LEGITIMIZATION OF STEWARDSHIP CODE : A STEP AHEAD FOR RESPONSIBLE INSTITUTIONAL INVESTORS
This blog has been authored by Ruchira Sudhir Halli, pursuing LL.M in Corporate and Commercial Laws from Maharashtra National Law University, Mumbai.
Understanding of Institutional Investors
Institutional Investors are the new talk of the town. Institutional Investors (hereinafter ‘IIs’) are a group that invests on behalf of its members. They are faced with less protecting regulations because they are expected to be more informed and in a better position to protect themselves. There are several divisions of IIs such as endowment funds, commercial banks, mutual funds, hedge funds, pension funds and insurance companies. IIs are the main sponsors to companies in India. Moreover, the latest government policies have resulted in an increase in the stream of foreign direct investment and foreign institutional investment. Although IIs’ activism is not predominant in India, it is becoming increasingly important. IIs play an active role in corporate governance of firms in the United States and the United Kingdom. They monitor the Board's decisions and help to build good corporate governance within the company. Large IIs can provide private information that they obtain from management to other shareholders.
Problems faced in Corporate Governance by Institutional Investors
Corporate governance (hereinafter ‘CG’) as defined by Gillan and Starks is “the system of laws, rules, and factors that control operations at a company.”[i] IIs being shareholders with large concentrated shareholding have the power to get involved with sound CG practices. The whole crux about IIs and CG is the fact called an agency problem that gradually moves with skilfully managed organizations. This agency problems tell us about the conflicting interests and responsibilities of the managers towards themselves and organizations. Managers mostly try to obtain maximum benefits at the cost of organisation and therefore there is a need of balancing the conflicting forces between them. “Common Ownership” by IIs have become influential in public listed companies by holding a significant share. The problem here is that of utilizing the power, as actively exercising votes lead to anti-competitive concerns, whereas passive approach fuels accusations of poor shareholder monitoring.
An Introduction to the Stewardship Code
Securities and Exchange Board of India (hereinafter ‘SEBI’) on 24th Dec, 2019 by its circular[ii] has made it compulsory for all the Mutual Funds (hereinafter ‘MFs’) and all types of Alternative Investment Funds (hereinafter ‘AIFs’) to prepare a Stewardship Code, in order to improve the CG and to give rise to the interest protection of investors, investing in Indian listed companies. IIs who are well off wealthy investors are now to act responsibly and comply with the policy and principles enshrined under the Code. The Code specifies certain principles which helps in development of obligations of the MFs/AIFs to safeguard the interests of their investors/beneficiaries. The Code shall come into effect on 1st April 2020. The Code considerably counts on the U.K. Stewardship Code, which obeys the ‘comply or explain’ method. The concept of Stewardship was formulated in 2015 at 5th meeting of SEBI Advisory Board and the same was restated by the Kotak Committee on CG dated 5th Oct. 2017.
Existing obligations on Insurers and Mutual Funds
Before exploring the new Code, Insurance Regulatory and Development Authority of India (hereinafter ‘IRDAI’) in 2017 made an obligation related to the need of stewardship, this code acknowledged the necessity of code and owes the responsibilities delegated on the insurance companies, for the reasons they are investors on behalf of policyholders. Therefore, the IRDAI code was introduced, which describes principles identical to the new Code. On 15th March 2010 SEBI by its circular, which cast on Asset Management Companies (hereinafter ‘AMCs’) the requirements to formulate policies by making it compulsory to disclose the voting rights by the MFs on their websites. Again, SEBI issued circular on 24th March 2014, which is modification of 2010 circular relating to transparency and disclosure of voting decisions of MFs considering the interest of their shareholders. It was made compulsory for MFs to submit the quarterly disclosures of voting along with the reasons behind each decision and to publish the summary of the same. All these requirements are undertaken by the new Code with further in detail research on voting decision.
An Analysis of the Stewardship Code–
The Code contains the following principles which must have policies framed by the MFs, AMCs and all the types of AIFs:
IIs should frame a thorough policy on the discharge of their stewardship responsibilities. Stewardship responsibilities includes active participation and monitoring investee companies on several matters such as strategy, financial performance, operational performance, capital structure, CG etc. Such participation can happen only through detailed discussion and interaction with investee companies and by voting in board and shareholders meeting. IIs should publicly disclose the policy, review and update it periodically, and the updated policy should be publicly disclosed on the entity's website.
To avoid the conflicts of interest towards fulfilling the stewardship responsibilities, IIs should make a transparent policy and publicly disclose it. IIs should make a detailed policy for foreseeable situation where there is conflict between IIs and investee company. The policy should be made in such manner that priority should be given to the interest of beneficiary before the interest of company. Committee can be formed for redressal on conflict of interest.
IIs should monitor their investee companies. IIs should make policy on continuous scrutinizing of their investee companies which shall include performance, CG, strategy, risks etc. of the companies. Identification of levels for monitoring different investee companies, even areas and mechanism for monitoring, etc. should be done by investor. IIs with small investments should pinpoint specific situations where they don’t want to participate actively with investee companies. While taking information from investee company, IIs should keep in mind the insider trading regulations.
IIs should make policy on intervention in their investee companies. SEBI has made it compulsory for them to identify and disclose conditions that merit intervention into the affairs of the investee companies through meetings, collaboration with other IIs, etc. The basic principle appears to provide transparency on parameters that will help fund managers to scrutinize the progress CG of listed companies and to provide transparency to their shareholders. Regular assessment of outcomes of intervention should be done.
IIs should make policy on voting and disclosures related to voting activity. SEBI has made it compulsory for MFs, AMCs, AIFs to publicly disclose voting policy and decisions (including rationale), use of proxy voting/voting advisory services, etc. This is to be done for protecting the wealth of clients and to enhance the CG of investee companies. Rather than blindly backing up with the management decisions, IIs should do in-depth research and then take their own voting decision. Voting can be done through e-voting, voting through proxy, in person, etc. The policy should also include detailed guidelines in which voting should be for/against/abstain from voting. Details of proxy voting and other advisory firm should also be disclosed through policies.
IIs should report periodically their activities on stewardship. SEBI has made it compulsory for IIs to report their clients periodically as to how they fulfil stewardship responsibilities in easy to understand form.
Thus, on implementation of these above principles the report of same should be displayed on the website. Any update on policy should be disclosed when done. The report can also to clients as annual intimation.
It is important to note that U.K. Stewardship Code operates as blueprint for the Indian Stewardship code. This Code is the most awaited step, one that incorporates a much-needed dimension of enfranchisement for unit holders of funds and acknowledges the need to funnel the financial influence of large institutions into a participatory corporate environment. AMCs, MFs and AIFs will now form a collective voice for both ends and help to strengthen the standards of IIs democracy and transparency. It is important to note that the Code though not rigid nor rule based but is mandatory, not following the ‘comply or explain’ model prevalent in the U.K. The new big name in CG, getting huge all the time, is the IIs. They hold good amount of public funds. It will be very interesting to see how institutions such as MFs and AIFs formulate, implement and enforce this code. These questions relate to goals, strategy, governance, performance and accountability and importantly, the agency problems. It remains to be seen whether IIs play the role expected of them and how SEBI tests these efforts.
[i] Stuart L. Gillan & Laura T. Starks, Corporate Governance, Corporate Ownership and the Role of Institutional Investors: A Global Perspective, Journal Of Applied Finance, 2003, at 5.
[ii]Circular No. CIR/CFD/CMD1/ 168 /2019, Stewardship Code for Institutional Investors, Securities and Exchange Board of India (Dec 24, 2019), https://www.sebi.gov.in/legal/circulars/dec-2019/stewardship-code-for-all-mutual-funds-and-all-categories-of-aifs-in-relation-to-their-investment-in-listed-equities_45451