best option when looking at from a third party point of view. This gives the necessary checks and balances, as rating agencies draw from previous experiences from various clients when giving their rating.
Q. What will be the future of the rating mechanism?
A. The rating industry is over 100 years old. It has evolved since then but the basic structure remains the same. Over the years, it has gone onto products like IPO rating, project finance rating, SME rating and insurance company rating. 2009 was a turning point in the rating industry since three big players were found to be directly responsible for GFC by courts. All three were fined. The three big players were Standard and Poor’s, Moody’s and Fitch.
Forward looking countries including European countries started looking at the Asian model in setting up of domestic rating agencies. Counties like China and Malaysia were able to withstand the shock due to its domestic bond market which is driven by domestic rating agencies. Lanka Rating Agency (LRA) was the only Sri Lankan company to be a member of Association Credit Rating Agencies Asia which is an organization of 29 rating agencies in Asia promoted by the ADB.(www.acraa.com). LRA’s license lapsed in 2015.
Europe also formed the European Credit Rating Agencies which was established in 2009 (www.eacra.fr) with 11 members at the moment, it is growing. The African region also has started its own domestic rating agencies. No longer are forward looking developing countries expecting or relying on the big three players to develop their bond markets or allowing the big three to have a say in their domestic economies. Russia and China have their own rating agencies. The big three players have been using different political and economic pressure on Russia and China to get control of this situation but have not been successful.
The trend is that local rating agencies would be owned by locals with banks and insurance companies, like RAM Malaysia, MARC Malaysia, CARE Rating India and PACRA Pakistan. The rating committee would consist of locals who are of good standing and have extensive experience in business, banking and securities. This gives the added advantage to holding the local rating committee members accountable for the rating. If the rating committee consists of expatriates, local regulators will have no control over them. Clients, regulators and the country will be at the mercy of a few individuals.
If Sri Lanka is planning to develop as a financial hub, it must follow the Malaysian model of developing the domestic bond market and the domestic rating agencies. Local rating agencies have a national interest and will invest in the market due to national interest. Foreign rating agencies will never invest in other markets since it is not in their best interest. We must follow India, Pakistan, Malasiya, Indonesia and China if our country is to develop the local bond market which will bring long term money to the economy. With SME rating combined, it will be a big boost similar to India. Local investors and rating agencies will not ask for tax breaks but will work for the benefit of the country. Locally owned domestic rating agencies is the way forward.