THE credit rating companies, important for the development of the capital market, typically give opinions on the creditworthiness and the ability of borrowing entities and issuers of debt securities to honour their financial obligations. In Pakistan, they have emerged relatively recently. High ratings by CRCs help borrowers mobilise funds at a relatively lower interest rate.

The Securities and Exchange Commission of Pakistan (SECP), which aims to ensure that our CRCs continuously adhere to international standards and best practices, has decided to update the applicable code of conduct as well as the CRCs Rules 1995.

Accordingly, the Code of Conduct 2005 has been substituted by a new and comprehensive code, implemented on January 13. And the upgrading of the CRCs Rules 1995 is currently under process.

The proposed amendments notified by the SECP on July 15 signify a major overhaul, as the rules were earlier amended only once, in 2002. Input has been obtained from the CRCs as well, but there is nothing to suggest that the rest of the stakeholders, particularly the State Bank of Pakistan and the stock exchanges, have been consulted.

The draft rules require any new credit rating company to have a minimum equity of Rs100m. This is considered

a roadblock for new entrants and is anti-competition

The SECP has published the notification for eliciting public opinion, and comments received within 30 days will be taken into consideration. All stakeholders are expected to share their views with the commission. To protect the interest of the investors as well as to safeguard the capital market, certain comments are submitted for consideration. The proposed amendments are generally appropriate, but as discussed below, there are apprehensions over some of them.

Under a new sub-rule (1) (bb) has been added to eligibility for registration (Rule 3) any new company can start operating with a minimum equity of Rs100m. This is considered a roadblock for new entrants and is anti-competition. Also, existing CRCs will have to increase their equity to this minimum threshold within five years. For the existing CRCs, the five-year relaxation is sort of a concession. Moreover, it may perhaps be better if the financial details of the existing CRCs are allowed to be made public.

Under the new rules, no company shall provide credit rating services unless it is registered with the SECP as a CRC. This move is welcomed, as it would open the field to new CRCs established on proper lines.

The registration fee has been raised 10 times, from Rs0.1m to Rs1m, while the renewal fee has been raised 25 times, from Rs10,000 to Rs250,000. The increase appears too much, but it is the first one after nearly 20 years.

If the application for renewal of registration is not decided by the SECP within 30 days, the registration shall continue to be valid until the application is decided by the regulator. The commission has to be more efficient, and may not ask for unlimited time. Only another 30 days may be allowed to the SECP for the purpose.

A new Rule 5A has been added to provide a procedure where registration is not granted or renewed. The procedure described here appears acceptable, except for sub-rule (5), according to which the SECP may allow a credit rating company whose application for renewal of registration is refused to continue to complete the rating of all pending assignments, if it considers that doing so is in the interest of the market in particular, and the public in general.

If this relaxation is allowed to a CRC, the public may be enticed to invest on the basis of a credit rating which may perhaps be perceived as ‘suspect’. To avoid complication, this sub-rule may be deleted.

The proposed process of suspension and cancellation may be given a second look and finalised without too much discretionary powers vested in the SECP. The commission may be exposing itself to court proceedings initiated by investors possibly suffering losses due to unnecessary delays or perceived sloppy handling of the process by the regulator. The commission has to revamp its monitoring of the CRCs.

Rule 9 (Restriction on Directors of CRCs) pertains to relaxation in case of a government-nominated director. For transparency and independence of CRCs, it is suggested that this exception is deleted.

Items at serial numbers six and nine in the annex to Form-I pertain to whether any director, officer or employee has been convicted of fraud or breach of trust in the past five years. The five-year period, which has been inserted as an amendment, needs to be deleted. Such a person may not be allowed to assume any position in any CRC. Moreover, all these people may be required to submit an affidavit in respect of the statements on items six, seven and nine in the annex.

After the international financial crisis of 2008-9, questions were asked regarding the possibly inflated credit ratings issued by one or more CRCs on certain financial products. Is there a possibility of further amendments for any potential moral or financial responsibility of the CRCs to the investors in case the ratings are found to be inflated, wrong or misleading?

The growing importance placed on their assessments and opinions requires the CRCs to conduct their activities in accordance with the principles of integrity, transparency, quality and good governance.

The CRCs in Pakistan are expected to face new and bigger challenges in the coming months, when mega coal powered or infrastructure projects will be mobilising financial resources for implementation. The local CRCs are expected to upgrade their capabilities to secure more business in possible competition with international CRCs, which are generally preferred by foreign investors.

Published in Dawn, Economic & Business, Aug 11th, 2014