SEBI orders Brickwork Ratings to shut shop, here’s why these agencies can't make mistakes

In 2018, when India’s state-funded Infrastructure Leasing and Financial Services (IL&FS) defaulted, it cost financial systems almost Rs 1 lakh crore and exposed misconduct by ratings agencies. The likes of India Ratings & Research, ICRA and CARE gave a shining AAA rating to the infrastructure developer, without flagging its public disclosures and weak financial condition. Years after those agencies were slammed with a penalty of Rs 25 lakh each, market regulator SEBI has ordered Brickwork ratings to shut shop.

A betrayal of investors’ trust?

The case against the Bengaluru-based ratings agency, one of only six registered with SEBI, came to light when the investigation started in 2020. Brickwork has been found guilty of failing to warn investors against Non-Convertible Debentures (NCDs) issued by Zee’s parent firm Essel Group and Great Eastern Energy. SEBI has cited failure to exercise due diligence on part of Brickwork, while rating the instruments used for raising long term funding. The agency didn’t warn investors about doubts over the ability of both firms to pay them back.

Why ratings agencies can’t afford to get it wrong

Agencies such as Brickwork are supposed to review and rate bank loans, bonds, commercial papers and fixed deposits among other instruments for investment. Their ratings are taken as recommendations by investors, and can be crucial in determining how much returns are delivered to people. Discrepancies in issuing these ratings are akin to betraying people investing money in fixed-income instruments. Ratings agencies even played a role in the 2008 financial crisis, by giving high ratings to mortgage bonds which later turned out to be high-risk.

Previous action didn’t prove to be effective

SEBI had also imposed a Rs 1 crore penalty against Brickwork over the misconduct, but has now given it six months to wind up its operations, since changes in governance and the fine haven’t had the intended effect. The regulator also added that the agency didn’t review ratings despite reports of delayed payments, and that the absence of surveillance of repayment schedule meant that ratings were inaccurate.

Apart from the deadline to shut shop, Brickwork has also been barred from going ahead with any new business activity. The decision could affect bonds of Adani, SREI and Edelweiss, which are currently rated by Brickwork.