147 ISMR A. Importance of corporate governance in the capital market Good corporate governance standards are essential for the integrity of corporations, financial institutions and markets and have a bearing on the growth and stability of the economy. Over the past decade, India has made significant strides in the areas of corporate governance reforms, which have improved public trust in the market. These reforms have been well received by the investors, including the foreign institutional investors (FIIs). A compelling evidence of the improving standards comes from the growing interest of FIIs in the Indian market; gross FII portfolio investment has risen from US $ 2.7 billion in FY 1996 to US $ 166.2 billion in FY 2013. Governance reforms and globalization of the capital markets have been mutually reinforcing. While continuing governance reforms have led to rising foreign investment, globalization of the capital markets has provided an impetus to the CG practices in the following manner. An important side effect of internationalization of Indian capital markets was a drive toward a more stringent corporate governance regime by the Indian industry itself. To market their securities to foreign investors, Indian companies making public offerings in India were persuaded to comply with corporate governance norms that investors in the developed world were familiar with. Further, Indian companies listing abroad to raise capital were subject to stiff corporate governance requirements applicable to listing on those Exchanges. They also adhered to the norms and practices of corporate governance applicable to markets where they listed their securities. It must however be recognized that such practices have remained largely confined to only some large companies and have not percolated to majority of Indian companies. International comparison According to a World Bank study Doing Business 2014, India ranks 34 th worldwide in terms of investor protection an important indicator of corporate governance--across all countries considered. It has fared better than China, Brazil and Russia (See Table-1). It may be noted that India has been outperforming other BRIC countries persistently over the past 5 years. At an overall score of 6.3 out of 10, India beats the South Asia average of 5.1 and is also marginally higher than the OECD average of 6.2. Table-1: Country wise ranking in terms of protecting investors Parameters India China Brazil Russia UK Protecting investors (rank) 34 98 80 115 10 Extent of disclosure Index (0-10) 7 10 5 6 10 Extent of director liability index (0-10) 4 1 8 2 7 Ease of shareholder suits index (0-10) 8 4 6 6 7 Strength of investor protection index (0-10) 6.3 5 4.9 4.7 8 Source: Doing Business 2014, World Bank
ISMR 148 B. Reforms in CG framework for listed companies During the period September 2012, to September 2013, the following changes have been made to the CG framework for listed companies. a. Disclosure of price sensitive information to the stock exchanges The listed companies in India are guided by, among others, Clause 36 of the Listing Agreement of the stock exchanges which states that The Issuer will intimate to the Stock Exchanges, where the company is listed immediately of events such as strikes, lock outs, closure on account of power cuts, etc. and all events which will have a bearing on the performance / operations of the company as well as price sensitive information both at the time of occurrence of the event and subsequently after the cessation of the event in order to enable the security holders and the public to appraise the position of the Issuer and to avoid the establishment of a false market in its securities. In addition, the Issuer will furnish to Exchange on request such information concerning the Issuer as the Exchange may reasonably require. In recent times there have been instances when certain listed companies have been giving monthly disclosures of certain price sensitive information like sales/ turnover/ production to their respective industry associations, without disclosing the same to stock exchanges. To curb this practice, the Securities and Exchange Board of India (SEBI) has made it mandatory for listed companies to disclose such price sensitive information first to the Stock Exchanges. b. Amendment to ESOP guidelines SEBI has amended Employee Stock Options (ESOP) guidelines to prohibit companies from acquisition of own stocks in secondary markets for the purpose of issuance of ESOPs to their respective employees. The revision to the guidelines comes after it was observed by SEBI that a few companies had set up Employees Welfare Trusts (EWTs), which purchased companies own shares in secondary market for issuance to the employees. This was generally done by companies which were averse to dilution of promoter shareholding. SEBI also apprehended that such purchase of treasury stock could constitute an unfair trade practice (since the EWTs may have some insider information) and could lead to undue fluctuation in the price of securities. c. Tightening of conflict of interest rules for market entities SEBI has asked market entities stock exchanges, rating agencies, brokers, depositories, and other market agencies to put in place a strong system to manage conflict of interest. The credit rating agencies have been specifically asked to deploy adequate systems and policies to ensure that they address any conflict of interest during investment decisions of their own funds or by their top management and employees. The key executives, such as CEOs and Managing Directors, would need to take prior approval from the Compliance Officer for sale or purchase of securities of the companies with which the credit rating agency may have rating-related dealings. SEBI has called for market infrastructure institutions and intermediaries to maintain "high standards of integrity" in conduct of their business. They have also been asked not to use any information received from the clients, under the normal business dealings, for any personal interest and to put in place "information barriers" to block flow of confidential information from one department to another. Market intermediaries, stock exchanges, clearing corporations and depositories have also been made responsible for educating their 'associated persons' for compliance of these guidelines. d. Stock exchanges to have stronger redress mechanism SEBI has asked stock exchanges to put in place a stronger and more effective system for faster resolution of investor grievances and to provide for immediate grant of monetary relief to investors after arbitration procedures. SEBI has decided to give monetary relief to investors having claims up to INR10 lakh, during the course of proceedings from the Investor Protection Funds (IPF) of stock exchanges. Further, SEBI has decided to shorten the time taken for these proceedings. All these regulations are aimed at streamlining the investor grievance redress mechanism at stock exchanges and make it more effective from the investor protection perspective.
149 ISMR e. SEBI asks stock exchanges to amend bye-laws to enforce listing conditions SEBI has prescribed certain amendments to bye-laws of recognised stock exchanges regarding non-compliance of some of the listing conditions and adopting standard operating procedure for suspension and revocation of trading of shares of listed entities for such non-compliances. Non-compliance of listing conditions has so far been considered as grounds for suspension of trading by the recognized stock exchanges. Accordingly, it has asked recognized stock exchanges to impose fines as 'action of first resort' in case of such non-compliance and invoke suspension of trading in case of subsequent and consecutive defaults. In order to maintain consistency and uniformity of approach, SEBI has prescribed the following additions to the bye-laws of the recognized stock exchanges: i) Uniform fine structure for non-compliance of certain clauses of the listing agreement; and ii) Standard Operating Procedure (SOP) for suspension and revocation of suspension of trading in the shares of such listed entities. SEBI has also asked stock exchanges to put in place a system to monitor and review compliance of respective listing conditions by the listed entities. It has asked stock exchanges to enforce compliance of respective listing conditions and disclose on their web sites the action taken against the listed entities for non-compliance of the listing conditions. C. Corporate Governance provisions in the Companies Act, 2013 The enactment of the companies Act 2013 was major development in corporate governance in 2013. The new Act replaces the Companies Act, 1956 and aims to improve corporate governance standards, simplify regulations and enhance the interests of minority shareholders. The new Act is a major milestone in the corporate governance sphere in India and is likely to have significant impact on the governance of companies in the country. Following are the main provisions related to corporate governance that have been incorporated in the Companies Act, 2013. i. The Companies Act, 2013 introduces new definitions relating to accounting standards, auditing standards, financial statement, independent director, interested director, key managerial personnel, voting right etc. For example, the legislation introduces a new class of companies called one person company (OPC) to the existing classes of companies, namely public and private. OPC is a new vehicle for individuals for carrying on a business with limited liability. ii. Board of Directors (Clause 166): The new Act provides that the company can have a maximum of 15 directors on the Board; appointing more than 15 directors, however, will require shareholder approval. Further, the new Act prescribes both academic and professional qualifications for directors. It states that the majority of members of Audit Committee including its Chairperson should have the ability to read and understand the financial statements. In addition, for the first time, duties of directors have been defined in the Act. The Act considerably enhances the roles and responsibilities of the Board of Directors and makes them more accountable. Infringement of these provisions has been made punishable with fine. iii. iv. Independent Director (Clause 149): The concept of independent directors (IDs) has been introduced for the first time in the Company Law in India. It prescribes that all listed companies must have at least onethird of the Board as IDs. IDs may be appointed for a term of up to five consecutive years. While the introduction of the concept of IDs in the new Act is a welcome move, it does not appear to sufficiently address the enduring challenges related to the effectiveness of IDs in the context of concentrated shareholding pattern in most of the listed companies in India. Related Party Transactions (RPT) (Clause 188): The new Act requires that no company should enter into RPT contracts pertaining to (a) sale, purchase or supply of any goods or materials; (b) sale or dispose of or buying, property of any kind; (c) leasing of property of any kind; (d) availing or rendering of any services; (e) appointment of any agent for purchase or sale of goods, materials, services or property; (f) such related party's appointment to any office or place of profit in the company, its subsidiary company or associate
ISMR 150 company. In case such a contract or arrangement is entered into with a related party, it must be referred to in the Board s Report along with the justification for entering into such contract or arrangement. Further, any RPT between a company and its Directors shall require prior approval by a resolution in general meeting. Violations of these provisions would be punishable with fine or imprisonment or both. v. Corporate Social Responsibility (CSR) (Clause 135): The new Act has mandated the profit making companies to spend on CSR related activities. Every company having net worth of Rs 500 crore or more or turnover of Rs 1000 crore or more or net profit of Rs 5 crore or more during any financial year shall constitute a CSR Committee of the Board. In pursuance of its CSR policy, the Board of every such company through these committees--shall ensure that the company spends (in every financial year) at least 2 percent of the average net profits of the company made during the three immediately preceding financial years. vi. vii. viii. ix. Auditors (Clause 139): A listed company cannot appoint or reappoint (a) an individual as auditor for more than one term of five consecutive years, or (b) an audit firm as auditor for more than two terms of five consecutive years. To avoid any conflict of interest, the Act has mentioned the services that an auditor cannot render, directly or indirectly, to the company, which include: accounting and book-keeping services, internal audit, investment banking services, investment advisory services, management services etc. Disclosure and Reporting (Clause 92): In the new Act, there is significant transformation in non-financial annual disclosures and reporting by companies as compared to the earlier format in the Companies Act, 1956. Serious Fraud Investigation Office (SFIO) (Clause 211): The Act has proposed statutory status to SFIO. Investigation report of SFIO filed with the Court for framing of charges shall be treated as a report filed by a Police Officer. SFIO shall have power to arrest in respect of certain offences of the Act which attract the punishment for fraud. Further, the new Act has a provision for stringent penalty for fraud related offences. Class action suits (Clause 245): For the first time, a provision has been made for class action under which it is provided that specified number of member(s), depositor(s) or any class of them, may file an application before the Tribunal seeking any damage or compensation or demand any other suitable action against an audit firm. The order passed by the Tribunal shall be binding on all the stakeholders including the company and all its members, depositors and auditors. D. Ownership structure The prevailing ownership pattern is a crucial impediment in raising corporate governance standards in India. There are two sets of issues pertaining to the ownership structure of the listed companies in India. First, there is high concentration of ownership, which gives particular individuals or families actual or effective control of most companies, even publicly traded companies. For example, the share of promoters in NSE listed companies rose from 47.7 percent in March 2002 to 57.8 percent in March 2010, but fell subsequently to 53.7 percent in March 2013. The picture is not very different for the top companies. Second, a large number of companies in India are grouped together under the common control of a single shareholder or family. In other words, not only are most firms effectively controlled by a promoter group, but the same promoter group often controls a large number of firms. This pattern of ownership poses challenges for improving governance, partly because it raises probability of price manipulation. Also, by making it easier for the controlling shareholders to use related party transactions (RPTs) as a vehicle for illegitimate expropriation of corporate value at the cost of minority shareholders interest, this pattern of ownership gives rise to serious potential conflicts of interest between the promoter group and the minority investors.. Partly with the aim of addressing this situation, the minimum public shareholding norms were prescribed in August 2010. Accordingly, the listed private and public sector companies existing as of the date of the circular were required to ensure a minimum public shareholding of 25 percent (by June 2013) and 10 percent (by August 2013) respectively.
151 ISMR As of the quarter ended in September 2013, all PSUs were in compliance with the minimum public shareholding; however, 21 non-psus listed on NSE were in non-compliance with the above provisions. E. SEBI consultative paper on CG In early 2012, SEBI released a consultative paper on Review of Corporate Governance Norms in India. To improve the governance standards of companies in India, the report had provided a broad framework in the form of (i) overarching principles of corporate governance, and (ii) proposals. The objective of the concept paper was to attract a wider debate on the governance requirements for the listed companies so as to adopt better global practices. An attempt was made to ensure that the additional cost of compliance with the proposals did not outweigh the benefits of listing, while at the same time the need to boost the confidence of the investors on the capital market was recognized. Establishment of the NSE Centre for Excellence in Corporate Governance NSE has continually endeavored to organize new initiatives relating to corporate governance (CG) in recognition of the important role that stock exchanges play in enhancing the CG standards. To encourage best standards of CG among the Indian corporates and to keep them abreast of the emerging and existing issues, the NSE set up in December, 2012, a Centre for Excellence in Corporate Governance (NSE CECG). This is an independent expert advisory body comprising eminent domain experts, academics and practitioners. The Committee meets from time to time to discuss CG issues and developments. The Quarterly Briefing, a note that offers an analysis of one emerging or existing CG issue, is a product emerging from these discussions. Various issues of Quarterly Briefing can be accessed on the following link in the NSE website: http:///research/content/res_nse_cecg.htm