Author: Hansaja Pandya
College: Gujarat National Law University
India has never had a rich history of investor activism1 owing to the age-old tradition of family owned business which give out only small stakes to other shareholders. Even when stakes were given out to institutional investors, they were government owned pension funds, mutual funds or insurance companies who were neither independent nor a threat to company management. They tagged along with the management in their decision hardly ever raising dissent. However, it was soon realized that such passive investor attitude was fostering unhealthy practices that was corrupting Indian market and prodding corporates frauds. Therefore, in order to enhance the role of institutional investors in Corporate Governance and Securities & Exchange Board of India (SEBI) enacted the Stewardship Code in December 2019 (SEBI Code).
One major reason prompting the introduction of the Code is the fact that performance of independent directors as recommended by the Kotak Committee Report has not been satisfactory, miserably failing to perform their duties. The series of scams right from IL&FS, Punjab National Bank to Yes Bank are a stark reflection of failure of the institution of independent directors. A workable alternative to this is to let the institutional investors engage more closely with the board of the company. Hence the Code aims to establish a conducive and a trustworthy environment for Institutional Investor to actively engage with investee company and impel them to embrace transparent, and quality disclosure norms and Economic Social Governance principles. But, a major thorn in this bed of rose-like governance aspiration is that the Code is a direct transposition of the UK based stewardship principles of 2012. UK amended its Stewardship Code in 2020, but yet, India chose to ‘borrow’ the outdated stewardship system of UK without giving it a sui generis character to suit the Indian corporate scaffolds.
Having said that, this Article seeks to analyse the implications – the good, bad and the ugly – of enforcing UK-based Stewardship Code in India. The questions that are sought to be answered include, whether compliance with the Code will actually lead a change in the investor behaviour? Will the increased engagement with the investee company lead to positive investor activism or too much intereference?
A. Positive Impact of the Code:
The Code is expected to push for greater management accountability and push companies to become more responsible members of the society. Institutional investors will be the enabling factors in achieving these goals by playing a consultative role, engaging with the investees, keeping themselves up-to date with the information and directing the company’s action in such a manner that it complies with Economic Social Governance norms. The expectation is that institutional investors will deliver these goals by engaging in positive activist practises and not unnecessarily over-indulging in the affairs of the company. The stewardship regime will bear fruits only if the intervention and monitoring policy drawn out by the investors is able to successfully prevent over-indulgence and negative activism.
The author is of the opinion that the Stewardship Code, 2019 is very likely to bring in positive investor activism. This observation is derived from the functioning of the Insurance Regulatory & Development Authority of India (IRDAI) and Pension Fund Regulatory & Development Authority (PFRDA) Stewardship Code. These codes also contained the same principles as there in the SEBI Code providing for collective intervention in certain circumstances to be decided by the institutional investor itself. The IRDAI and PFRDA Codes were enacted in 2017 and 2018 respectively and in spite of staying in operation for 3 full years, there have not been any instances of negative investor activism. Although one reason might be the fact that the IRDAI Code was enforced on ‘comply or explain’ basis making it of voluntary nature. But the PFRDA Code was mandatory, just like the SEBI Code and in spite of that there have not been any reported cases of negative investor activism in India. To the contrary, some commentators have noted that the IRDAI and PFRDA codes increased adherence of investee company to the National Action Plan on Business and Human Rights.2
Activism led by investment companies and pension funds, alibeit very rare in India, has nevertheless aligned business of investee companies with the social and economic goals of the country, pushed them towards responsible governance and revived the functioning of the shareholder’s right committee of the board.3 The Code, when fully functional will most likely have the same impact encouraging regular outreach programmes and meetings with key institutional investors to bring them on board of the company and correct skewed plans of the management.
The author also believes that when the investors will have the right to formulate management and intervention policies and when implementation will be in their hands, they will be bound to take calculated steps so as not to endanger the interest of their own beneficiaries by engaging in over-indulgence or negative activism. The institutional investors will be vigilant enough to draw a line in their policies and not overstep that boundary of intervention and management or in other words, they will be careful enough so as not to render the board of the company function-less by taking over the company management. For instance, after the IRDAI and PFRDA codes were enacted, the investors of Tata Sponge Iron Ltd. successfully prevented a RPT transactions that seemed suspicious4. But this prevention did not completely take the transaction off the table. The institutional investors allowed the investee company to re-negotiate the terms of the RPT and ensured that it complied with the regulatory requirement. Similarly, investor funds of Raymond Ltd. voted against a transaction between the investee company and its promoters and allowed the transaction to happen only when the terms of transaction were in conformity with the Companies Act, 20135. These instances show that although investors do engage positively with the investee company to prevent malafide transactions and ensure good governance, they do not overstep the line. They allow the investee companies to correct the mistake. The investors do not make decisions on behalf of the company. They simply prevent the wrong decisions adversely affecting the corporate governance system from being implemented.
There are primarily two factors that support the observation:
Commercial decision-making is the task entrusted to the board of the company.6 Institutional investors can obviously exercise their voting right and prevent the passing of any resolution that they deem to be faulty, or without regulatory clearance or as those that restraint the good governance practises of the company. By doing so they definitely prevent faulty acts, but they never take decision for or on behalf of the board. Thus a line of separation is clearly established by the law itself which prevent investor from deciding for the board. The Stewardship Code only encourages the investors to monitor the decisions of company and intervene only when situation demands – excessive risk taking, governance failure, etc.
Stewardship Code has specified a process to be followed during intervention.
The first step is only communication, negotiation and discussion of the problem. Next step involves engagement, collaboration and finally escalation. Escalation of investor activism is allowed only if the other primary methods do not bear results. Investors cannot direct escalate their intervention without following the procedure. Therefore, the kind of activism envisaged by the code is relatively gentle. The Code requires the parties to first engage in ‘constructive dialogue’ rather than intervention.7
This sufficiently establishes that the Code is all set to bring about a trend of positive investor engagement in India and positively affect the change in the investor behaviour in India. But there are grey areas as well which will adversely impact the implementation of the Code and reduce its effectiveness. The lacunae in the Code are analysed in detail in Part II of the article.
1 UmakanthVarottil, ‘The Advent of Shareholder Activism in India’, (2012) 6 Journal on Governance 582
2 Supratim Guha, Poonam Pal Sharma, Parag Shrivastav& Simone Reis, ‘Institutional Shareholder can no longer be mute spectator: Stewardship Governance in India’ (Nishith Desai Associates 7 June 2020) https://nishithdesai.com/fileadmin/user_upload/Html/Hotline/YGM_CR_Stewardship_governance_in_India.html accessed 16 October 2020
6 Gopal Das Guiarati v. Titagarh Paper Mills co. Ltd.19861 60 comp Case 92O (Cal); World Phone India pvt. Ltd v. WPI Group Inc. case no. 38 of 2013
7 Jennifer G. Hill, ‘Good Activist/Bad Activist: Rise of International Stewardship Code’, (2017) ECGI, Sydney Law School, Legal Studies Research Paper NO. 17/80