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Saturday, December 10, 2011

Fixed credit rating fee cap model for some issuers-is CARE heading for disaster?

CARE had issued a draft prospectus earlier this year(http://www.sebi.gov.in/cms/sebi_data/attachdocs/1317804515879.pdf), and being a credit rating agency, I was sure that its prospectus would make interesting reading given the recent macroeconomic turnmoil in EU/USA etc. And I was not mistaken. It was interesting, but for another reason. Risk factor 7 reads as follows(emphasis added is mine alone)
As a part of our efforts to compete effectively, we have adopted a fixed fee cap model for certain clients for a particular duration of time. Once the fee cap is exhausted, we are, as part of our terms of engagement with such clients, restricted from charging them any additional fees for additional debt issuances or bank loans or facilities availed for the duration of the period agreed. If we are unable to negotiate fee caps with these clients at appropriate levels and if we exhaust the fee cap, we will be required to continue to perform our services in accordance with the terms agreed with such clients for no additional fees. If this occurs with a large number of clients, our business, results of operations and profitability could be adversely affected

The issuer pays model by itself has inherent conflicts of interest, which competition would address to some extent, by ensuring a check on quality. But such an agreement implies exclusivity and tie in, because no issuer will rationally use different credit rating agencies, when it can get a 'free' rating from CARE once its limit is exhausted. Yes, CARE may get pissed but it can't even tinker with the rating to get even! There may be a tendency to cut corners by using the earlier work as the basis to rubberstamp opinions for fresh issues. After all, given the option of working on new mandates versus working on no-extra-fee mandates of the client when cap is crossed, which one would YOU prefer? the client would not care less, but users of the rating would. One can only hope that SEBI Code of Conduct is applied in letter and spirit, to ensure that fees do not affect the quality if miscalculated wrongly.
Discussions with those in the industry inform me that this is now a standard practice, especially for frequent issuers. So maybe I was too harsh on CARE.  

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