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Institutional EYE

Commentary on Corporate Governance Issues

One India, One Stewardship

Indian regulators - SEBI, PFRDA and IRDAI, have all mandated stewardship, and this is a welcome step. But in having each regulator requiring this, we have a fragmented stewardship. The regulators need to work together and have one stewardship code for India. Investors will welcome it.

India’s experience with stewardship first began in March 2010, when SEBI asked mutual funds to have a voting policy and to start voting. Having set the ball rolling Securities and Exchange Board (SEBI) held back and did not ask its regulated entities to unreservedly embrace stewardship. IRDA did so in March 2017 as did the PFRDA in May 2018. SEBI finally chose to show-up at the high table on Christmas-eve last December, when it asked mutual funds and all categories of Alternate Investment Funds to adopt a stewardship code.

What is stewardship?

A white paper by Blackrock describes’ stewardship as engagement with public companies to promote corporate governance practices that are consistent with encouraging long-term value creation for shareholders in the company. Engagement and voting provide shareholders an opportunity to express their views’. In short, governance for funds.

Why do we need investor stewardship?

After the 2008 financial crisis, a view that gained currency was that institutional investors had neglected their fiduciary duties, being far more focussed on their opaque NAV’s and impenetrable incentive structures. They were seen as very much being a part of the problem. What was needed was a more sceptical community of investors that was more active and engaged with their investee companies. Such contrafactual speculation, many believed, would have prevented a financial melt-down.

So, in 2010, the UK Financial Reporting Council (FRC) rolled out seven stewardship principles encouraging investors to have a greater say in governance of companies – through engagement with investee companies and voting in shareholder meetings. Although the 2010 was a comply-or-explain policy, investors were held accountable by getting them to disclose their voting and stewardship activities.

The code has since been imitated across the globe, including in India. A summary is given in Exhibit 1 and in some more detail as Annex A.

The Indian experience

As mentioned above, while stewardship codes were first rolled out in 2017, India’s experience with stewardship began earlier with SEBI’s March 2010 circular.

These intervening years coincided with the adoption of the new Companies Act 2013, with its trust on governance and increased institutional ownership (from ~24% to ~35% today). The Companies Act made e-voting mandatory for companies, facilitating voting by funds without getting up from their desks. Institutional investors bulking up on their shareholding implies collectively they can engage with the controlling shareholders, (almost) as equals. By encouraging investors to focus more on long-term goals, the expectation was that they will not exit a stock at the first whiff of a governance muddle: they must engage.

As investors have adopted stewardship, they have moved from ticking the box, to a more nuanced view regarding the governance framework of companies they invest in. While currently the disclosures have focussed on voting, there are enough instances of engagement which have largely gone undisclosed. With the thrust on disclosures, as engagements get reported, expect additional pressure to nudge corporate behaviour. As companies may not even propose some resolutions expecting push back, its benefits may not always be obvious, like the dog that did not bark.

Looking ahead

The UK code underscored the need for including investors in the governance chain. Its adoption in India has encouraged investors to vote and be more engaged with companies. Even as stewardship increasingly gets embedded in the investment process, there is ample scope for regulator to reset investor stewardship.

In India, there is an urgent is the need to address what Umakanth Varottil, of NUS, describes as ‘fragmented stewardship’. The regulators – SEBI, IRDA and PFRDA have each enunciated principle that their regulated entities need to adopt. This is a far cry from how stewardship was originally expected to be rolled out. The Financial Sector Development Council headed by the finance minister was expected to announce a stewardship code for India. There is an urgent need to fix this and have one code across all categories of investors.

We are already starting to see more pronounced signs of regulatory divergence. IRDA’s through its 7 February 2020 circular has asked insurance companies to review and update their policies by including not just engagement on ESG, but for a more muscular code with intervention on poor financial performance, engagement on compensation, and litigations. They have set the cat among the pigeons, by asking insurance firms to explore having a nominee on company boards.

Umakanth Varottil highlights the difference in firm ownership structures in UK and India. Singapore, cognisant of this, has rolled out investor stewardship together with stewardship principles for family businesses.

Since then UK has moved ahead and its 2020 code builds on the 2012 code. For one it shifts from ‘comply or explain’ to ‘apply and explain’. It asks investors to focus on ESG. And importantly, recognizing that the growth of assets other than equities – fixed income, bonds, real estate, infrastructure, and the circumstances in which they can exercise stewardship.

It is also important to note one other development in this area namely, the Shareholders Rights Directive (SRD-II), adopted in the EU countries. This is part of a wider push to align interests along the investment chain—companies, boards, managements, asset managers and owners and other stakeholders. He is in favour of rolling these into the Indian code.

One code will give us an opportunity to have a more holistic approach to stewardship and give us the governance structures more in consonance with our markets. It will also be the perfect chance to align SRD-II with stewardship.

We are now seeing flows from India driving share prices, in contrast to FII’s determining what the price should be. Our investors are sophisticated enough to analyse companies, spot opportunities, and in separating the wheat from the chaff. They expect investors to collectively engage with companies. The regulators now need to work collectively by giving the market one code.

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