Credit rating agencies – Vinod Kothari Consultants

SEBI Circular prescribes uniform approach to be ensured by CRAs

Vinita Nair, Senior Partner & Palak Jaiswani, Manager | corplaw@vinodkothari.com

Default in payment of interest or redemption amounts has far reaching repercussions for an issuer of debt securities. A delay of 1 day even of 1 rupee (of principal or interest) from the scheduled repayment date is considered as default in terms of SEBI Master Circular for Credit Rating Agencies (CRAs) and the same triggers an immediate downgrade of the rating of the issuer. After a default is cured and the payments are regularized, the CRA would generally upgrade the rating from default to non-investment grade after a period of 90 days based on the satisfactory performance by the company during this period.

Inability on the part of the issuer to ensure payment in case of incorrect bank details or dormant a/c of the debenture holders resulting in bounce back of the amounts intended to be credited is a common phenomenon experienced by issuers especially in case of servicing publicly issued debentures involving retail investors. Till date, these were considered as technical default and dealt with by the CRAs in accordance with the policies framed by it. Unlike a financial default, where the issuer fails to make payments due to insufficient funds, technical defaults occur despite the issuer having sufficient funds to fulfill its payment obligations.

SEBI Circular dated November 18, 2024 issued in line with the recommendations of the working group for CRAs for EoDB provides guidance on the manner of identification of technical default and verification and disclosures to be ensured by CRAs thereafter. In terms of the SEBI Circular, failure to remit payment due to absence of correct information or due to incorrect or dormant investor account furnished by the investor(s) or due to notice/ instruction received from a government authority to freeze the account of investor(s) will be considered as technical default.

Is technical default a default?

According to SEBI Listing Regulations, a “default” occurs when there is non-payment of interest, dividend, or principal amount on the pre-agreed date, recognized at the first instance of delay. Default is triggered when the issuer fails to pay due to insufficient funds. In contrast, a technical default happens when payment is delayed due to factors like incorrect bank account details or frozen accounts, despite the issuer having adequate funds. The Working Group also highlighted in the SEBI Circular, that instances mentioned above (as technical default) arise where the non-payment is due to reasons beyond the control of the issuer.

It is also to be considered that similar technical issues arise in case of payment of dividends, wherein the Company is unable to credit the amount in the bank account of the members due to incorrect account details provided by them. However, such cases are not treated as default.

While the term used the word ‘default’, it is actually a case of technical delay

Impact on credit ratings

CRA Master Circular requires CRAs to closely monitor the servicing of debt obligations by the issuer and review the ratings, through various modes:

stock exchange intimations made by the issuer- Regulation 57 of Listing Regulations requires issuers to inform stock exchanges on the status of payment (interest/redemption) within one working day from the due date;
payment status intimated by the debenture trustees (para 3 of Chapter VIII of DT Master Circular and para 28.2.1 of CRA Master Circular);
no default statements submitted by issuer on a monthly basis (para 9.3.1 of CRA master Circular)

Credit ratings reflect the creditworthiness of an issuer. Defaults trigger a downgrade to the default grade, significantly affecting the issuer’s reputation. For issuers having multiple ISINs, there may be numerous instances of technical delays, but the same does not indicate financial distress on the part of the issuer. Treating technical delays as default will lead to unjustified rating downgrades and have a negative impact on the issuer’s reputation. Technical delays, caused by factors like incorrect account details or frozen accounts, do not reflect the issuer’s financial health and cannot be treated at par with financial default.

The SEBI Circular omits the term “technical default” from the scope of policy in respect of the upgrade of default rating to investment grade rating framed by CRAs and highlights the instances of non-payment due to reasons beyond the issuer’s control.

Steps to be followed by CRAs for technical defaults:

Conclusion:

While the SEBI Circular gives clarity on the treatment of technical defaults and obligations of the CRA in this regard, clear actionable on the part of the issuer has not been specified. Therefore, in those instances, the issuer should provide the above details to the CRA for onward disclosure. Further, the details to be provided under Reg. 57 inter alia requires providing ‘reasons for non-payment/ delay in payment’. The feasibility of reporting the same in case of technical defaults is not clear as several times the issuer becomes aware of the failure to credit the amount after 1-2 days.

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