LEGAL DEVELOPMENT AND POLICY REVIEW

VOLUME I ISSUE II
June, 2019

LAW LEAGUE
Maharashtra National Law University Mumbai
MNLU CETTM Campus, MTNL,Hiranandani Gardens, Powai, Mumbai – 400 076
LEGAL DEVELOPMENT & POLICY REVIEW VOL. I ISSUE II

ABOUT
Legal Development and Policy Review is a quarterly, open-access, double blind peer reviewed,
interdisciplinary journal published by Law League. The journal aims to provide a platform to
enhance the understanding of contemporary legal issues as well as setting out new ideas and
arguments. The purpose of Legal Development and Policy Review is to bestow on our readers
outspread information on recent developments affecting laws and development.

The Aims of Legal Development and Policy Review:

 The primary aim of the journal is to generate a platform for discourse of issues relating to
crucial developments in the legal field.
 To monitor legal developments, reforms and seek appraisal of the legal system.
 The Journal shall thrive to spread legal knowledge and education to diverse communities.

Legal Development and Policy Review receives a considerable amount of support and guidance
from its Board of Advisors. The Board of Advisors is composed of Legal Practitioners and
academicians from across the country. The Board of Editors seek advice of the Board of
Advisors on issues pertaining to practice in the law field along with prolongation and
enlargement of relations in various areas of law. The journal encourages contributions from legal
luminaries, professors of law and other related fields, academicians and students.

Recommended form of Citation

(2019) I LDPR 2 <pg no.>

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LEGAL DEVELOPMENT & POLICY REVIEW VOL. I ISSUE II

FROM THE PATRON’S DESK

I am delighted to present the first Volume of Legal Development and Policy Review. There is a
need to enhance the understanding of contemporary legal issues among the diverse communities
and monitor legal developments, reforms and seek appraisal of the legal system. The Journal is a
welcome first step for the same.

On this occasion, I would like to thank the students who have worked tirelessly to bring this
publication and to congratulate the authors whose exceptional work has been finally incorporated
in this Volume. I look forward to all the future editions of the Journal and I am hopeful that this
journal will be helpful to the legal fraternity.

Prof. Bhavani Prasad Panda

(Founding Vice Chancellor, NLU Mumbai)

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 LEGAL DEVELOPMENT & POLICY REVIEW VOL. I ISSUE II

PATRON IN CHIEF

Prof. Bhavani Prasad Panda

Founding Vice Chancellor, NLU Mumbai

EDITORIAL ADVISORY BOARD

Mr. K.K. Sharma Mr. Bhumesh Verma
First Director General of Managing Partner, Corp Comm
Competition Commission of India. Legal

Dr. Anil G Variath Shri Sadashiv Deshmukh

Dean of Amity University, Mumbai Director, Center for Clinical Legal

Education,MNLU

Mrs. Mahua Roy Choudhary C. Scott Pryor

Founder and Principal Partner of Professor, Campbell University

ROYZZ & CO.

EDITORIAL BOARD
Editor in Chief

Reuben Philip Abraham

Advocate, Supreme Court of India

Deputy Editor in Chief Senior Compiling Editor

Mr. Sparsh Gupta Mr. Yashaswi Pande

Executive Editors Assistant Editors

Mr. Ashok Chikte Ms. Sara Jain Ms. KareenaSobti

Ms. Sunidhi Pubreja Ms. Ritisha Gupta Ms. Shruti Dhondhe

Ms. Aditi Bohra Ms. Mrinal Dave Mr. Raja Reeshav Roy

Ms. Karolina Makuch Mr. Bhanukaran Jodha

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LEGAL DEVELOPMENT & POLICY REVIEW VOL. I ISSUE II

CONTENTS

Conflicts between Trade Law & Competition Law: WTO & Indian Perspective 1
Reuben Philip Abraham

Critique on the Concept of Rule of Law and its Application in the Indian Polity 20
Disha Gujarathi

Biotechnology: Ethical and Legal Implications 29

Siddharth Swain and Raman Puri

Abuse of Dominance as Unfair Trade Practice 46

Samridhi Chauhan

Unencumbered Freedom of Expression 62

Ayaan Hafiz

The Emerging Sports Law in International Arena 68

Varad Dixit

The Private Detective Agencies (Regulation) Bill, 2007 [Bill no. 40 0f 2007]- Key
Issues and Critical Analysis 86
Avani Rathore

'Section 3' of The Competition Act, 2002 with regards to Intellectual Property Law 99
Advait Rastogi

Pro- Life or Choice? Roe v. Wade and Abortion Legislation on Abortion in the
United States 107
Ross Couto

Extradition of Economic Offenders - Effectiveness and Symbolism 113

Shivani Rani

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LEGAL DEVELOPMENT & POLICY REVIEW VOL. I ISSUE II

Model Role and Critics of Credit Rating Agencies 120

Karan Shelke

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 Model, Role and Critics of Credit Rating Agencies

MODEL, ROLE AND CRITICS OF CREDIT RATING AGENCIES

- Karan Shelke1

Abstract

Credit rating agencies (CRAs) are tasked with disseminating information of various
securities and other instruments to the public. CRAs are tasked with analyzing data
available to them for assigning relevant rating as may be prescribed by law. They are not
merely rubber stamps in rating securities as they are required to follow strict guidelines
and fair procedure while maintaining a sound business model. Since all developed
jurisdictions have made it mandatory for the public companies to have its instruments
rated by recognized CRAs, it has become important for regulators to keep a close eye on
CRAs. Recently CRAs have been plagued with many issues of corporate governance due
to failure on behalf of them while rating an instrument. Hence this paper essentially deals
with challenges faced by regulators and corporate governance issues with CRAs in light
of recent financial crisis.

1
The author is a student at the Maharashtra National Law University, Mumbai.

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 Model, Role and Critics of Credit Rating Agencies

INTRODUCTION

Credit Rating Agencies (CRAs) are companies required by law to perform duty of rating
instruments issued by other companies to the general investors. CRAs are important
information providers in the markets and the quality of the ratings are dependent on
general performance of the instrument issued by the issuer.

However, information regarding the securities to its highest purity should be the required
standard for investor confidence. This principle of highest integrity can be affected by
number of factors which can be aggressive competition for revenue generation. This might
led to deteriorating standard of credit evaluation as was observed during the financial
crisis of 2008 which was fueled by issuers rating shopping attitude which resulted in
added pressure for CRAs to retain the client 2.

Fundamental concern for the regulators of different jurisdictions have been the conflict of
interest generated by rating agencies. 3

The question of corporate governance in CRAs have been a major headline aftermath of
IL&FS crisis in the Indian market where severe liquidity crunch was observed in the
NBFC sector after IL&FS defaulted on its financial obligations. 4 Being the largest
financial company in its spectrum, the news of IL&FS defaulting had a trickle down effect
on the rest of the NBFC sector. In IL&FS crisis, CRAs downgraded debt instruments of
the issuer after it had defaulted on the payments to the creditors which is a clear sign of
market failure. Due to such market failure ICRA and CARE have come under scrutiny
after SEBI launched an investigation against them.5 After the crisis, NBFC sector in India
saw liquidity crunch has many companies like Indiabulls, DHFL, Religare, Kotak lost

2
John Griffin and Jordan Nickerson, Rating Shopping or Catering? An Examination of the Response to
Competitive Pressure for CDO Credit Ratings (May 18, 2019, 08.07 PM).
https://www.sec.gov/divisions/riskfin/seminar/tang061412.pdf
3
Stéphane Rousseau, Enhancing the Accountability of Credit Rating Agencies: The Case for a Disclosure-
Based Approach, 51 McGill L.J. 617, 621 (2006)
4
, IL&FS: The crisis that has India in panic mode, The Economic Times (October 3, 2018, 10:20 PM)
https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-about-the-ilfs-crisis-
that-has-india-in-panic-mode/articleshow/66026024.cms .
5
Khusbu Narayan, IL&FS crisis: Fraud office probes role of 4 credit rating agencies, The Indian Express
(May 9, 2019, 7;20 AM)
https://indianexpress.com/article/business/ilfs-crisis-fraud-office-probes-credit-rating-agencies-sebi-sfio-
5718085/

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 Model, Role and Critics of Credit Rating Agencies

their share-value.6 This affects general investors who had trusted the ratings delivered by
CRAs.

Corporate governance within CRAs forms important policy of any CRA while
maintaining the integrity of the financial system. The contractual ties between issuers and
raters according to Regulation 14 of the SEBI (Credit Rating Agency) Regulations7 have
two components:

(i) Rating agencies perform rating services, usually charging according to a

standardized price list depending on the market determination, and
(ii) Rating agencies also perform a variety of non-rating often referred as
‘consulting/advisory services. One example of advisory services is “ratings
assessment services”, which performs pre-rating analyses as well as
assessments on any potential effect of a hypothetical transaction which issuer
desires, such as amalgamation, buyback or spin-off. Other non-rating services
may include wealth management of the firm, debt restructuring consulting,
regulatory advice and monitoring services.

BUSINESS MODELS OF CRAS

Since the evolution of the CRAs, all of CRAs followed ‘Investor-pays’ model till 1970s in
the United States. Investors in the course of business subscribed to the ratings forum
which used to be released by the CRAs, and this subscription was the main source of
revenue for the rating agencies which came out of the pocket of investor.8 This principle
can be surely effective in tackling the problem of ratings shopping in the market.
However, it was observed that due to fear of piracy of ratings issued by the CRAs, the
model was soon shifted from investor pay to issuer pay principle.

‘Issuer-Pays’ Model has its own disadvantages and benefits. The biggest advantage of this
model is that the ratings are available so there is information symmetry in the market. The
information in the market to all the general investors would be free. The ‘Issuer Pays’
6
Furquan Moharkan, Deccan Herald, https://www.deccanherald.com/business/business-news/dh-deciphers-
is-there-crisis-in-nbfc-sector-734084.html (2018)
7
Regulation 14 of the SEBI (Credit Rating Agency) Regulations, 1999
8
R Rajesh Babu, Rating Agencies, Indian Institute of Management Calcutta working paper series, (June
2014) https://www.iimcal.ac.in/sites/all/files/pdfs/wps_746_0.pdf

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 Model, Role and Critics of Credit Rating Agencies

Model along with publically available information will also have access to confidential
information about the issuer’s company for the ratings. SEBI has already notified the
regulations to stop ‘rating shopping’ by asking the rating agencies to disseminate all the
ratings issued by it, regardless of their acceptance or rejection by their clients. 9 This has
been done to avoid rating shopping by the issuers of the company.

Issuer’s pay model requires regulators to be watchdog of the contractual agreement

between issuer and CRAs to oversee those factors affecting the free flow of information.
Further factors which affect functioning of CRAs are conflict of interest, declining rating
quality and lack of competition in the market.

The challenges that regulators experience can be different for both the models due to basic
distinction in functioning of both the models in the market.

REGULATORY CHALLENGES TO CRAS AND COMPETITION

The Securities and Exchange Board of India (SEBI) Act, 1992 provides a great
discretionary power to SEBI in framing rules for investor protection and accordingly the
SEBI (Credit Rating Agencies) Regulations, 1999 have been introduced to keeps checks
and balances within the system. It provides a simple ‘registration model’ with sufficient
power for supervision and penal consequences to SEBI.10 Only registered firms are
permitted as a CRA is required to enter into an agreement with the client defining the
mutual rights and liabilities, the quantum of fee and the obligation of periodic review of
the ratings which is contrary to what is followed in United States. However, India has seen
certain erosion in the standard of evaluation of rating by CRAs especially after the IL&FS
fiasco even after ample jurisdiction which has been provided to SEBI.

Declining rating quality

The reliability of any credit rating agencies is an important condition for economic
stability to an extremely large number of investors who are active in the market and
who rely on the ratings and credit quality explanations of securities, governments
and business entities. In recent years, credit rating agencies have found themselves

9
Regulation 14 (e) of the SEBI (Credit Rating Agency) Regulations, 1999
10
Supra note 4

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 Model, Role and Critics of Credit Rating Agencies

targeted by many critics, mainly because they are considered the main cause of the
global financial crisis. They were supposed to be market sirens which would predict the
quality of asset in future. CRAs have stated in multiple hearings before the senate
committees that they are merely tasked with giving opinions on securities. 11

Indian CRAs have always followed the issuer pay business model. This system has
exposed some of its disadvantages to the Indian financial system. Many cases have
highlighted possible conflict of interest while assigning ratings to companies.

Conflict of interest

One study conducted by the National Stock Exchange found that rating agencies that also
perform consulting services for an issuing company, on an average, rate that company
higher (that is, issue ratings designating lower default risk) as compared to other rating
agencies who do not provide any consulting services to the issuing company. So the ratio
of companies subscribing both the services offered by CRAs as mentioned earlier gets
more positive rating. However, the companies who subscribed both the services had
higher default rate in BB and B rated securities. 12

Conflicts of interest can be termed to be the Achilles’ heel for the all powerful CRAs in
the market and their management and identification is the most significant concern
currently. 13 The conflicts plaguing them can be recapitulated as under:14

CRAs are paid by the issuers for the ratings and thus this can create direct conflict of
interest. This has been the criticism of market based price identification as CRAs might
give out favourable ratings of securities which might be compromised in some way.

11
Examining the role of credit rating agencies in the captial markets, U.S Government printing office
https://www.govinfo.gov/content/pkg/CHRG-109shrg28059/html/CHRG-109shrg28059.html (2005)
12
Baghai, R. and B. Becker, Conflicts of Interest and the Provision of Consulting Services by Rating
Agencies: Indian Evidence, “Non-rating Revenue and Conflicts of Interest”, NSE-NYU Stern Working
Paper (2016).
13
International organization of securities commissions (IOSCO Report), U.S. Securities and Exchange
Commission, Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities
Markets, (2003)
14
IOSCO Report; U.S. Securities and Exchange Commission, Report on the Role and Function of Credit
Rating Agencies in the Operation of the Securities Markets, (2003), at p.23; Arthur R. Pinto, Control and
Responsibility Of Credit Rating Agencies In The United States, 54 Am. J. Comp. L. 341, 342-43 (2006);
Carol Ann Frost, Credit Rating Agencies in Capital Markets: A Review of Research Evidence on Selected
Criticisms of the Agencies, (March 15, 2006), at pp.15-19

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 Model, Role and Critics of Credit Rating Agencies

Further, the rating process becomes more vulnerable where the analyst compensation is
linked with rating fees. CRAs offer many services other than credit rating like corporate
restructuring, value derivation of any scheme between the firms and other advisory
services.

Moody’s reported in 2014 that Moody’s Investor Services generated close to $2.4 billion
in ratings services offered by the firm, while the group’s other division which had business
in non-rating services (Moody’s Analytics), generated close to $1.1 billion from selling
services for which were advisory in nature. Its non-rating arm of the firm operates with
margin of 20%.15 Hence it can be inferred that non rating activities make up for significant
business of any CRA. The amendment of 2018 mandates that if a CRA does have a
separate activity other than rating instruments, the same should be separated within the
period of two years.

CRAs or their promoters/employees/directors may be associated with the client by having

certain interest in the client/securities of the client or being engaged in a business
relationship with the client. This is however prohibited by Regulation 26 and 27.16

Lack of competition in the market

One of the concerns that regulators have addressed is the lack of competition among
CRAs. This was largely seen during the 2008 crisis when only two or three CRAs had
market share for more than 90% of the instruments. This enabled CRAs to have longer,
well- established relationships with the issuers. 17 As such, this allows CRAs, their
employees, and analysts to get so familiar with the issuer that their independence may be
affected, further exacerbating the inherent conflict. India has six SEBI registered CRAs
which are dominant in their sectors in terms of type and volumes of issue. However the
issue of anti-competitive concern has still not affected Indian markets with emphasis on
CRAs.

15
Moody’s Annual report https://s21.q4cdn.com/431035000/files/doc_financials/annual/1500069041.pdf
(2014)
16
Regulation 26 and 27 of the SEBI (Credit Rating Agency) Regulations, 1999
17
Jennifer Payne, ‘The Role of Gatekeepers’ in N. Moloney, E. Ferran and J. Payne , Oxford Handbook of
Financial Regulation ( 2015).

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CONCLUSION

Investor confidence is a must for any financial system to sustain and credit rating agency
play an important role in helping keep that. They are tasked with providing information
about the companies and its instruments issued by them to the general investors. CRAs are
profit making companies and they generally get compensation by way for fees given to
them by the issuer. The model itself has been questioned by many due to conflict of
interest. There is still lack of clarity as to whether it was right to prohibit CRAs from
conducting other non rating activities by SEBI considering it does bring in a lot of
business for the firm.

The rating agencies may adapt to changing legal and economical value for the future of
the financial industry would depend much on how effectively they could overcome the
legitimacy test while conducting the business. They also need to make sure that the
business model that they adopt is ethically sound and financially viable for the company in
the long run. One must note that the flaws in the rating industry are only a reflection of the
problems inherent in the financial industry as a whole due to issues of corporate
governance prevailing at the core of such firms. Blame shall also rest with the
Government in their role in creating such a market condition of impunity and uncertainty
in the financial market. The overlapping jurisdiction of many authorities for regulating
CRAs has also created confusion among the stakeholders.

CRAs should be held accountable to investors that use their ratings for investing in the
financial market. Reputational risk has been insufficient to promote accountability, and
credible litigation risk would help in such promotion as opinion given by CRAs on
instruments can be scrutinized.

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