Prevention is always better!

I thought this is a more appropriate thing to share before getting in to detail.

In a previous post, I discussed about the recent developments in the Credit Ratings industry in Sri Lanka and expressed my concern that the recent explosive growth in the industry would lead to certain undesirable outcomes like breach of integrity, lack of independence, loss of quality of work, etc. Before even 6 months’ lapse, some scary news are coming out. 

News Item 1: Restraining LRA from issuing new ratings

As per this news release  from Securitiesand Exchange Commission of Sri Lanka (SEC), the Lanka Rating Agency (LRA) is restrained from issuing new ratings with effect from 25 March 2015 until the LRA complies with regulatory requirements. The letter further says that they the decision follows their deliberations on “structural issues pertaining to the company”.  This to me means that LRA has failed to comply with their own Code of Conduct in which it says, “the Provisions, c. Integrity of the Rating Process, 1.11. LRA and its employees will comply with all the applicable laws and regulations governing its activities in each jurisdiction in which LRA operates”. Moreover, it is also questionable whether LRA was able to achieve what is expected under the Code provision which says “LRA will institute policies and procedures that clearly specify a person responsible for compliance, by LRA and its employees, with the provisions of this Code and with the applicable laws and regulations. This compliance officer will be substantially independent from LRA’s rating operations”. Because, if so the compliance officer should have devised mechanics to avoid issues or identified the structural issues pertaining to the Company, if they were present, to my understanding.

News Item 2: Breach of SEC Act by LRA

Five days later, as per the Directive SEC/LEG/15/06/04, the SEC directs that a recently proposed debenture issuance of EAP Broadcasting Company Limited be deferred until the issuer obtains an independent credit rating. The Directive says that they find conflict of interest in the rating of the above debenture issuance by the LRA as both the companies have a common director on respective boards and that two of the directors of the issuer company also sit on the Rating Committee as members. Most notably, the SEC finds that LRA are in breach of Part V D (vi) of the Schedule to the SEC Act.   

Here again, the rating agency has failed to comply with the Code, “LRA will structure its rating committees and rating teams to promote continuity and avoid bias in the rating process”.  (the Provisions, 1.A.1.8) Further, this situation raises the inevitable questions whether the rating agency dealt fairly here as per the Code “LRA and its employees will deal fairly and honestly with Issuers, investors, other market participants, and the public”. Moreover, there many other clauses in the Code that they have fail to comply/adhere with. I don’t think that this outcome will be tolerated by Association of Credit Rating Agencies in Asia of which they are a member.  

Bottomline

In essence, it can be pointed out that none of the stakeholders would expect to see such outcomes as a result of non-compliance to regulatory requirements on the part of a Credit Rating Agency as well to find that the rating process itself is tainted due to flawed procedures at the rating agency level. In fact, if the incident took place after the conclusion of the subscriptions there would have been many other unintended repercussions. Hence, it is praiseworthy that SEC took measures before the unfold of those events.