The brouhaha over the HDFC vote

The recent shareholder vote on HDFC and Uday Kotak’s comments on regulating ‘proxy firms’ have brought focus on this nascent industry. This Institutional EYE looks at the contours of the business, why the Indian firms should be called voting advisory firms – and not proxy firms and highlights the implication of governance standards transcending geography, industry and ownership structures.

Last month, in related but contrasting developments, foreign institutional investors jostled to put money - lots of it, into two HDFC group companies - its asset management business and the bank, while at the same time they almost succeeded in voting out its chairman – the very person on whose shoulders these institutions have been built. The vote was explained away as being on the advice given by two global proxy advisory firms but it did amplify a risk that Uday Kotak underlined a few months ago, when he rhetorically asked and answered “Who controls the so called diversified foreign ownership? It is two proxy advisors.”

Proxy firms cast the vote at shareholders meeting, on behalf of the investors i.e. they hold the proxy for shareholders, hence proxy firm. The proxy voting firms are a relatively new addition in the investors support system. They are said to have their origins in the US with the passage of the Employee Retirement Income Securities Act 1974, which among others, required the funds to vote at shareholder meetings. Today, two firms dominate the global sphere: ISS, the oldest started in 1985 and first offered voting services in 1992 and Glass Lewis which was established in 2003. Institutional Investors Advisory Services India Limited (IiAS), India’s first [disclosure: I am the founder and managing director] was incorporated in June 2010 around the time SEBI let slip a section on Corporate Governance in a non-descript circular to mutual funds in March 2010 saying that ‘…. funds should play an active role in ensuring better corporate governance of listed companies.’ SEBI then went on to ask the funds to formulate policies regarding how they will vote and disclose how each fund has voted. But unlike in the US, where the firms hold the proxy vote, in India, the firms give non-binding voting advise to funds: Indian firms are better described as voting advisory firms and not proxy firms.

A few factors explain the contrasting behaviour of funds seen in HDFC. These include the size, geographical spread and complexity of the fund management business. An investment – say in HDFC, may be owned by different funds within the same global fund-house: by an India fund operating out of Singapore, in an Asian fund out of London, an emerging market fund in Boston, one of more index funds in New York. The holdings all merge at the back-end. Consequently, it is not the various fund managers, but the ‘governance’ or ‘stewardship’ teams that are responsible for engagement and voting. This is true mainly for the larger investments or where a VW like crisis occurs. For the remainder investments, funds are happy to leave it completely or substantially to the opinion of proxy firms.

The other is the investors ‘business model.’ While we use institutional investor as shorthand to characterize all professional money managers, they all have different time frames, different objectives and different fees structures. Private equity takes a seat on the board and is hands on, while a hedge fund may have taken a positional call. Take index funds, a growing category. Given the low fee structure, they generally prefer to outsource the voting. Larry Fink, Blackrock’s boss recognized that the best way to mitigate the risk of being the ultimate long-term investor in a company is by focusing on its governance. But they too, concentrate on their larger investments.

Needless to add, not all investors are structured in manner described above and many have their investment and governance/stewardship teams working in sync – a lot closer to the way Indian investors are organized. And, everything that matters in other markets, need not necessarily matter in ours.

The US and UK based investors all frown on director over-boarding i.e. number of boards a director sits on, the issue on which Deepak Parekh found himself across the aisle from some investors. As companies have no controlling shareholder or promoter, the non-executive directors are expected to guide and challenge the executive management. Understandably, the time commitment expected from board members is high. In contrast the expectations of Indian investors are very different. Given that an overwhelming number of companies have promoters driving businesses, Indian investors view independent directors as those who arbitrate between the ‘promoters’ interest and that of the public shareholders. Consequently, the domestic investors have far different expectations regarding their time commitment and number of boards a director sits on.

This owner-manager structure prevalent in India, has other characteristics, yet regulation has evolved to conform to codes stemming from the Cadbury Committee. Sure, India has introduced mandatory auditor rotation, and mandatory women directors on boards, but we have not gone far enough in recognizing other local idiosyncrasies like the ‘promoters’ who are on the leash for defaults including business failure or putting in place an information sharing framework, as was proposed by the Kotak Committee.

Will having a local regulated voting advisory industry take cognisance of the Indian sensibilities? Haven’t rating agencies gone down this path? It’s true that rating agencies have India-centric models, but the agencies achieved this by recalibrating their rating scales. So yes, having domestically regulated voting firms may make them more sensitive to local practices, but it’s unlikely that their voting policies will change.

Importantly, for the rating agencies, the money raised on the back of their ratings, is locally in rupees – making it far easier for the agencies to tweak their rating policies. In contrast Indian businesses have a perennial need of foreign capital, and it is clear why foreign mores – and practices, will dominate. Remember, governance transcends geography, industry and ownership. Consequently, there is a convergence in governance standards across the globe. And if you cannot recalibrate governance, or change your voting policy, voting outcomes are not likely to change.

If we want more nuanced shareholder voting, we need to ensure that pools of capital and their money managers reside in India. This alone will ensure a win for the Indian economy, Indian markets, Indian industry and Indian managements.

PS: Given the concern the global proxy firms have on over boarding, it’s only fair to ask, wouldn’t it have been more sensible for them to have voted against Deepak Parekh re-appointment in any of the other six listed companies, rather than in HDFC?

A modified version of the above appeared in Business Standard on 14 August 2018. It is behind a paywall; subscribers to the newspaper can access it by clicking on this link or typing the following url:

https://www.business-standard.com/article/opinion/the-brouhaha-over-the-hdfc-vote-118081301387_1.html