Eligible promoters

A credit rating is an opinion that investors and regulators lean on heavily. If anyone at all could set up a rating agency, a group could create one to flatter its own bonds. The Credit Rating Agencies Regulations therefore control not just the agency, but who may stand behind it.

Eligible promoters is that gate. SEBI will not even consider an application unless the applicant is promoted by one of a short list of financially substantial, regulated or experienced entities — and once the agency exists, the regulations stop it rating its own promoters and their connected entities.

The five categories (Chapter 21). SEBI shall not consider an application for registration as a credit rating agency unless the applicant is promoted by a person belonging to any one of these:

1. a public financial institution as defined in section 2(72) of the Companies Act, 2013;
2. a scheduled commercial bank included in the Second Schedule to the RBI Act, 1934;
3. a foreign bank operating in India with RBI approval;
4. a foreign credit rating agency incorporated in a FATF member jurisdiction, recognised under its law, with at least five years' experience rating securities;
5. any company or body corporate with a continuous net worth of at least Rs 100 crore, as per audited annual accounts, for the previous five years before filing the application.

Conditions on the applicant and its promoters. Among others: set up as a company with rating as a main object; minimum net worth of Rs 25 crore; applicant and promoters of professional competence, financial soundness and reputation of fairness and integrity; no securities-market legal proceedings adversely affecting investors against the applicant, its promoter or their directors; no conviction for offences of moral turpitude or economic offences; and the promoter holds at least 26% of the credit rating agency.

After registration — what a CRA may not rate (section 21.7).

• A security issued by its promoter. Where the promoter is a lending institution, its chairman, directors or employees may not be chairman, director or employee of the CRA or its rating committee.
• A security issued by a borrower of its promoter, a subsidiary of its promoter, or an associate of its promoter where there are common chairman, directors or employees (including on the rating committee).
• A security of its own associate or subsidiary where the CRA or its rating committee shares a chairman, director or employee with it — except that an associate with a common independent director may be rated if that director does not participate and the rating announcement discloses it.
• Its own securities (code of conduct).

Illustrative facts. Four groups want to promote a new credit rating agency.

The engineering company goes ahead. It must hold at least 26% of the new CRA, and the CRA itself needs Rs 25 crore of net worth. If it capitalises the CRA at Rs 30 crore, its own stake must be at least:

26% × Rs 30 crore = Rs 7.8 crore of the CRA's equity

Three years later. The engineering company's subsidiary issues Rs 500 crore of NCDs and asks the CRA to rate them. It cannot: a CRA may not rate a security issued by a subsidiary of its promoter. Neither may it rate the bonds of a road developer that has borrowed from the promoter.

Chapter 21 (SEBI (Credit Rating Agencies) Regulations, 1999), 3% of the paper, opens with the promoter categories and names "restrictions on rating of securities issued by promoters" as a learning objective. Its review question 1 asks the continuous net worth a corporate promoter must have for the previous five years — Rs 100 crore.

Expect the five categories, the Rs 100 crore / five years and five years' experience numbers, the 26% minimum promoter holding, and the "cannot rate" list.

• Rs 100 crore is the promoter's continuous net worth for five years; Rs 25 crore is the CRA's own net worth. Do not swap them.
• "Continuous" — a single year below Rs 100 crore fails the test.
• A foreign CRA must be from a FATF member jurisdiction and have five years' rating experience.
• Scheduled commercial banks must be in the Second Schedule to the RBI Act; foreign banks need RBI approval to operate in India.
• The promoter must hold at least 26% of the CRA.
• No rating of the promoter's securities, or of its borrowers or subsidiaries — and of its associates where there are common chairman, directors or employees.
• A common independent director does not bar rating an associate, if the director stays out and the announcement discloses it.