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Credit Rating Agencies: Need for a shift away from the "Issuer Pays Model"

Written by Sandhra S.

Fourth Year, BA. LLB. The National University of Advanced Legal Studies (NUALS), Kochi

Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.



A credit rating agency means a body corporate which is engaged in or proposes to be engaged in, the business of rating of securities offered by way of public issue or rights issue.[1] Credit rating agencies are governed in India by Securities and Exchange Board of India Act, 1992; and SEBI (Credit Rating Agencies) Regulations, 1999. Apart from that, the Reserve Bank of India also plays an important role in the regulation of rating agencies.

The process of credit rating involves the assessment of the credit risk of the borrowing company. A credit rating is done in order to give an indication of the credit-worthiness of the borrowers and to ensure the prospective investors that the principal and interest would be paid by the issuer in a timely manner.

Rating, according to the SEBI (Credit Rating Agencies) Regulations, 1999 means: “an opinion regarding securities, expressed in the form of standard symbols or in any other standardized manner, assigned by a credit rating agency and used by the issuer of such securities, to comply with a requirement specified by these regulations.”[2]

The agency assigned with the task of rating the securities would make an analysis of the company’s past lending and borrowing transactions; as well as the statement of assets and liabilities, and reach a conclusion with regard to its repayment capacity.

Credit ratings act as a source of reliable information for current and prospective investors, as well as for other users like merchant bankers, underwriters, etc., indicating the soundness of the company and the strength of the instrument that is rated by the rating agency. The instruments rated in this manner will thereby help the investors in making an informed decision on whether or not to invest in the company. The ratings given to securities by the rating agencies are usually represented as AAA, AAB, Ba3, CCC, etc. up to D. The highest among the rating is 'AAA', and it is given to the borrower who has more probability of paying back the credit.

Keywords: Credit rating; SEBI; Issuer

Issuer pays model

One of the models of credit rating accepted in many parts of the world; and especially in India is the 'issuer pays model'. According to this model, issuers of securities choose their own credit rating agencies. In this model, the issuer assigns a particular credit rating agency to rate their securities. Further, an agreement is entered upon between the issuer and the credit rating agency which specifies the fee to be paid by the issuer to the rating agency. [3] After the rating is done by the rating committee, it is disseminated to the public through printed reports.

India follows the issuer pays model for rating processes. In this essay, the author analyzes the defects and the allied issues within this model, and the necessity to shift away from the status quo. The analysis would be done on the basis of some of the existing issues associated with this model along with recent case law. Further, the author proposes other alternative models that could be implemented in place of the existing issuer pays model.

Quality of rating and conflict of interest

One of the main drawbacks of this model is that a true and fair rating cannot be obtained. Since the investor himself pays for the service; the rating agencies serve the interests of the investors by rating the securities according to their needs. Because of this practice, more often, the actual ratings are never disclosed, and it proves detrimental to the investors who have no other option but to believe in this rating. It is very obvious that in this kind of a compensation structure, the ratings would be aligned to provide a relatively favorable rating to the issuer.

Hence, there would be an obvious doubt regarding the linkage between payments made to the rating agency and the subsequent ratings given by them. Issuers tend to stick on to a rating agency that fairly rates them. The case of IL & FS [4] is worth mentioning in this respect. This further, leads to the issue of rating shopping.

Rating shopping

In the ‘issuer pays’ model of rating, the issuer gets to choose their desired rating agencies. This means that, if in any case, the issuer is not satisfied with the ratings given, they are free to approach different credit rating agencies, and the process goes on. After one agency completes their rating process, it up to the issuer to decide whether or not to stick on to this rating or go about for other favorable ratings. This is one of the main shortfalls of this methodology, which is known as rating shopping. It is a situation where an issuer approaches different rating agencies for preliminary ratings and then chooses to publish the most favoUrable ratings to disclose it to the public via media while concealing the lower ratings. Since there are other rating agencies as well, the issuer is at liberty to choose any one of their choices. It is to be noted that the issuer can negotiate not only for lower prices but also for higher rates. [5] Hence, ratings are easily manipulative in this kind of model.

One important case in this regard is that of the IL & FS crisis. [6] Infrastructure Leasing & Financial Services (IL&FS) is a Core Investment Company with the Reserve Bank of India and is engaged in the business of giving loans and advances to its group companies (and holding an investment in such companies). It failed continuously to service its debt and the imminent possibility of a contagion effect in the financial market led the Central Government to move an application under Sections 241 and 242 of the Companies Act, 2013 before the NCLT, Mumbai Bench. Credit rating agencies ignored the rising debt levels at the IL&FS group while assessing its creditworthiness. The point to be noted here is that, even when the company was unable to pay its debts, credit rating agencies like ICRA, CARE, and India Ratings had given its debt papers AAA/AA+ ratings. Subsequently, SEBI had to intervene in the matter and penalize these rating agencies with Rs. 25 lakh each for lapses in their duty to investors by not taking timely action.

Rotation mechanism

The rotation mechanism is one of the mechanisms which can be adopted to overcome the shortcomings associated with the issuer pays model. In 2009, the European Union came up with this mechanism. According to the Council Regulation, rotation of rating agencies is required to be undertaken and lead rating analysts cannot be involved in credit rating activities related to the same rated entity or a related third party for a period exceeding four years. Thereafter, a cooling-off period of 2 years is also mandated. [7]

In India, the introduction of rotation mechanism was put forth by the Standing Committee in its 72nd Report [8] wherein they stated that mandatory rotation of credit rating agencies may be implemented in order to have more vibrant functioning of domestic capital and money markets and enhancing credibility in the credit rating industry. The implementation of this mechanism will per se have many benefits for the investors. It can help in minimizing, or rather avoiding rating failures and thereby maintain stability in the financial system of the country. Further, rotation is likely to bring more accountability among the Credit Rating Agencies as they will be wary of committing negligence.

Way forward

The issuer pays model which is in practice has inbuilt shortfalls which SEBI proposes to rectify. According to SEBI, [9] this model shall be replaced by another model. One model which is kept under consideration is that of the investor pays model. The functioning of this model, briefly described, would mean one, where the issuer submits a draft prospectus with the stock exchanges, and the credit rating agencies make ratings for the same. Those investors who wish to see the ratings will have to make payments for the same through an exchange platform. By adopting this mechanism, the defects with the previous model such as issuer bias can be done away with and credit ratings shall become more transparent. When compared to the issuer pays model, the determination of rating by resorting to the investor pays model is deemed to be far more accurate and reliable. This is because, when an issuer intending to offer securities to the public is at a loss of rating, such a company will be duty-bound to obtain a fair rating by paying higher amounts to rating agencies. [10] On the other hand, in the case of the investor pays model, the issuer does not have an option to purchase, or rather ‘shop’ for their desired ratings. Hence, such ratings would reflect the true and fair credit-worthiness of the issuing company.

Though a far-fledged option, another alternative to the issuer pays model could be that of the ‘Government or Regulator’ pays model. In this model, the Government should choose the credit rating agency which is to rate the instrument and would pay for the rating.

This method could be adopted so that a far better rating could be obtained as the rating agencies are left with no incentives as compared to the issuer pays model. How far it is possible to be implemented has to be looked upon by the Regulators. Lastly, another option available is that of the 'exchange pays model.' Under this model, the exchanges pay for the ratings and recover the cost through an additional trading fee. The major advantage of this model is that the investors would be paying for the rating thereby eliminating the conflict of interest inherent in the ‘issuer pays model’. At the same time, the rating agencies would not be influenced either by the rated company or the investors.

Moreover, implementing the rotation mechanism will also be helpful, as long term association between the issuer and the credit rating agencies would again result in the same issues as mentioned above. Further, considering the recent instances of failure of credit rating agencies in predicting the problems with their client entities, such kind of reformation is the need of the hour.

Conclusion and Recommendations

The main objective behind rating by credit rating agencies is to have high-quality ratings and to make such ratings available to all. If these two requirements are to be met with, neither of the two models of ‘investor pays’ or ‘government pays’ would work out in totality.

In this situation, it would be ideal to bring about a mechanism wherein the investors pay for requiring detailed reports of the ratings and at the same time, the government intervenes and makes a concise form of the ratings available to the general public.

In this manner, the above-stated shortfalls in credit rating, such as a conflict of interest as well as rating-shopping can be done away with. The Standing Committee on Finance, in its 72nd Report, has also made a remark to reconsider the issuer pays mechanism and to shift to the investor pays model or the government pays model. However, a decision with regard to such kind of shift has to be taken by SEBI after consulting with the Reserve Bank of India as well as the Credit Rating Agencies.


[1] S.2(h), Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

[2] S.2(q), Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

[3] S.14(b), Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

[4] Union of India, Ministry of Corporate Affairs v. Infrastructure Leasing & Financial Services Ltd, MA 1173/2018 in C.P No. 3638 (MB)/2018.

[5] Who should be paying for the credit rating of bonds?, (May 13, 2020, 12:33 AM),

[6] Union of India, Ministry of Corporate Affairs v. Infrastructure Leasing & Financial Services Ltd, MA 1173/2018 in C.P No. 3638 (MB)/2018.

[7] Article 7, Council Regulation 1060/2009 of 16 September 2009 on credit rating agencies [2009] OJ L302/1.


[9] Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, Ministry of Finance, Capital Markets Division, 2009.

[10] Anil K Kashyap & Natalia Kovrijnykh, Who Should Pay for Credit Ratings and How? (2015).

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