While credit rating agencies (CRAs) are required to frame a detailed policy on provisional ratings and disclose the same on their website, on April 27, 2021, SEBI issued a circular to standardize and strengthen policies related to provisional rating by CRAs for debt instruments (Circular).
As per the Circular, a CRA cannot assign a rating, including a provisional rating, for an issuer or client evaluating strategic decisions. Further, a CRA would now have to prefix the word ‘Provisional’ before the rating symbol for all provisional ratings, in all communications. Furthermore, a rating will not be considered final till such time the said rating is contingent upon:
- execution of a letter of comfort, corporate guarantee, or other forms of explicit third-party support;
- execution of documents such as debenture trust deed/ debenture trustee agreement, legal agreements/ opinions, representations and warranties, final term sheet;
- assignment of loan pools or finalization of cash flow escrow arrangements;
- setting up of a debt service reserve account; or
- opening of an escrow account.
Additionally, a CRA must convert a provisional rating into a final rating within 90 days from the date of issuance of the debt instrument. However, on a case-to-case basis, the said period may be extended by another 90 days in accordance with the CRA’s internal policy, but no further.
While assigning provisional ratings, SEBI has mandated the following additional disclosures to be included in the rating rationale and the press release:
- pending steps/ documentation considered while assigning provisional rating;
- risks associated with the provisional nature of the credit rating, including risk factors that are present in the absence of completed documentation / steps;
- rating that would have been assigned in absence of the pending steps/ documentation considered while assigning the provisional rating;
- conversion of the provisional rating into a final rating in case of issuance of debt instrument;
- rating and timeline implications.
Further, in relation to Real Estate Investment Trusts (“REIT”) and Infrastructure Investment Trusts (“InvIT”), CRAs would have to disclose the broad details of the assets that are proposed to be held by the REITs/ InvITs, the proposed capital structure, etc. Further, the rating rationale of the CRAs should disclose that the sponsor of a REIT/ InvIT has given an undertaking that assumptions related to assets, capital structure, etc. are in consonance with the details provided by the sponsor with SEBI. Lastly, the Circular mandates that in the event the provisional rating is not accepted by the issuer, then along with publishing the ‘non-accepted ratings’ the CRA would have to disclose the steps for assigning the rating in detail.
These additional disclosure norms would aid investors in better understanding the rating rationale of CRAs and make informed decisions. Investors will now be able to compare changes between a provisional and a final rating with greater ease, taking into account the factors that were responsible for the changes in the rating. Further, by mandating that in case of provisional ratings, the term ‘Provisional’ would have to be prefixed to the rating, it allows investors to clearly identify the nature of the rating and serves as an additional disclaimer.
SEBI’s move to strengthen the norms regarding provisional rating and the decision to disallow assignment of a rating, including provisional decisions, to an issuer or client evaluating strategic decisions will bring further transparency in the securities market apart from standardizing the criteria for assigning a credit rating, as any rating for an issuer evaluating strategic decisions would be highly subjective.