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What next, Crisil?

By moving ahead, Crisil has now made it difficult for any other entity, including India Ratings, to plan inorganic growth through acquiring Care Ratings


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Rajesh Mokashi, managing director and chief executive officer of Care Ratings Ltd, will complete his first year in the new role later this month. He has a tough task ahead. Apart from expanding business and working hard for higher profits, Mokashi, who has been with the company since its inception in 1993, needs to keep the morale of his 800-odd colleagues high as many of them believe the company is under a takeover threat.

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Care Ratings is the second-largest credit rating agency in India in terms of rating revenue and it does not have any foreign affiliation. As of March 2017, it had at least 15,000 clients, and since inception it has rated around Rs92 trillion of debt.

In the last week of June, Crisil Ltd, a Standard and Poor's associate company, bought 2.62 million shares of Care Ratings or a 8.9% stake for Rs435.26 crore in a block deal from Canara Bank.

"The investment has been made pursuant to a bid process conducted by Canara Bank, subsequent to their request for quotation issued on June 19. This investment in the equity of Care Ratings has no special rights and is in compliance with applicable rules and regulations," Crisil said in a notice to BSE. The price of the share purchase was at a 10.65% premium to the Rs1,500 floor price set by Canara Bank.

Canara Bank had been one of the large founding shareholders of Care Ratings along with IDBI Bank Ltd and the erstwhile Unit Trust of India. Laden with bad assets and starved of capital, most public sector banks are under pressure to sell off their so-called non-core businesses and generate cash. When Care Ratings got listed in December 2012, its existing shareholders' stakes came down. Subsequently, in March 2015, IDBI Bank sold its 9.9% stake to Life Insurance Corp. of India (LIC) through a negotiated bulk deal and followed it up with selling residual shares in the market. Canara Bank followed a similar path. After selling off 8.2% stake to the highest bidder, it is left with 28,984 shares which roughly account for 0.1% of Care Ratings. After LIC, which holds 9.9% stake, Crisil is now the second-largest shareholder in Care Ratings, which does not have any defined promoter.

My understanding is Icra Ltd, a Moody's company in India, was keen to buy the IDBI Bank stake in 2015 and even earlier, but it did not succeed. While selling its shares, IDBI Bank had kept Care Ratings informed about the prospective bidders but Canara Bank has not done so (to be sure, it is not mandatory) and that has taken the Care Ratings management by surprise.

The Crisil note to the stock exchange says it "continuously evaluates investment options as a part of its corporate strategy" and this "stake purchase is an investment in the excellent longterm prospects of the credit-rating sector in the country." However, even a school kid will find it difficult to believe that India's largest rating company is picking up 8.9% stake in a rival company as an "investment" without any medium- or long-term plan.

So, what could be the behind-the-scene story?

Poison pill strategy?
I am not privy to any classified information but prima facie Crisil could be following the so-called poison-pill strategy-a tactic employed by companies to prevent or discourage takeover of a particular entity by others. It is done by making the shares of the target company unattractive or less desirable to the prospective acquirer. In vogue for decades now, the poison-pill strategy works in different ways. It can make the target company prohibitively expensive for an acquirer, or turn it unattractive with a rival company getting a toehold before the acquirer as that makes it difficult for the acquirer to gain control of it.

The three large rating agencies in India-Crisil, Care Ratings and Icra- roughly account for 85% of the rating business in India. The rest is shared by India Ratings and Research Pvt. Ltd (a wholly-owned subsidiary of the Fitch Group); Brickwork Ratings India Pvt. Ltd (Canara Bank is its promoter and strategic partner) and Smera Ratings Ltd (owned by Small Industries Development Bank of India, Dun and Bradstreet Information Services India Pvt. Ltd and a clutch of banks), with the newest entrant in this business Infomerics Valuation and Rating Pvt. Ltd holding the smallest share, a few basis points.

Since both Crisil and Icra are foreign-owned, and India Ratings has been trying hard to get a decent share of the market, it is logical that at some point, India Ratings, backed by the Fitch Group, would look for an inorganic growth and Care Ratings gives it the right opportunity. By moving ahead, Crisil has now made it difficult for any other entity, including India Ratings, to plan inorganic growth through acquiring Care Ratings.

Looking for acquisition?
The other option could be, ultimately, Crisil will move towards acquiring a controlling stake in Care Ratings. This will help Crisil grow its rating business exponentially. Currently, rating business accounts for less than one-third of Crisil's revenue; its main source of revenue is research and advisory services. Between its own rating business and that of Care Ratings, it could be as much as 65% of the market and this will grow handsomely with Indian corporate bond market gaining depth and banks chasing the small and medium enterprises in a big way to lend money (rating of loans is mandatory now).

I do not know whether any investment banker advised Crisil on its buying Canara Bank's stake. Typically, when a company acquires a stake in another company to prevent competition from gaining control over it, or if the company itself is planning a takeover bid, it goes for warehousing-a procedure whereby a comoffered pany gradually builds up a holding of shares in a firm it wishes to take over in the future. Interestingly, between 10 March and 23 June (a week before the deal happened) a Reserve Bank of Indiaregistered non deposit-taking, non-banking financial company Infina Finance Pvt. Ltd kept on buying Care Ratings shares from the market. In the process, its holding of Care Ratings rose from 670 shares as on 3 March to 301,020 shares or 1.02% by 23 June.

A 28 June Crisil note (on Infina's Rs8,000 crore commercial paper issue) describes Infina as a Kotak group associate which derives strength "from the group's expertise, and systems and processes". Kotak Mahindra Capital Co. Ltd, Komaf Financial Services Ltd and Kotak Trustee Co. Pvt. Ltd are its shareholders.

Foreign raters hijacking Indian market?
Since S&P holds 67.05% in Crisil and Moody's owns 50.54% in Icra, Care Ratings has always been considered a home-bred entity; naturally in certain quarters Crisil's acquisition is being seen as foreign raters' plan to hijack the Indian market. Incidentally, not too happy with S&P and Moody's dominance in the global rating space, five-nation group BRICS has been planning to set up an independent rating agency based on market-oriented principles to "strengthen global governance architecture". "We agreed to fast-track the setting up of a BRICS Rating agency," India's Prime Minister Narendra Modi had said at the BRICS Summit, in October 2016.

Under the banking laws, one bank is not allowed to buy more than 10% in another bank; similarly regulations of the Securities and Exchange Board of India (Sebi) prohibits a registered merchant banker to set up another merchant bank through itself or its associates, but no such restrictions are there for rating agencies. However, if Crisil moves ahead and ramps up its stake beyond 10%, will it be "unfair competition"-something which the code of conduct of the credit rating agencies, laid down by the market regulator, does not allow?

Incidentally, Article 6a of the regulations of the European Securities Markets Authority or ESMA for the European Union prohibits any shareholder holding over 5% in a rating agency to hold 5% shares or voting rights in any other rating agency directly or indirectly except in those cases where the agencies belong to the same group.

Even if Crisil stops at holding 10% in Care Ratings, it will be successful in preventing a rival agency from eyeing Care Ratings as under the Companies Act, 2013, a shareholder holding 10% or more of a company assumes the status of a "minority" shareholder, and can have certain statutory rights and protections. What are these rights? Under Section 100 of the Act, shareholder(s) holding 10% or more of the paid-up capital of a company has the right to call for an extra-ordinary meeting of the shareholders of the company.

Under Section 230 of the Act, a shareholder holding 10% or more of the paid-up capital of a company has the right to object to any scheme of compromise or arrangement proposed by the company.

Under Section 241 (read with section 244) of the Act, a shareholder holding at least 10% of the paid-up capital of a company may make an application to the National Company Law Tribunal (NCLT) for an action against oppression and/or mismanagement by a company and/or majority shareholders.

Finally, under Section 245 of the Act, shareholder(s) of a company holding a certain percentage of its share capital, may make an application to the NCLT for seeking certain remedies against the company, its directors, auditors, etc., for certain actions taken by the company/directors/auditors which are against the interests of the company/shareholders. The rules relating to Section 245 are yet to be notified but the shareholding percentage threshold for enabling a shareholder to claim remedies under this section is prescribed as 10%.

Indeed, these rights are a tool to protect minority interests in a company but if they are available to a shareholder who is also the firm's largest competitor, it could be open to potential misuse.

If Crisil is serious, it will not stop at acquiring 10%. If it moves ahead and along with others-the so-called persons acting in concert-acquire shares and voting rights of 25% or more in Care Ratings, it will have to make an open offer under the Sebi takeover norms. Crisil's investments and cash position as per consolidated accounts as on 30 June, 2017 is Rs587.48 crore. If we exclude its investment in Care Ratings, Crisil is left with surplus cash of Rs152 crore. Naturally, S&P would need to bring in the money; or, they could follow the share-swap route.

Current Sebi norms do not prevent Crisil from buying a 10% stake in Care Ratings or even acquiring a majority stake. Sebi guidelines for granting registration to a rating company says it should be promoted by a public financial institution, a scheduled commercial bank, a foreign bank operating in India and, a foreign credit rating agency with at least five years experience in rating securities and any company having continuous net worth of Rs100 crore for the previous five years. Going by Section 25 of Sebi's credit rating agency regulations, a "promoter" is one which holds 10% or more in a rating agency and the agency cannot rate any security issued by its promoter.

The Competition Commission of India (CCI) norms also do not come in the way of Crisil acquiring Care Ratings. Acquisitions where enterprises whose control, shares, voting rights or assets are being acquired (the target enterprise), have assets of not more than Rs350 crore in India or turnover of not more than Rs1,000 crore in India, are exempt from filing a notice for such acquisitions with CCI up to 3 March 2021. However, the exemption is applicable only to acquisitions and not to mergers or amalgamations. As of March 2017, Care Ratings' total assets were about Rs553 crore and total income Rs313 crore, as per consolidated accounts.

Should we have more raters?
Indeed, Crisil would not face any regulatory hurdles if it wants to gobble up Care Ratings but the nature of the business raises a few questions. Should one or two rating agencies have a disproportionately high market share? Shouldn't we have different raters doing the health check of Indian corporations, particularly when the bond market is getting deeper and wider? Isn't competition key to the success of a healthy rating market where the corporations and the users-those who subscribe to bonds based on ratings-have multiple choices?

Going by the December 2016 annual reports of nationally recognized statistical rating organizations (NRSRO) in the US, S&P, Moody's and Fitch collectively have 93.2% share of the market. In the aftermath of the global financial crisis, the US Securities and Exchange Commission (SEC) has been pushing for increasing competition in the credit rating business; it has even brought down the entry barrier by removing the three-year track record which was a necessary precondition for the NRSRO status. Since September 2007, at least 10 rating agencies have been granted registrations as NRSROs and no application seeking registration has been pending with the SEC.

On the day Crisil struck the deal, shares of Care Ratings surged 16.8%-its maximum gain since its listing day in December 2012. It may continue to rise if it is indeed a target company. Reacting to Crisil acquiring Canara Bank's stake in Care Ratings, Mokashi had said he would like his company to remain independent. We will wait and watch how the scene unfolds.

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