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RAM Lanka has been operating in Sri Lanka for the past 10 years. RAM came to Sri Lanka with the sole objective of developing the domestic bond market similar to that of Malaysia (which is ranked as having South Asia’s third best domestic bond market) by incorporating a domestic Rating Agency. This was due to our former Deputy Chairman of RAM, Tan Sri Rajendran, who is a Sri Lankan now living in Malaysia.
In Sri Lanka the corporate bond market is in its infancy and is still developing. Some of the issues for this slow growth have been rectified such as the tax issue in our 2012 Budget, but a lot more needs to be done. RAM wanted to restructure by divesting RAM Lanka as its performance was not up to expectation. After further study it was also evident that not only the rating agency but also the shareholders, the majority of the rating committee members and the company name too should be local. After the change we were able to achieve the required growth targets in 2013.
Across Asia, locally incorporated rating agencies have been the pioneers in developing the local currency bond market. Development of the domestic bond market is in the hands of Sri Lankan rating agencies and Sri Lankan investment banks and not with outside parties. It is sad that we expect foreigners to come and develop the capital market in Sri Lanka.
Malaysia did not develop its corporate bond market with the help of foreign rating agencies or foreign investment banks; it is the same with China, India, Thailand, and Indonesia. The foreign rating agencies came to their markets after they were developed by the locals. In China and Malaysia, foreign rating agencies are not permitted to do domestic ratings. Thailand and Indonesia are closely looking at this model. It is good for a developing country like Sri Lanka to look at how ASEAN countries developed their capital markets.
Q: Credit rating of an instrument done by a credit rating agency provides investors with an overview about the degree of financial strength of the issuer company. For example, a highly-rated instrument of a company gives an assurance to the investors of the strength of the instrument. As a company, how do you ensure the ratings given by LRA can stand the test of time?
A: If I remember right, some time back a bank and a finance company in Sri Lanka which got investment grade ratings from a subsidiary of a global rating agency would have gone bankrupt if not for Central Bank intervention. This was despite it being public knowledge that there were huge corporate governance issues within that Group and it was a matter of time before it would go bankrupt.
This was mainly due to the fact that the rating committee members who were foreign were completely ignorant of the local situation. Also the true facts of the group had not been disclosed to the rating committee. This was the reason why LRA, after carefully studying the mistakes made by rating agencies which led to the 2009 global financial crisis, included for the first time a team of highly professional local rating committee members who have the expertise in capital markets, law, banking and finance and above all are conversant with the local market conditions.
Further, we have the assistance of CRISIL India, which has provided the technical expertise and training to our founder parent RAM Malaysia and also to several other rating agencies in the Caribbean and Israel. CRISIL is the largest rating agency in Asia and is a subsidiary of Standard & Poor’s, the largest rating agency in the world. All our analysts are also highly qualified and conform to the requirements of the SEC, which ensures that the ratings given by the LRA are accurate and will stand the test of time.
Q: Generally the absence of business links between the rating agency and the rated firm establishes ground for credibility. How do you ensure LRA is independent of the issuer company and has no business connections or otherwise any relationship with it or its Board of Directors, etc.?
A: Rating agencies have two independent boards, the shareholder board or main board and the rating committee board. The shareholder board is independent from the rating committee board and rating committee is headed by a separate chairman who does not report to the main board. The main board has no control over the ratings assigned by the rating committee.
In addition LRA has taken steps to recruit a full-time dedicated professional as a compliance officer, in line with IOSCO code. I am taking India and Malaysia as examples since they are developed and are big markets. The top four rating agencies in India are local rating agencies, so as in Malaysia. Initially they were owned by banks, insurance companies, private equity firms, investment banks, etc. LRA adopted the Malaysian model for the rating committee and has gone one step further by keeping the rating committee completely independent and has no business connection whatsoever with the companies that they rate or their directors.
Q: The quality of credit rating done by professional experts of the credit rating agency reposes confidence in the public to rely upon the rating for taking investment decisions. What is your strategy to build and grow in-house expertise?
A: LRA being relatively a small company has always made it a point to train its staff both locally and overseas. In addition, all our analysts are professionals and qualified graduates conforming to SEC requirements. We also get technical assistance from CRISIL. I must say that our ratings have been always stable, which confirms the accuracy of our ratings.
In addition to the two nominees from CRISIL, we have three esteemed local professionals on our Rating Committee – Dr. Dayanath Jayasuriya PC, former Chairman of SEC; Russell De Mel, former CEO of NDB Bank Plc; and K. Kanagasabapathy, who has extensive public sector experience and who has served in the Treasury. The local Board as well as CRISIL of India have placed full confidence in them.
Q: Most global credit rating agencies have now increased the importance of enterprise risk management in their rating frameworks. What impact has enterprise risk management had on LRA’s rating methodology?
A: I agree that similar to any other rating agency we also place a lot of emphasis on ERM, but in our case RC members do not take note of the ERM report published in the company annual report at face value. There have been instances where companies have been close to bankruptcy in spite of having very good ERM reports, the reason being that the Rating Committee Members have taken the ERM reports at face value without checking on the implementations. Many companies have lengthy ERM reports in their annual reports purely as marketing tools. Our Rating Committee members who are conversant with the local market conditions will always take into consideration the actual ERM implementations as disclosed in the report.
Q: In most developed markets, several alternative credit rating instruments are available for making investment in the capital and debt markets and the investors therefore can make a clear choice depending on their risk profile. As a country, what more needs to be done to get to that stage of development?
A: I wholeheartedly agree that we need more innovative instruments, but the industry cannot do this alone and we need to have regulatory support. The regulations must be market friendly and the investors should be educated with forums, workshops, etc., similar to the way done in Malaysia so that they will not solely depend on the ratings given by the rating agencies when making their choice. It is also important to regulate our investment banking sector like in other countries. Our investment banks are unregulated.
Q: Is approaching a credit rating agency a good option for Small and Medium Enterprises (SMEs), given the problems they face in seeking finance? In South Asia according to banking analysts, only 13%-15% of the registered SMEs have access to finance from formal sources.
A: For any developing country, the SME sector is the backbone. Trying to develop the country’s economy without developing the SME sector will not give sustainable results. Developing the SME sector does not mean just giving subsidies but to ensure that SMEs will have a sustainable long-term growth. In order to address the issue of them having access to cheaper source of finance, we need a model similar to that of India and South Korea. We don’t need to recreate a model but can just copy a model that is successfully implemented from another country. It is heartening to note that the Ceylon Chamber of Commerce is going to conduct the first-ever Sri Lanka National Forum on SME Empowerment in October 2014.
SME credit scoring is a mandatory requirement for all domestic rating agencies in India and they are very firm on that segment. Also SME credit scoring will create the pipeline of companies to the SME exchange and CSE too should implement this practice before long.
Q: Do ratings agencies in Sri Lanka have tie-ups with banks to offer preferential interest rates based on ratings? For example, CRISIL Ratings in India has a working arrangement with banks and financial institutions for concessional funding.
A: So far no, as our system is not yet developed in that area. However, our analysts have been trained in this area and we hope to come up with a new business model in the near future.
Q: Finally, where would you like to see LRA in five years?
A: LRA should be like CRISIL of India or RAM, Malaysia. We are working towards making LRA one of the best rating agencies in the region. Both market players and the public need to be better aware of the value to be attached to ratings. We need more professionals well versed with the methodology of rating in this country as well as in the region. LRA intends to address some of these issues and carve out for itself a unique role.
(The writer is a CIMA Graduate and a final year undergraduate student in the UK.)
