Pakistan Credit Securities and ExchangePakistan Credit Rating Agency 

Securities and Exchange Commission of Pakistan 

1Tuesday, September 6, 2011

Regulators…IN ACTIONRegulators…IN ACTION

CRAs, …… , play a critical “gatekeeper” role in the debt market…because of (their) systemic importance and the l l d ( h ) hreliance placed on (their ratings), ….the 

activities and performance of CRAs … , are matters of national public interest , as CRAs are central to capital formation, pinvestor confidence, and the efficient performance…of the…economy” 

US Congress (Dodd‐Frank Wall Street Reform and Consumer Protection Act, January 5, 2010)

2

A New Paradigm…

Dodd Frank

Integrity Skill SetClean Bill of Health…But need improvement

Good….BUT Needs to be Better….

Dodd Frank Act DRIVEN

AccountabilityFocus onEnhanced  Focus on 

transparencyRegulatory Oversight

A NEW PARADIGM….in the makingRegulatory Oversight CRA Initiatives

CRA Business Model • Separation of ratings from non rating advisory functionsCRA Business Model • Separation of ratings from non‐rating advisory functions• Separation of business solicitation and execution 

Governance Structure • Independent directors of the board

Q lit f R ti P A l it i iQuality of Rating Process • Annual criteria review • Training of credit analysts

• Exception recommended where CRA’s size is small 3

Region – An Overview Soveraign Ratings [S&P]

BBB

BBB-

BB+

BB

BBB

BBB-

BB

BB+India

B-

B

BB-

BB

BB-

B

B-

BB

B+ B+

P ki t

Bangladesh

CCC CCC

20102006 2007 2008 2009

Pakistan

Region – NUMBERS SPEAK

N b 2010 2008 2000 2007USA

Numbers 2010 – 2008 2000 – 2007

GDP Growth (Average) 0.4% ~ 3.5%

PakistanGDP Growth (Average) 3.0% 5.5%

NPLs (2010) 14.0% 7.0%

IndiaGDP Growth (%) 8.0% 7.0%

NPLs (%) 2.7% 7.0%

BangladeshGDP Growth (%) 6.0% 5.5%

NPLs (%) 7.9% > 15%4

India – A Proactive regulatory regime for CRAsCRAs 

• ROBUST ECONOMY ‐ RATINGS STILL have to face the test of economic distress…..• Significant penetration (CRISIL from less than 1,000 to above 11,000 ratings)• An MoF‐led commission (Dr. K.P. Krishnan Report ‐ Dec 21’09) comprising all stakeholders 

KEY Commission Findings – CLEAN BILL OF HEALTH FOR INDIAN CRAs

Area under focus Recommendation

(SEBI, RBI, Industry bodies) sat & deliberated Upon the CRAs…..

Area under focus Recommendation

Regulatory Oversight SEBI  (to be the lead regulator) + Standing Committee (having other regulators as members)

Transparency Disclosure of Fee in greater detailTransparency Disclosure of Fee in greater detail

Conflict of Interest Separation of ratings from other CRA businesses

Quality of Rating Process Process & Compliance audits (bi‐annual)Compliance with IOSCO

US CRA regulations in 2007

India – CRA regulations in  trast…

. 

US – CRA regulations in 2007EU – still in process

place in 1999 –Updated 2010

In Con

t

5

Bangladesh – Emphasis on high‐li l i l iquality legislation

• Limited penetration of• The Youngest in the Limited penetration of Ratings…Expected to grow rapidly 

The Youngest in the Regional Ratings Industry 

•Comprehensive regulations & undertakings

• Enhanced Disclosures

Mandatory Ratings

CRA Ratings for 

regulatory 

Robust Regulatory Framework

ALL IPOs issued @ premium

Unrated Exposure penalized 

purposes

•Regulator driven (SECB + BB) 

business volumes

•Regulatory Curbs on Rating 

Shopping

Unrated RW”  125%

• All Asset Backed  Securities (ABS)

• All Financial Institutions (inInstitutions (in case of an IPO)

6

Pakistan – The CRA Default ExperiencePakistan  The CRA Default Experience

WHAT made CRA Ratings Falter• Poor Economy

CRA F ll i C di Q liReal GDP Growth (%)

2008 –2011

2004 –2007

< 2.5% 7.25%

CRA – Fall in Credit QualityCRAs 2011 2010 2009 2008 & 

BeforeTOTAL

PACRA &

• Stock Market Crash & Closurei idi h i k

Pakistan Economic SurveyPACRA & JCR‐VIS 8 6 1 2 17

• Liquidity crunch in money market• Crumbling Law & Order 

7

PACRA - SNAPSHOTFirst & Largest Credit Rating Agency of PakistanFirst & Largest Credit Rating Agency of Pakistan

Established in 1994 as JV between IFC, Fitch Ratings and Lahore Stock Exchange.

Ab 1050 ti i i i i tiAbove 1050 rating opinions since inception.

Technical partner for NCR-Bangladesh (National Credit Ratings Limited).

Founding member of ACRAA (Association of Credit Rating Agencies in Asia).g ( g g )

Drafted NBFI’s regulatory and framework for Bangladesh – World Bank assessment

Participate actively in finance related forums – Staff College, LUMS etc.

International Rating for Fitch.

Market share 54% with over 60% share of Corporate and Debt Instruments.

P d t PACRA JCR T t lProducts PACRA JCR Total

Financial Institutions 65 91 156

Corporates 44 29 73

Mutual Funds 62 47 109

Debt Instruments 61 30 91 Ratings penetration: LowDebt Instruments 61 30 91

Total 232 197 429

Ratings penetration: LowCorporates: Very Low

* Note the small size. FIR # 58 not included. 8

1. Organizational Structure

CreditabilityManaging Director

RC (5 members)

2. Staffing

Business ManagementCriteriaR & D2 Rating Teams

2. Staffing Core Team Composition and Expertise

Accountants 10 MBA/MSc 11 BScs 5

Quants• 2 CFAs

Policy Development• 3 dedicated members

• 4 Level-III candidates• 4 Level-II candidates

• Multiple policies developed

Banking Exposure• 2 professional bankers •+50 years cumulative experience • Credit, Risk, CFO, Ops

3. Pecuniary MattersEntity Category

Profitability Loan Size Asset Size Fees

Small <200 <2,000 <4,000 350‐400,000

Medium <500 <5,000 >10,000 400‐450,000

Large <1,000 <10,000 <20,000 400‐600,000

Extra Large >1,000 >10,000 >20,000 600‐750,000

Profitability, Loan size and Asset Size are in PKR mln and fees is in PKR only9

4. Rating Process

PROCESS

Creditability Cont.

Well populated RC

Analytical Team independent of RC

Enhanced documentation

Independent Criteria & Research 

Rating Programs

Compliance Audits

Internal Code of Conduct

Compliance Audits

10

WHAT WE LOOK AT WHILE EVALUATING A CORPORATE RATING

Creditability Cont.

PACRA arrives at its ratings by evaluating the following factors:

1. Ownership & Governance - Owners credit history –businessacumen & financial strength. Governance structure –distinctionin roles - board oversight - processes to avoid conflict of interest.Transparency and accountability measures.

2 Sponsor Support Sponsors commitment is studied and classified as “Core” Strategic” or “Non2. Sponsor Support - Sponsors commitment is studied and classified as Core Strategic or NonStrategic Investment”. Here we look at the sponsors ability & willingness to provide support intimes of crisis.

3. Management Quality - Here we study the organizational structure, quality of management, itsbili d l i f ibili d ’ bili h istability, delegation of responsibility and management’s accountability mechanism.

4. Systems and Controls - It is constituent of policies & procedures, control mechanism,MIS (Reporting), technology infrastructure. A clue is taken to their appropriateness andeffectiveness.

5. Business Risk- Starting with factors such as current economy, sector performance, entitypositioning, diversification are studied. Then companies’ own strategy of performance isanalyzed.

6 Financial Risk Detailed analysis of company capital structure and cash flows is6. Financial Risk - Detailed analysis of company capital structure and cash flows isundertaken.

11

Conflict of Interest

Share holder No interference in the company’s affairs

Board Board – Independent 6 (o/o 7)Board Board Independent 6 (o/o 7)

Rating Committee RC – Independent No shareholder/BoD representationNo reporting to BoDWell Populated RCWell Populated RC

• 3 Apex members[ 2 independent of rating execution process, while 1 is in transition]

• Heads of Rating Teams (2)• Analyst/s

d f i i d• Heads of criteria and R & D (on invitation)

Standard Fee Structure Transparent – in Public domain

Single Business CompanySingle Business Company

12

Rating Shopping – Not prevalentRating Shopping Not prevalent

Year  Total Switch PACRA to JCR JCR to PACRA

Entity  Rating Action  Entity  Rating Action 

National Downgrade

FY2011 2

National Investment Trust

Downgrade (1Notch)

Escort Investment Bank 

Downgrade ‐Short Term (1Notch)

IGI FundsUpgrade (2Notches) Asia Insurance

Upgrade (1Notch)IGI Funds (2Notches) Asia Insurance (1Notch)

FY2010 3

House Building Finance Corp Maintain

National Fullerton Asset Mgnt Maintain

JS Investments (AMC)

Downgrade (1Notch) ‐ ‐

FY2009 2

Al‐Baraka Islamic Bank

Upgrade (1Notch) ‐ ‐

Dual Ratings  ‐ Current 

( No difference in rating opinion between two agencies)1Faysal Bank Limited2The Bank of KhyberFY2009 2

KASB FundsUpgrade(2 Notches) ‐ ‐

y3Askari General Insurance Company Limited4New Jubilee Insurance Company Limited5East West Insurance Company Limited6Pakistan Kuwait Investment Company (Pvt.) Ltd.7Al Baraka Bank (Pakistan) Limited8Tameer Microfinance Bank

13

TimelineTimelineTRANSITION TO DEFAULT

(PACRA Defaults)

Key Lifetime Ratings Prior to Default Rating DEFAULT

Entity / Issuers Initial Highest One year Last Financial Institutions

Network Leasing BBB BBB BBB BBB D Network Leasing

(Mar-00) (Mar-00) (Jan-06) (Jan-06 (Oct-06)

First Dawood Investment Bank Limited

BBB (May-98)

A+ (Mar-03)

BBB- (Feb-09)

BB (Nov-09)

D (Dec-09)

Industrial Corporates

D C t Li it dA A BB CC D

Restructured within 90 days

Dewan Cement Limited (Jul-06) (Jul-06) (Dec-08) (May-09) (Nov-09)

Maple Leaf Cement Factory Limited

A (Oct-07)

A (Oct-07)

A- (Dec-08)

BBB- (Dec-09)

D (Dec-09)

Shakarganj Mills Limited BBB+ (Feb 08)

BBB+ (Feb 08)

BBB+ (Feb 08)

BB- (Apr 08)

D (Nov 09)

Under Restructuring 

(Feb-08) (Feb-08) (Feb-08) (Apr-08) (Nov-09)

Pace (Pakistan) Limited A+ Jun-07

A+ Jun-07

A (May-10

A (Oct-10)

D (Mar-11)

Azgard Nine Limited A Apr-04

A+ Nov-08

A- (Mar-10)

BB+ (Jun-10)

D (Mar-11)

Under Restructuring Agritech Limited A+ Jun-07

A+ Jun-08

A- (Mar-10)

BB+ (Jun-10)

D (Mar-11)

14

15

Investor Confidence

R‐1 Make Rating Agencies strong Investor ConfidenceR 1  Make Rating Agencies strongR‐1.1 Strengthen oversight and regulationR‐1.2 Critical Size 

• Essential for structure

• Transparency• Conflict of Interest• Accountability

• Quality of people

R 2 Conflict of Interest

y• Regulatory Oversight

R‐2 Conflict of InterestR‐2.1  Curb “ratings shopping”R‐2.2  Transparent and equitable fee 

R‐3 Self‐regulationR‐3 1 Creation of ACRAA Pakistan ChapterR‐3.1 Creation of ACRAA Pakistan Chapter

16

Market DevelopmentThe Fundamental Cannon that must be pursued by markets that aspire to befair, transparent and affording low systemic risk is to ensure that corporatesand businesses desirous of accessing “pubic money” must disclose not onlytheir earnings but also their risk

Disparity in Returns…..??

A h i i b i d d f i l

R‐4 Protection of public interest ‐ Mandatory rating of:

PIBs14%

TAJ Co.

Authentication by independent professionalsEarrings: AuditorsRisk: CRAs

p y g fR‐4.1 New IPOsR‐4.2 Large cap companies (Asset size of over PKR 1bln)R‐4 3 Listed companies

15%

R 4.3 Listed companies

In a phased & progressive manner……

Nos. Company with asset size Within (month)120 > PKR 5,000 mln 18 months225 PKR 500 mln – 5,000 mln 24 months218 < 500 mln 36 months

563

Banks, NBFIs, Funds not included17

Market DevelopmentMarket DevelopmentR‐5 Bond Market expansion 

R 5 1 Put optionR‐5.1 Put optionR‐5.2 Stickiness with minimum “A” ratings

R‐6 Legislation in harmony with region 

India BangladeshIndia Bangladesh

Higher risk weight (150%)1and loan threshold level

Penalizing unrated exposure with higher risk weight (125%)

R‐7 Mutual Fund Ratings / Rankings 

1 Temporarily suspended by RBI as an economy‐stimulating measure.  However, expected to be re‐instituted anytime in the near future.  Applies to all corporate loans above INR 10mln 

18

Efficient EconomyEfficient Economy 

NewPACRA – One of the few knowledge organizations in P ki

Grants New Markets

Pakistan

PACRA – Ability to f

Referrals to OTHERtake up the role of a 

THINK TANKOTHER REGULATORS for developing the Ratings Business

Further expansion & development of CRITERIA; Sector Research

19

THE NEXT STEPTHE NEXT STEP….

20

Response – SEBI revised guidelines

Q lit fTransparency

• Greater detail

Quality of Rating Process

Transition Studies in

Conflict of Interest

• Code of Conduct

• Greater detail in methodology 

Studies in greater detail

• Nature of compensation 

• Record keeping

parrangements • Chinese Walls –

Rating solicitation & Production• Ownership 

structurestructure

In response to the COMMISSION FINDINGS & RECOMMENDATIONS….SEBI issued revised guidelines for CRAs ‐May 3, 2010 21