Who should be paying for the credit rating of bonds?

Credit rating agencies are in the glare for failing to flag worsening credit profile of companies.

At the heart of the issue is the way the agencies are compensated.

ET Wealth asks experts what is the right approach.


Dhirendra Kumar, CEO, Value Research

“Investor not protected if bond issuer signs cheque”

He who pays the piper calls the tune. Nowhere is this more true than in the credit rating business. Companies choose credit rating agencies to rate their debt, they negotiate what they will pay for the rating and they pay the same. If they don’t like the services or price, they go to a different provider.

We have to be utter fools to believe that ratings produced through this process will serve anything but the goals of the company that is paying for the exercise. This has been demonstrated repeatedly, and disastrously, over the last decade, starting with the financial crisis of 2007-09. At the root of that crisis were the made-to-order ratings that S&P, Moody’s and others were selling to whoever could pay. That disaster sadly did not lead to reforms. We have seen repeatedly that enthusiastically optimistic ratings are at the root of every debt blow up.

Rating agencies will always serve the paying customers’ interests and as long as it’s the bond issuer signing the cheque, the investor’s interest will not be protected. Rating agencies point out that a majority of ratings do not turn out to be troublesome but this is a useless argument. A majority of bond issuers do not suffer declining financial health. It’s the problem cases where ratings are really needed and that’s where they fail. We also hear the noise about ‘global practice’. This is a racist argument that amounts to saying that we must follow whatever westerners do. I hope the regulator creates a pioneering example that the rest of the world can follow.

Also Read:
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Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital

“If insurer pays, the ratings will be more accurate”

It does not require too much imagination to understand that a compensation structure where the issuer pays for ratings will be more aligned to provide a relatively favourable rating to the issuer. This issue is further exacerbated when we take a competitive bidding process where multiple rating agencies are vying for business from the same issuing firm. In this case, the issuer can not only negotiate for lower prices but could also negotiate for a higher rating.

There could be a system where the investors pay for the ratings. However, since in a public debt market there are numerous investors, how they will be charged needs to be well-thought out. It is clear from international experience that an “investor pays” model is much better at getting more accurate ratings. From 1971 to mid-1974 S&P, in the US, charged investors while Moody’s charged issuers. Research shows Moody’s rankings clearly exceeded S&P’s during this period.

We suggest a system where there would be some kind of a central organisation that could be linked to debt exchanges or the depositories to charge a specific fee to the issuer for the debt. This organisation could compensate the rating agencies and get at least two independent ratings. Further, there should be some incentive with a bonus payment to the rating agencies if their ratings turn out to be accurate and the capital and interest is paid according to schedule. There has to be a compensation for close monitoring and early detection of deterioration by the rating agencies.


Arvind Chari, Head, Fixed Income & Alternatives, Quantum Advisors

“Neither model is fool-proof”

Credit rating agencies are regulated by Sebi and if they are deemed to be providing a public utility service, they must also be made accountable for their actions.

Moving to investors paying the fees for the rating instead of the issuer is up to question: 1) How will you ensure that the investor remains objective? 2) Can the investor influence the rating agency to initially assign a lower rating so that the investor can get a higher yield? 3) Will the investor objectively allow the rating agency to downgrade a bond held by the investor after having paid the fees? One can also look at another option of creating a common pool where all investors contribute a fee on each trade/issue which is then used to remunerate the respective rating agency.

No matter the model followed, it won’t be foolproof. Fiduciary investors, who use the credit ratings, have no option but to carry out their own proprietary research and use ratings only as a validation to their investment process. Rating agencies have to be more transparent on the dealings with the issuer, put out more analytical data on how they assign ratings and have to work towards clearing the perception that they can indeed be influenced.


Aditya Agrawal, Managing Director, Morningstar India

“User pays model minimises potential for conflict of interest”

We think the user pay model will be more suitable as it minimises the potential for a conflict of interest.

Both models have their pros and cons. The issuer pays model ensures the opinions of CRAs are available to the entire market. One fallout of the user pay model is that the ratings are available only to a select few. It will be interesting to see how the regulator plans to implement the new plan and how ratings costs will be charged to investors. Though minimal, it could result in higher cost to investors, but should yield better outcomes.

Sebi has been nudging asset managers to build their internal research capabilities rather than solely rely on CRAs to strengthen their risk management framework. AMCs have added resources to augment their research setup.

A user pays model is not entirely untested. Sell side equity research firms have successfully run businesses by providing research which is paid for by the user through the brokerage. At Morningstar too, our mutual funds ratings are completely independent. While moving to a user pays model is a step in the right direction, it will also be important for CRAs to review their surveillance mechanism to earn the trust of all stakeholders.


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