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Published on 6 April 2025

SEBI's New Circular: Enhancing Transparency in Credit Ratings

Introduction

SEBI has made a groundbreaking circular with effect from January 1, 2023, aimed at enhancing the credibility and transparency of credit ratings underpinned by Credit Enhancement (CE). The initiative is landmark for Credit Rating Agencies (CRAs), investors, and issuers as it tries to restore investor confidence and enhance regulatory efforts in the Indian securities market.

Scope and Applicability

Who Must Comply

The circular is applicable to all CRAs operating in India. It is for credit ratings of securities listed or proposed to be listed on recognized stock exchanges and any ratings under circulars or rules of SEBI.

Reporting Requirement

The CRAs must report compliance, certified by their respective boards, to SEBI within a quarter from the date of operation of the circular.

Key Amendments and Provisions

1. Repetition and Expansion of the 'CE' Suffix

  • CE Suffix Requirement: Security grades that carry explicit external credit enhancement—e.g., third-party guarantees or letters of comfort—must have the 'CE' suffix. This exception applies only where the security is bankruptcy-remote from the issuer.

  • Specified Support Considerations: SEBI circular Annexure A specifies support measures which are eligible for the CE suffix, including:

    • Unconditional and irrevocable guarantees

  • Letters of comfort

    • Share pledges
    • Parent or group company put options
    • Standby letters of credit

2. Stricter Disclosure Requirements

  • Dual Rating Disclosure: All rating press releases shall clearly disclose:

    • The unsupported rating (excluding any effect of credit enhancement or specified support)
    • The supported rating (including credit enhancement effects)

  • Specific Covenants of Security: All of the covenants of the security must be described in detail in order to make investors aware of their securities and obligations within the instrument.

  • Transparency to Investors: Such transparency enables investors to estimate both the inherent quality of the issuer and the level of external support, and thus make better-informed investment choices.

3. Independent Due Diligence and Legal Certification

  • Tight Review: CRAs now have to carry out independent due diligence regarding the nature and enforceability of credit support. This entails:

    • Formulating a definitive internal opinion regarding the effectiveness of the support
    • Sourcing external legal opinions when needed to verify the legal robustness and enforceability of the credit support

  • Verification of Documentation: CRAs must confirm that:

  • Support is unconditional, irrevocable, and enforceable in law until the obligations are fulfilled

  • Financial health of the support provider is assessed independently to ensure that they are able to pay their obligations

  • Probability of default of the support provider is lower than that of the rated issuer over the life of the outstanding rating

4. Continuous Monitoring and Compliance

  • Internal Audits: Compliance with these guidelines will be tried by half-yearly internal audits under Regulation 22 of the SEBI (Credit Rating Agencies) Regulations, 1999.

  • Penalties for Failure to Cooperate: If an issuer fails to cooperate with a CRA for more than six months, the rating will be lowered to a non-investment grade, marked with an "INC" (Issuer Not Cooperating) status, and no new ratings can be published until cooperation resumes.

Complete Descriptions and Subtle Observations

Practice Credit Enhancement Forms

  • Irrevocable and Unconditional Guarantees: For instance, when an infrastructure major issues parent company-backed irrevocable guaranteed bonds, the rating should reflect the improved credit profile of the parent but at the same time disclose the issuer's stand-alone rating.

  • Letter of Comfort: If a public sector undertaking (PSU) issues debt with a letter of comfort from the government, the rating agency must evaluate the legal enforceability and operational relevance of this support in addition to its availability.

  • Pledge of Shares: Where shares have been pledged by a promoter as collateral against a debt issue, the CRA will consider the liquidity and volatility of the shares to ensure that the enhancement is sufficient to counteract risk.

Why These Changes Matter

Investor Protection

By insisting on detailed disclosures and independent verification, SEBI shields investors from artificially inflated ratings based on support from outside parties alone.

Market Discipline

This structure discourages excessive reliance on credit enhancements and promotes a more accurate representation of underlying credit risk.

International Alignment

The measures taken align India's credit rating practices with international standards, thereby enhancing the credibility of Indian debt markets.

Real-World Example

Consider a renewable energy company issuing green bonds backed by an unconditional guarantee from a highly-rated multinational parent. Following SEBI’s circular, the CRA is required to issue a press release that includes:

  • The standalone rating of the renewable energy company (absent the guarantee)
  • The enhanced rating reflecting the parent’s guarantee (with the ‘CE’ suffix)
  • Detailed account of legal enforceability of the guarantee, parent company's financial well-being, and all covenants of the bond.

Conclusion

This circular, being issued under Section 11(1) of the SEBI Act, 1992, and Regulation 20 of the SEBI (Credit Rating Agencies) Regulations, 1999, is an important initiative toward protecting investor interest, promoting greater transparency, and enhancing India's capital market regulation regime. With stricter terms imposing on the CRAs and compelling full disclosures, SEBI is building a safer and more sound financial system.

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