[Vibhor Maloo is a fourth year B.A., LL.B. (Hons.) student at Hidayatullah National Law University, Raipur]
The Securities and Exchange Board of India (SEBI), on 9 July 2025, released a consultation paper proposing significant changes to the regulatory framework governing Credit Rating Agencies (CRAs) in India. The initiative stems from persistent concerns regarding conflicts of interest, lack of transparency, and the limited accountability of CRAs and issues that have remained unresolved despite previous regulatory interventions. This post examines SEBI’s proposed structural reforms, which aim to realign CRA incentives with investor protection and systemic stability.
India’s credit rating ecosystem has traditionally followed the “issuer-pays” model, where the rated entity pays the CRA for assigning the rating. While efficient in certain ways, this strategy has frequently led to rating inflation, particularly when issuers shop across agencies for more favourable ratings. The 2018 collapse of IL&FS and the 2019 default of DHFL, both of which were highly rated before their failures, highlighted the risks of a system where financial incentives compromise rating impartiality. SEBI has previously acknowledged the high concentration in the CRA industry, with over 90% of the market share held by three major players, as noted in prior discussion papers and reports. SEBI’s most recent attempt is a response to these shortcomings, with a more ambitious set of changes aimed at rebalancing the industry’s structure.
Mitigating Conflicted Incentives: SEBI’s Push for Revenue Diversification
One of the most significant proposals in the consultation paper is the mandate that at least 25% of a CRA’s annual revenue must be sourced from non-issuer clients. These may include institutional investors, research subscribers, or users of environmental, social and governance (ESG) and credit analytics services. The objective is to reduce CRAs’ dependence on issuer fees and thereby mitigate the structural conflict of interest in the existing model. While the regulatory intent is sound, its implementation raises both practical constraints and conceptual challenges. The investor-pays model, observed in specific sovereign and structured finance scenarios, remains underdeveloped in India. Without parallel efforts to develop an investor-based market, such as pooled investor funds or targeted regulatory incentives, CRAs may find it difficult to meet the requirement without engaging in revenue reclassification or cross-subsidization.
Globally, while both the IOSCO Code of Conduct for CRAs and the Dodd-Frank Act of 2010 recognise the risks inherent in issuer-funded models, major jurisdictions such as the United States of America (USA) have refrained from imposing comparable quantitative limits. SEBI’s plan is notably interventionist; although it demonstrates regulatory ambition, it may need gradual implementation and transitional support to prevent the suppression of smaller CRAs or the further entrenchment of dominant players.
Governance Reforms and the Role of Independent Oversight
To reinforce institutional independence, the consultation paper proposes that at least 50% of a CRA’s board comprise independent directors (IDs), and that a dedicated rating oversight committee, chaired by an ID, be constituted to review rating methodologies. This move to establish internal checks, mirrors a larger trend in Indian corporate governance, where independent board leadership is increasingly viewed as a counterbalance to executive dominance. However, as prior experience with independent directors in Indian corporations has shown, formal independence often fails to translate into substantive oversight. Without statutory backing, such as access to rating models, internal review mechanisms, or voting rights on final decisions, IDs risk functioning as figureheads.
SEBI’s recommendation that rating determinations be subject to periodic review by these oversight committees presumes a degree of analytical expertise and sectoral familiarity that many board members may not possess. Therefore, any significant reform must require the inclusion of subject matter experts with demonstrated experience in credit ratings or risk assessment. Further, regulatory clarification on the scope and authority of these committees should be analogous to the audit committee setting under the Companies Act, 2013.
Enhancing Market Transparency and Curbing Rating Shopping
The consultation paper also proposes compulsory disclosure of cases where an issuer rejects a rating or withdraws midway from the rating process. This is intended to avoid “rating shopping,” a practice in which issuers consult numerous agencies but publicize just the most positive outcome. Under the current regulatory framework, CRAs are under no obligation to disclose such rejections, leaving investors unaware of potentially adverse assessments.
By mandating such disclosures, SEBI aims to follow the approach adopted under the European CRA Regulation No. 1060/2009, which treats transparency as a regulatory good, per se. However, the Indian framework must strike a careful balance between transparency and reputational fairness. Clear rules must be established to distinguish between genuine business withdrawals and those that aim to exploit selective disclosure. Additionally, investor understanding of such disclosures will depend on the surrounding context and explanation, which will require careful formulation of these obligations.
Another significant proposal is the periodic rotation of lead rating analysts, supported by internal audits of rating assignments. While the concept is similar to auditor rotation under Section 139(2) of the Companies Act, 2013, the implications are materially different. Ratings are generally longitudinal and dependent on sectoral expertise, especially in complex or infrastructure-heavy portfolios. Forced rotation might interrupt analytical continuity and, paradoxically, reduce rating quality. While internal audits are a welcome safeguard, they must be independently administered and subject to regulatory scrutiny to ensure they are not reduced to procedural formalities.
Benchmarking Performance through Quantitative Indices
Among the most forward-looking proposals is the construction of a public “rating index” for each CRA, incorporating rating transition data, default probabilities, and downgrade rates over defined time periods. This system would enable both regulators and investors to assess the predictive accuracy of a CRA’s ratings, thereby introducing an element of market discipline through reputational benchmarking.
Similar to the SEBI’s 2021 benchmarking initiative for mutual funds, these indices can serve as tools to promote transparency and regulatory comparability. However, the efficiency of such an index depends highly on its formulation. For instance, whether the index is weighted by issuance volume, credit risk severity, or time to default can drastically influence how CRAs appear to perform. SEBI must consult on the technique and consider appointing an independent administrator, such as a central information repository like CRILC, in order to establish credibility. Additionally, these indices should be updated periodically, publicly accessible, and integrated into both regulatory inspections and issuer-level disclosures.
Notably absent from the consultation is any consideration of liability for ratings that are grossly negligent or misleading. Moreover, in the USA, the Dodd-Frank Act provides for civil liability against CRAs where credit ratings are shown to be materially misleading and have been relied upon by investors. In contrast, India currently has no legal avenue, in either civil or regulatory, through which investors may hold CRAs accountable for failure, unless outright fraud can be shown. If SEBI’s object is to strengthen market integrity, this legal lacuna must be addressed, either through an amendment to the SEBI Act, 1992 or via a dedicated liability framework within the CRA Regulations.
Conclusion
SEBI’s consultation paper reflects a significant step in the Indian credit rating structure. By seeking to overhaul not only disclosure norms or analytical models, but the very incentive structures and governance systems within which CRAs operate, the regulator is addressing the root causes of systemic vulnerabilities revealed in prior crises. However, as with any structural reform, the success of these proposals will depend heavily on the rigour and balance of their implementation.
Revenue diversification will require parallel development of a supportive investor ecosystem; governance reforms must be anchored in statutory empowerment and subject-matter expertise; and performance benchmarking must be grounded in transparent and strong methodologies. While the reforms are timely, they remain incomplete in the absence of enforceable liability provisions, investor representation in CRA governance, and regulatory adaptability to emerging risks such as algorithmic ratings and ESG-driven volatility.
If these critical gaps are addressed in the final framework, SEBI’s initiative could mark a watershed moment in restoring trust, credibility, and long-term integrity to India’s credit rating infrastructure.
– Vibhor Maloo