Rating Reset: Building Trust in India’s Debt Markets

In any functioning debt market, Credit Rating Agencies (CRAs) play a critical role in bridging the gap between issuers, regulators, merchant bankers and investors. Rating agencies play a vital role in boosting the bond market by providing an independent and credible assessment of an Issuer’s creditworthiness. These ratings help reduce information asymmetry, enabling investors to make informed decisions and better manage risk. High-quality ratings of instruments / securities attract a wider pool of investors, thereby improving liquidity and market depth. They also assist in pricing bonds appropriately based on risk, which supports efficient capital allocation. Ultimately, by enhancing transparency and investor confidence, CRAs are supposed to contribute towards the growth and stability of the bond market.

In India, however, a series of bond defaults has exposed structural weaknesses in the credit rating ecosystem. Recent incidents, most notably the TruCap Finance default on structured market-linked debentures, have highlighted the issue with rating of debt instruments. Since 2016, India has witnessed several high-profile rating defaults, including IL&FS, DHFL, and Reliance Capital, exposing gaps in credit rating practices. These defaults shook investor confidence and highlighted concerns around rating timeliness and independence. Regulatory tightening followed, with SEBI mandating enhanced disclosures. Despite reforms, the need for more proactive, independent, unbiased, timely, objective and transparent ratings remains critical.

As India seeks to deepen its bond market, both in scale and sophistication, strengthening the credit rating framework is critical. Valuable lessons can be drawn from international reforms, especially in the U.S., EU, and China, regions that overhauled their CRA oversight following crises of their own.

Some Key Challenges faced by Indian CRAs
Despite their integral position in the market, Indian credit rating agencies have faced manifold challenges, mainly due to the following:

• Reactive approach: Ratings often change only after the financial stress becomes visible or after a default has occurred.
• Limited disclosure: Methodologies, assumptions, and stress scenarios are often not transparently shared with investors.
• Lack of dynamic surveillance: CRAs typically rely on periodic financial disclosures and management interaction, rather than ongoing market intelligence or alternative data. Nothing prevents the CRAs from asking for additional information from the companies – in case needed to review the ratings on an ongoing basis.
• Several high-profile defaults over the last decade, from IL&FS to DHFL have made these shortcomings increasingly untenable.

 

Global Experiences in CRA Reform

United States: The Dodd-Frank Era
The 2008 subprime mortgage crisis exposed how leading CRAs gave ratings to complex, risky financial instruments that ultimately resulted in default. In response, the Dodd-Frank Wall Street Reform and Consumer Protection Act was introduced to provide for the following:

• Civil liability for CRAs in cases of gross negligence or misconduct.
• Creation of the Office of Credit Ratings (OCR) under the SEC to conduct annual reviews of rating agencies’ practices, including governance, methodologies, and conflict management.
• Mandatory disclosures of historical rating performance, analytical assumptions, and methodologies.
• Enforced separation between analysts and commercial operations to avoid rating manipulation.
• These measures emphasized accountability, transparency, and deterrence.

 

European Union: Centralized Oversight by ESMA
The European Securities and Markets Authority (ESMA) was given direct supervisory powers over CRAs. Reforms included:

• Mandatory registration of all CRAs under strict guidelines.
• Disclosure of rating performance histories and methodological updates.
• A centralized public database, the European Rating Platform (ERP), allowing investors to access all rating changes and related documents in one place.
• Stronger emphasis on managing conflicts of interest and preventing “rating shopping.”
• The EU also introduced  Sanctions for non-compliance, creating a culture of continuous accountability.

 

China: Enforcement and Data Integration
China has approached CRA reform with a focus on enforcement and integration of market data. Key steps include:

• Regulatory penalties and suspensions for agencies that failed to downgrade entities in a timely manner.
• Compulsory continuous surveillance rather than a one-time rating at issuance.
• Use of a centralized credit registry, integrating data across banks, bond markets, and even shadow lenders to assess issuer risk holistically.
• This approach combines discipline, technology, and surveillance to ensure rating credibility.

 

What India Can Learn: Consolidated Lessons from Global Reforms

Drawing from these international reforms, India can consider a series of concrete changes to strengthen the functioning of its credit rating agencies:

 

Establish a Dedicated Oversight Unit
Just as the U.S. created the Office of Credit Ratings under the SEC, SEBI could consider the establishment of a specialized CRA supervisory cell. This unit should:

• Conduct annual inspections of Agencies’ governance, compliance, and internal control systems.
• Track historical performance of rating actions, especially around defaults and stress events.
• Ensure separation of analytical and commercial functions within CRAs.
• Review adherence of CRAs to the IOSCO CRA code.

 

Mandate Real-Time and Event-Based Monitoring
Indian CRAs should move away from periodic reviews and move towards dynamic, event-triggered surveillance. Ratings must incorporate:

• Bond yield movements and market signals.
• Stock price crashes and promoter share pledging trends.
• Resignations of key personnel.
• Negative news or social media sentiment.
• Advanced analytics, AI models, and integration with credit bureaus and exchanges can support this shift.

 

Improve Methodology Transparency
CRAs must be required to:

• Disclose rating methodologies and assumptions in public domain documents.
• Present stress-test scenarios (e.g., interest rate hikes, liquidity crunch) alongside base case ratings.
• Include qualitative assessments, such as governance quality and regulatory exposure, in addition to financial ratios.
• These measures help investors make better-informed decisions and evaluate rating reliability.

 

The IOSCO Code of Conduct Fundamentals for Credit Rating Agencies (the “IOSCO CRA Code”) is intended to offer a set of robust, practical measures as a guide to and a framework for CRAs with respect to protecting the integrity of the rating process, ensuring that investors and issuers are treated fairly, and safeguarding confidential material information. Globally, regulators are using the IOSCO CRA Code as the benchmark for registration and oversight programs related to CRAs. Regulators the world over are also looking at ways and means to address the basic issue of ‘Conflict of interest’ associated with the ‘Issuer pays’ model where lines often get blurred between Analyst divisions and Business development functions of CRAs.

India’s ambitions of building a vibrant, globally competitive bond market depend critically on investor confidence and that confidence is deeply tied to the credibility of credit ratings. Recent defaults, like that of TruCap, have shown that without meaningful reform, the current CRA framework risks falling behind the needs of a more dynamic, retail-inclusive debt market.

India doesn’t need to reinvent the wheel. The U.S., EU, and China have all faced similar crises and responded with regulatory clarity, stronger enforcement, and technological integration. These global models offer a clear path forward.

The time is right for a rating reset, where Indian CRAs transform from being reactive scorekeepers to independent, forward-looking sentinels of credit risk – and also looking at other risks which in turn impact the credit rating of instruments. With stronger oversight, better transparency, and smarter monitoring tools, Credit ratings can once again serve their true purpose – protecting investors and strengthening the integrity of financial markets.

Author:
CMA Suresh Narayan, Adjunct Faculty NISM