Increasing the Role of Institutional Investors in CG

 

On January 04, 2013, SEBI issued a consultative paper on revising CG norms in India, with the intention of aligning the corporate governance framework in India with the OECD Principles on Corporate Governance and other global best practices. One of the key provisions in the consultative paper is to increase the role that institutional investors should play in promoting good corporate governance practices in their portfolio companies.

 

Increased monitoring by institutional investors and exercise of their ownership functions effectively in their portfolio companies will drive listed companies in India to enhance their corporate governance practices. Recognizing this, SEBI has proposed mandatory provisions in the consultative paper to increase institutional investor intervention in their portfolio companies.

 

The main provisions of the consultative paper are summarized below:

a)       Institutional investors should have a clear policy on voting and disclosure of voting activity

The provision seeks to make voting mandatory for institutional shareholders on all shares held by them in portfolio companies along with public disclosure of their voting records and reasons for non-disclosures. They cannot automatically support the board in passing resolutions and if they are unsuccessful in reaching a satisfactory outcome through active dialogue with the Board, then they should register an abstention or vote against the resolution.

b)      Institutional investors to have a robust policy on managing conflicts of interest

Institutional investors should formulate and regularly review a policy for managing conflicts of interest, which may include voting on matters affecting a parent company or a client.

c)       Institutional investors to monitor their investee companies

Investee companies should be regularly monitored to determine when it is necessary to enter into an active dialogue with their boards. As part of these monitoring, institutional investors should:

  • Seek to satisfy themselves, to the extent possible, that the investee company’s board and committee structures are effective, and that independent directors provide adequate oversight, including by meeting the chairman and, where appropriate, other board members;
  • Maintain a clear audit trail, for example, records of private meetings held with companies, of votes cast, and of reasons for voting against the investee company’s management, for abstaining, or for voting with management in a contentious situation; and
  • Attend the General Meetings of companies in which they have a major holding, where appropriate and practicable.

Institutional investors should consider carefully the explanations given for departure from the Corporate Governance Code and make reasoned judgments in each case.

d)      Institutional investors to be willing to act collectively with other investors where appropriate

Institutional investors should disclose their policy on collective engagement with other investors especially during significant corporate or wider economic stress, or when the risks posed threaten the ability of the company to continue. When participating in collective engagement, institutional investors should have due regard to their policies on conflicts of interest and insider information.

e)       Institutional investors to establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value

Institutional investors should set out the circumstances when they will actively intervene and regularly assess the outcomes of doing so. Intervention should be considered regardless of whether an active or passive investment policy is followed. Initial discussions should take place on a confidential basis. However, if boards do not respond constructively when institutional investors intervene, then institutional investors will consider whether to escalate their action, for example, by

  • Holding additional meetings with management specifically to discuss concerns;
  • Expressing concerns through the company’s advisers;
  • Meeting with the chairman, senior independent director, or with all independent
  • directors;
  • Intervening jointly with other institutions on particular issues;
  • Making a public statement in advance of the AGM;
  • Submitting resolutions at shareholders’ meetings; etc.

f)        Institutional investors to report periodically on their responsibilities and voting activities

Like US funds, Indian asset management funds are now required to disclose their general policies and procedures for exercising the voting rights in respect of the shares held by them on their websites as well as in the annual report distributed to the unit holders from the financial year 2010-11. However, research has shown that there is only a marginal increase in for/against votes and many funds fail to even attend meetings and have abstention as a policy. Even among funds that voted, there is little alignment between the votes and the voting policy. In view of above, existing policy needs to be examined. Fund houses should be mandated to adopt the global practice of quarterly vote reporting and fund-wise vote reporting and to adopt detailed voting policies. Further, vote reporting by fund houses should also be subject to audit.

 

The paper seeks deliberations from market participants on how to create incentives for institutional investors that invest in equities to become more active in the exercise of their ownership rights, without coercion, without imposing illegitimate costs on them, and given India’s specific situation.