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Letter to PFRDA : Why go back to Requiring Rating for Bonds

The PFRDA seems to have ditched the Expert Group. In it’s call for comments, I notice that they have both an incorrect entry (of what the Expert Group said) and they have chosen to ask that “75% of all investments made in corporate bonds must have an investment grade rating from at least one credit rating agency”.

Oh come on. After all the fabulous comments by high-ranking people in the Expert Group (see this post) the PFRDA has simply overriden them and gone with whatever they wanted.

I’m furious; we’re going down the exact route of the US, and feeding the illiterate public gyan that rating is good. It is irrelevant and such agencies have shown themselves to be incompetent earlier.

I refuse to put my pensions into any such scheme unless the rating requirement is removed – or, invest solely in the “E” and “G” groups, where rating is not required.

Here is what I wrote, to everyone on this page:

Sirs,

I have noted with deep regret that the PFRDA has gone back against the Expert Group recommendations on the “C” group of investments, now requiring at least investment grade on 75% of the investment in the C category where the investment is in Debt securities of Corporates and banks or NBFCs.

Sirs, I first want to correct you on one aspect of the request for comments given here:
http://pfrda.org.in/writereaddata/eventimages/Inviting%20Comments_EG%20Report9758426936.pdf

It says that the Expert group required a “credit rated” government bond or corporate bond. The Expert group, in fact, does not say so. It says specifically:

“Traditionally, investment restrictions have been put in place based on the credit rating
of the bond issued. However, while we do consider that there is value in a bond that has
a credit rating compared to a bond that does not have a credit rating,12 the EG does not
consider it either necessary nor sucient to include a minimum credit rating for a bond
that NPS funds can be invested into.”

They do not require a credit rating, but your release for request for comments seems to indicate they do. This may have been overlooked but the fact that the recommendation spent nearly two more pages explaining why they feel credit ratings are irrelevant, incompetant or dishonest, I request you to investigate why such blatantly incorrect wording was placed in the public release. It does not deem good on the reputation of esteemed people such as yourselves or on the PFRDA itself which will manage the money of a number of citizens, to have made or ignored such a glaring error.

Secondly, and most importantly, Sirs: Why are we requiring ratings at all in the “C” group? Rating agencies have lied, have corroborated with issuers, have been lazy or incompetent, and have been non transparent. Why should we trust what they say, for our long term savings? Please also make it cheaper for our corporates and our municipalities to issue bonds – after all, if they should get it rated, they must pay heavy fees to the rating agencies – and for ratings which are largely irrelevant. Again, if we ever get to the global concepts of bond insurance, we will go down the US route as it has with AIG, which built upon the bubble created by incompetently rated bonds.

I request you to please remove any rating requirements. Please help make our pensions safer by allowing our managers to ignore incorrect opinion. We will otherwise have to suffer in our old age, due to the gross incompetence, negligence and dishonestly that we have already seen in the US pensions where ratings were required. Please, sir, keep our children’s futures bright. Please make ratings irrelevant. They are only an opinion, after all.

  • Siddharth says:

    >Deepak, Thanks a lot for putting this very important issue afront.
    Aye Aye Captain, I am with you on this.

    regards.

  • Siddharth says:

    >Deepak,
    On the contrary, I smell rat as usual in this decision making. A huge deal of future and elections up. If rating agencies are at stake they will go down the route of bribes/political influence.

    Rationaly it should be decided for GOOD of the People investing and not otherwise for instant gains in swiss accounts.

    mazhe don paise!

  • Technovestor says:

    >’ghoom phir ke ham waapas wahin aa gaye hain’- meaning ‘we are back to square one’ !! it really looked like for once these guys are going to wake up and take some recommendations of the expert group seriously, why t f do we need a rating when so much of crass is going on around us..

  • Arkad says:

    >Deepak,

    Great, am with you on this.

  • Anonymous says:

    >So the common man gets screwed again! While rating agencies make sure they keep collecting fees for doing a terrible job! But we all know that. My question is how do we make sure it doesn’t happen again? Deepak how can we make our voices heard?

    Mark

  • Anonymous says:

    >Deepak

    I dont think you understand what the recommendation of the committee was. The committee at no stage is recommending that credit rating should not be done or looked into. It is stating that in case of listed companies let the decision be based not just on credit rating bu also on other variables.

    The objective is knowing that credit rating agencies cannot move as fast the market in their rating updates the committee is recommending that the fund manager uses other sources of data coupled with the credit rating to base his decision. It is not saying that credit rating is stupid or rating agencies are stupid. It is recognising that in a real world rating has its shortcomings so dont base ur decision soley on that

    By your logic since PWC mucked up and were incompetent in their audit of Satyam why dont we stop the process of auditing for all companies.

    It is easy to throw out a system without suggesting the alternative or understanding the implications of ur action.

    U r saying that in case of pension money which is long term money the fund manager on his discretion can lend money to any company he choses to whether it is a real estate company or a company that is defaulting based on his discretion.How does the trustee of the fund know the fund manager is screwing up. Or are u suggesting that they also independently investigate and analyse each balance sheet and ratify the transaction of the fund manager.

    Rating agencies are not perfect but they have their value.

    Lets stop all audits and each of us go thru every balance sheet and analyse whether the management is speaking the truth.

    PS: I dont work for a rating agency or have anything to do with them.

  • Deepak Shenoy says:

    >Siddharth, Technovestor, Arkad, Anon1: Thanks for your support. I’m not sure how we can do things better but I hope we can do something by expressing our opinion.

    Anon2: I think I did understand – the recommendation was that rating wasn’t a “required” bit – that fund manager could choose to ignore the rating altogether. This is not so as per PFRDAs RFC which says that a minimum of investment grade is required. That is the problem.

    If there is a minimum rating, PF managers will choose only those that are rated, giving rise to the nexus between issuers and rating agencies (as has happened in the US), where stuff like muni bonds are rated lower than corp bonds just because the muni bond insurers pay the rating agencies a lot more.

    Apart from that we all know that AAA barely meant that, so we have to go down the route of analysing every instrument anyhow (rating has near-zero link with the current situation). So why make rating important at all? Rating should be irrelevant to decision making as a rule – if people choose to take it, let them, but don’t make it mandatory.

    A PF Manager should be able to buy unrated instruments, or decide that a lower rated instrument is because of total incompetance of the rating agencies. I really do not want to hear that my pensions depend on the rating of an incompentent rater.

    Btw, Auditors do not provide an opinion. If auditors say everything is ok, do we believe it? C’mon. Even before the PWC/Satyam scandal we would go through financials with a fine toothed comb – that was how the ENron fiasco was revealed! Audits therefore are not “required” for investment decisions; they are required for something else entirely (which is ok, I don’t care)

    I don’t want to stop rating. I just want to make them non-mandatory. Just like audits are non-mandatory for investment decisions – we all go a lot by “unaudited” results announced by companies no?

    SO leave rating just like audits. If the PF managers want,they can look at it.Otherwise, it’s not essential.

  • Anonymous says:

    >Deepak

    To quote you "I really do not want to hear that my pensions depend on the rating of an incompentent rater."

    And how do u judge the competency of the fund manager or know that the fund manager is not incompetent. You are suggesting that bond issuers and rating agencies have a nexus ( which could be true) but what prevents the fund manager from having a nexus with the bond issuer. Dont you think the probability of a entire organisation being corrupt is less than the probability of the fund manager being corrupt. That S& P & Moodys would worry more about their reputation than a fund manager.

    I would suspect that the fund manager has a greater incentive to have a nexus with the bond issuer when he is unregulated and cannot be questionned the basis of his investment decision. I would rather go with a fund manager who is bound to go for a rated instrument ( however faulty it is) as opposed to one who will take his decision based on whim and fancies. I agree there are flaws in the current system but what u r suggesting is no system at all.

    Incidentally the fund manager is not bound to invest in all AAA rated instruments. He can chose which instruments he would want to invest in if he is sceptical about the ability of the rating agency in analsysing a company and his personal take is that the credit rating of that organsiation is lower.

    Also on audits.

    What other reasons are audits required for if I may understand?

    How do u go thru financials with a fine toothed comb when the document that u have been presented to look into which is the balance sheet has been provided by the auditor or are u suggesting that we go to every company and examine their books of accounts and prepare our own balance sheets and profit and loss accounts.

  • Deepak Shenoy says:

    >Anon: Good questions, let me take them one by one.

    1) How do you judge the competence of a fund manager (remember this is not a person, it’s a company)? You always have to go by the judgement rules – experience, past money managed etc. It doesn’t matter in the rating discussion: you have to go with the fund manager ANYWAY.

    2) What prevents a fund manager/bond issuer nexus versus a rater/bond issuer nexus? Firstly, the bond-issuer rater nexus is happening, is well known and is currently being abused. In fact it was even more abused in the past – think Enron, the junk bond scandals and AAA rated subprime crap. Therefore tehre is a good known and very prevelant precedent which we should stop – and to do that doesn’t mean stopping rating agencies, it means stopping the making of their opinion mandatory. Anyone can choose to be stupid of course.

    Secondly, fund managers are answerable to the pension owners, who will eventually be able to change managers too. Raters are accountable to NO ONE. I repeat, they are not accountable. Period.

    3) who has incentives to game the system: Believe me, raters have far more incentive simply because they do not have to stand behind or justify their results. Do you see rating agencies pay back fees after their AAA rated bonds defaulted WHILE THEY WERE STILL RATED AAA?

    4) What I am suggesting is no system at all? All I’m saying is: Don’t make rating mandatory. ANd thankfully they aren’t so for government bonds, or for state govt. bonds, muni bonds and PSU bonds. It’s only needed (investment grade) for corp bonds and bank/NBFC debt – which again I don’t agree with.

    DO you know if there’s any rating standard? There isn’t. Each rater has his own special guidelines which arent’ even standard across customers – for instance if you were to rate countries and municpalities with the same standards as corporates, you would find a lot of the former being AAA. Okay, Lehman and GE as AAA and India as junk? C’mon. I don’t want these idiots dictating my pension investments – after all, if they think India is junk and GE Is AAA, I would rather my pension fund invest in what they call junk.

    You are wrong where you say the PF manager can invest where the credit rating is low – the PF manager has to go only with “investment grade” (which means different things). If the PF manager has the ability to invest where he sees value, we are on the same page, no need for argument.

    4) Coming to Audits: Here’s the 101. Auditors are representatives of the government. Audits are government requirements to see that companies follow the laws. They are not investment requirements. No company is required to publish audited quarterly results, yet people invest on that basis?

    And you say people don’t go through accounts themselves? OF course they do! That’s how preferential investments happen. That’s what the funda is of an annual general meeting – all of us can go through the books.

    Can you even question a rating agency as to how it arrived at a rating? No. They are not obliged to reveal how. They are not accountable. They don’t have to pay for their sins. They can hide behind the phrase “free speech” but can still rake in big fees because pension funds are mandated to only invest where they rate highly. No downside only upside. I say, screw that. Make it non-mandatory. That’s not even a punishment. It’s a better playing field. Make the rating agencies irrelevant.

  • Deepak Shenoy says:

    >One thing I want to change: Auditors are licensed by the government to audit the company’s books on behalf of the government AND the shareholders. They are supposed to be an independent verification of what the company states in its accounts, for shareholders and the Ministry of Company Affairs.