Can Court Block Rating? Can SREI Block Fitch?
Last week we came across another first. SREI Infrastructure Finance obtained a stay order from the Calcutta High Court against a rating downgrade by credit rating agency Fitch. Neither party will comment. Fitch has been gagged, but the hearings began yesterday and my colleague Amrita Panja sneaked a peek at the petition.
It says since SREI had terminated its agreements with Fitch, Fitch was no longer entitled to rate it and the purported downgrade from AA- to A+ is invalid. SREI has sought a perpetual injunction restraining Fitch from proceeding with the downgrade or making it public.
Can a company go to court against a rating downgrade? Can a court save a company from a rating downgrade? Can rating shopping be allowed?
To answer that I have with me Amit Tandon, Former MD of Fitch India and now MD with proxy advisory firm IIAS; and H Jayesh of Juris Corp.
Doshi: You have explained to me the process of how ratings work in the country - to put it briefly - ' A company has the opportunity or the option to accept or reject the first rating by a rating agency after it signs the contract but thereafter any rating changes by the credit rating agency have to be accepted by the company'. But SREI seems to be making the argument that its contract with Fitch had been terminated and hence a downgrade should not be publicized, do you agree? And in your response can you lay out the Indian process vis-ŗ-vis international processes?
Tandon: I presume the first thing SREI would have said is that Fitch cannot publish a rating action, if they were to say the rating downgrade then the cat is out of bag in any case.
Doshi: It does say downgrade.
Tandon: Absolutely; so Fitch has been restrained from taking any rating action. The question is since SREI has terminated its contract with Fitch, can Fitch continue to publish? Under the SEBI guidelines, Fitch has an obligation to continue to monitor SREI as long as the instrument which they first rated is outstanding. I think what is fundamental is that each of the rating agencies needs to take a call- is there sufficient information available in the public domain because you need to remember the rating would be in two parts. First is, there would be information such as the annual report, other brokerage reports etc. Fitch's own outlook, rating agencies outlook on what is going to happen in a business. The second is management meetings. SREI has decided that they will not cooperate; one part of this is not possible which is having management meeting. But the rating agency still can take part in investor meet with equity investors and so on and so forth and still form an opinion.
Doshi: I get the point that you are making, which leads to my second question and that is SREI has also claimed that Fitch ignored material information - this is what we picked up from the hearing although I don't have the full petition; so I am not making that claim with much authority but that seems to be one of the arguments. Sources also tell us that SREI is pointing to a far more favorable rating from CARE and also rating upgrade that CARE undertook in the last few months. My question comes back to you Amit on this- can a company not choose between two ratings and pick the one that is more favorable to it?
Tandon: People do that all the time; so right to first use the rating would be with SREI- once Care, Fitch and ICRA have assigned ratings- in this instance they would be free to pick and choose. So fundamental difference between the way ratings happen internationally versus what happens in India- in India a particular instrument is rated. So Fitch could have rated the 2010 bond issue, CARE might have rated the 2012 bond issue. Therefore they are saying we are issuing 2012 bonds which are rated by CARE. Internationally you are rating an entity and therefore all the paper which they issue can carry the same rating.
The second matter here is that these are all opinions, so you could point out that ICRA has lower rating, CARE has a rating which is once notch higher than what Fitch has but at the end of the day you need to remember a rating is an opinion and as rating agencies they are free to give their opinion just like brokerages are free to give buy and sell recommendations on stock. You will not go and put gag order on brokering recommendations. You are not going to turnaround or I have not heard of instances where someone has gone to the court and said the auditor cannot publish the audited accounts. So this is also highly unusual.
Doshi: In this highly unusual situation, what do you think courts can or should do when faced with the situation of having to decide whether a rating is fair or not on grounds of not enough material information etc, all grounds except for malafide grounds which may point to some sort of corruption in the process?
Jayesh: One thing we need to understand first is that any situation like this or many other situations, the courts first thought would be- somebody comes before me and says that grave and irreparable damage, i.e life and death situation- so the court will think let me protect the person till I hear the other side. So what the court has done is not even really a gag order, it's merely a status quo to be maintained till we hear both sides and then we decide what the order should be.
Doshi: So you are saying this action by the court is justified but now the court is faced with the hearings and maybe even decisions that they should grant that perpetual injunction or not, what do you think the court should or could do?
Jayesh: Something similar has happened but though not in India and let me share with you what happened. This was in Singapore, a few yeas back, REIT- real estate trust went to court and sought an injunction against Moody's- the court granted an injunction. The argument was that Moody's is wrongly going to downgrade them merely because they are going to sell some assets of the REIT and Moody's counter was that in our assessment, there is a bit of a credit deterioration and therefore we need to and the law of Singapore requires listed entities to have a rating and that is what we are doing and the public will be impacted if you don't allow us to do our job. Ultimately the court there lifted the injunction. But the interesting thing there was that after the injunction was lifted, Moody's downgraded but the REIT concerned went and did a further fund raising. So nobody really got hurt ultimately there. That is a very useful precedent to keep in mind. The other interesting thing which we are watching is we believe the court has effectively asked SEBI to come and present itself, or at least they should notice, so we are hoping SEBI will get impleded and make submissions because what is at stake out here is a key element of capital market regulation.
Doshi: But Jayesh what do you expect SEBI to do? How do you expect SEBI to react, do you expect SEBI to intervene. I imagine SEBI is empowered to intervene but what can it do really to try and fix something like this?
Jayesh: If one were to be advising SEBI, we would have said even if the court were not to call you, you should be trying to intervene because this is the first of its kind and we need to be careful that something which hurts the market in the long term doesnít happen.
Tandon: As Jayesh has said that itís in the interest of the market that rating agencies be allowed to continue to publish their opinion. I donít have a recollection I am but pretty sure anytime you change an outlook to negative, you kind of take rating action- companies come up and say your analyst is not understood it, there is a lot of facts and figures they have not taken into account, you donít understand the company and go on so far as to threaten the rating agencies by saying we will ensure that your license is cancelled, we will report you to SEBI, we will go to RBI and so on and so forth. I would say in my years of experience each downgrade follows a similar pattern of conversation. Having said so, I havenít come across anyone who then took the next step and went to court.
Doshi: Last word to you Jayesh, say what you have to and also tell me how you expect this to go from here onwards?
Jayesh: One thing we havenít considered is this a case of unsolicited ratings because Indian regulations explicitly contemplate unsolicited ratings except that you have to say so. So if SREI is claiming contract has terminated and maybe its not instrument specific rating and itís a company rating, then maybe SREI has a point that, ok we had an arrangement in place for rating the company and the arrangement has ended so now Fitch has no business. Again then, there is definitely a regulatory gap.
Doshi: Amit what would you like the court or what would you like to see as the culmination of this battle?
Tandon: Itís pretty much as Jayesh said that at the beginning that the rating agencies need to be permitted to continue to do what they do. You may or may not agree with what the outcome is but then its for you to explain to the investor that look while Fitch is downgraded, there is another rating agency which has a higher rating or we believe the following facts are not taken into account and therefore we believe that the rating needs to be a notch higher. But itís a question of communicating with the investors what the view is.
Doshi: Alright, communicate, donít go to court. Thank you very much for your time, Amit, Jayesh thank you for joining us on The Firm.