Corporate Governance and The Role Institutional Investors

Legal Aspects of Business Assignment

Sarita Meena Section D 2013PGP351
3/21/2014

Contents
Contents................................................................................................................................. 2 Institutional Investors and Corporate Governance in India.....................................................3 Introduction: ........................................................................................................................... 3 Corporate governance in india................................................................................................6 Regulatory Framework for Corporate Governance in India................................................. !nforcement of Corporate Governance "orms...................................................................# $ey Issues in Corporate Governance in India % &anaging t'e (ominant )'are'older*s+ and t'e ,romoter*s+.......................................................................................................... -. !nforcement for non/compliance of Corporate Governance "orms..................................-3 Companies 0ill1 2.-- and its Impact on Corporate Governance in India...........................-2 Institutional investors............................................................................................................ -3 4opology of t'e institutional investors5 community in India................................................-3 (evelopment Financial Institutions....................................................................................-3 )tate/owned insurance companies...................................................................................-# ,rivate sector insurance companies.................................................................................2. &utual funds and FIIs....................................................................................................... 26egal and regulatory framework for Institutional Investors....................................................22 Institutional )tructure of Regulation..................................................................................22 0anks and (FIs................................................................................................................ 22 Insurance companies........................................................................................................22 &utual Funds and Foreign Institutional Investors..............................................................22 ,ension Funds Industry....................................................................................................27 0oard representation8Clause 7#.......................................................................................22 Independent (irectors.......................................................................................................22 "ominee (irectors............................................................................................................ 26 Role of Institutional Investors................................................................................................2# 4'e role of institutional investors in ot'er countries:.............................................................33 &andate for Conflicts of interests in 9!C( Countries:......................................................32 ,olicy recommendations......................................................................................................36 References:...................................................................................................................... 7

2|,age

Institutional Investors and Corporate Governance in India

Introduction:
The Report falls within the framework of cooperation on matters of corporate governance Its mandate is to increase awareness of good corporate governance practices through workshops and seminars, sponsor academic research, and set up a training program for board members The 2004 CG R !C assessment conducted b" the #orld $ank benchmarks India%s corporate governance framework to the &C' (rinciples of Corporate Governance )The &C' (rinciples*+ It focuses on the rights of shareholders, the e,uitable treatment of shareholders, the role of stakeholders, disclosure and transparenc", and the duties of the board of listed companies+ The assessment found that over the last decade or so, a series of legal and regulator" reforms have improved the Indian corporate governance framework markedl"- the level of responsibilit" and accountabilit" of insiders have been strengthened, fairness in the treatment of minorit" shareholders has been enhanced, together with board practices, and transparenc"+ .onetheless, enforcement and implementation of laws and regulations remain important challenges+ The areas flagged as a high priorit" for India in the CG R !C assessment were/ a* the compliance b" corporations with the new corporate governance framework and the need for strict enforcement b" regulators for corporate governance violationsb* the clarification of regulator" and supervisor" responsibilities between the securities regulator and the stock e0changes as far as monitoring and surveillancec* the role of institutional investors in the corporate governance of their portfolio companies and the need for more transparenc" on their policies on corporate governance and voting decisions- and d* the creation of a credible directors% training institution+ The rationale underl"ing the polic" recommendations is that increased monitoring of Indian listed corporations b" institutional investors will drive the former to enhance their corporate governance practices, and ultimatel" their abilit" to generate better financial results and
3|,age

growth for their investors+ (ositive e0ternalities for the whole corporate sector can also be e0pected+ $ased on the e0perience of countries where shareholders activism is vibrant, such as for e0ample 1ustralia, 2rance, the 34, or the 3nited !tates, it is reasonable to e0pect that Indian institutional investors could in some circumstances, enhance the value of their portfolio b" undertaking a reasonable amount of anal"sis and b" using their ownership rights more activel"+ 2ailure to e0ercise their ownership rights ma" in some cases result in a loss for their investors+ The purpose of the polic" recommendations is therefore to encourage institutional investors to factor such value enhancements5losses in their costs5benefits anal"sis+ In addition, institutional investors, especiall" those acting in a fiduciar" capacit", are better positioned than retail investors to pla" a monitoring role in their portfolio companies because the" do not face the collective action )free6rider* problem to the same e0tent+ The polic" recommendations focus e0clusivel" on the role of institutional investors in the corporate governance of their portfolio companies+ The" do not address the more comple0 issue of the corporate governance of institutional investors themselves which was not part of the #orld $ank mandate+ $ased on the findings from two ,uestionnaires sent to institutional investors and companies, complemented b" interviews with market participants, it was found that most domestic mutual funds take a passive role in the corporate governance of their portfolio companies+ The" seldom if ever review the agenda of shareholders meetings, do not attend shareholders meetings, and do not e0ercise their voting rights, unless something goes drasticall" wrong, or if a takeover situation occurs+ .or do the" disclose their voting records+ 2oreign institutional investors tend to e0ercise their ownership rights more activel"+ Insurance companies and banks are somewhat more active than domestic mutual funds but less active then foreign institutional investors+ The latter institutions do attend shareholders meetings, vote at shareholders meetings or through postal ballot and convene informal meetings with management on an ad hoc basis, but like the first group, the" support incumbent management+ The" sometimes consult with other institutional investors+ The polic" recommendations address four main issues/ )7* the disclosure b" institutional investors of their corporate governance and voting policies and voting records)2* the disclosure of material conflicts of interests which ma" affect the e0ercise of ke" ownership rights-

7|,age

)8* measures to facilitate the e0ercise of shareholders rights b" institutional investors- and )4* the practice of nominee directors+ In addition, it is recommended that the G I urgentl" focuses on the corporate governance of institutional investors themselves+ The remainder of the paper contains four sections+ !ection II below identifies the various t"pes of institutional investors active in the Indian market+ It includes a brief summar" of the historical conte0t in which the" have evolved and provides recent statistical information on their assets under management, their relative si9e, and historical growth+ !ection III summari9es the legal and regulator" framework governing the various t"pes of institutional investors operating in the Indian market, together with a summar" of the relevant sections of Clause 4: and a discussion on nominee directors+ !ection ; sets out the polic" recommendations+

2|,age

Corporate governance in india

Corporate governance in India gained prominence in the wake of liberali9ation during the 7::0s and was introduced, b" the industr" association Confederation of Indian Industr" )CII*, as a voluntar" measure to be adopted b" Indian companies+ It soon ac,uired a mandator" status in earl" 2000s through the introduction of Clause 4: of the <isting 1greement, as all companies )of a certain si9e* listed on stock e0changes were re,uired to compl" with these norms+ In late 200:, the =inistr" of Corporate 1ffairs has released a set of voluntar" guidelines for corporate governance, which address a m"riad corporate governance issues+ These voluntar" guidelines mark a reversal of the earlier approach, signif"ing the preference to revert to a voluntar" approach as opposed to the more mandator" approach prevalent in the form of Clause 4:+ >owever in a parallel process, ke" corporate governance norms are currentl" being consolidated into an amendment to the Companies 1ct, 7:?@ and once the Companies $ill,2077 is approved the corporate governance reforms in India would have completed two full c"cles 6 moving from the voluntar" to the mandator" and then to the voluntar" and now back to the mandator" approach+ The 1nglo6!a0on model of governance, on which the corporate governance framework introduced in India is primaril" based on, has certain limitations in terms of its applicabilit" in the Indian environment+ 2or instance, the central governance issue in the 3! or 34 is essentiall" that of disciplining management that has ceased to be effectivel" accountable to the owners who are dispersed shareholders+ >owever, in contrast to these countries, the main issue of corporate governance in India is that of disciplining the dominant shareholder, who is the principal block6holder, and of protecting the interests of the minorit" shareholders and other stakeholders+ This issue and the comple0it" arising from the application of alien corporate governance model in the Indian corporate and business environment is further compounded b" the weak enforcement of corporate governance regulations through the Indian legal s"stem+ 2urthermore, given that corporate governance is essentiall" a soft issue, whose essence cannot be captured b" ,uantitative and structural factors alone, one of the challenges of making corporate governance norms mandator" is the need to differentiate between form and content- for instance, how do we determine whether companies actuall" internali9e the
6|,age

desired governance norms or whether the" look at governance as a check6the6bo0 e0ercise to be observed more in letter than in spirit+ Currentl", corporate governance reforms in India are at a crossroads- while corporate governance codes have been drafted with a deep understanding of the governance standards around the world, there is still a need to focus on developing more appropriate solutions that would evolve from within and therefore address the India6specific challenges more efficientl"+ Corporate governance is perhaps one of the most important differentiators of a business that has impact on the profitabilit", growth and even sustainabilit" of business+ It is a multi6level and multi6tiered process that is distilled from an organi9ation%s culture, its policies, values and ethics, especiall" of the people running the business and the wa" it deals with various stakeholders+ Creating value that is not onl" profitable to the business but sustainable in the long6term interests of all stakeholders necessaril" means that businesses have to runAand be seen to be runAwith a high degree of ethical conduct and good governance where compliance is not onl" in letter but also in spirit+

Regulatory Framework for Corporate Governance in India

1s a part of the process of economic liberali9ation in India, and the move toward further development of India%s capital markets, the Central Government established control over the stock markets through the formation of the !&$I+ regulator" riginall" established as

an advisor" bod" in 7:BB, !&$I was granted the authorit" to regulate the securities market under the !ecurities and &0change $oard of India 1ct of 7::2 )!&$I 1ct*+ (ublic listed companies in India are governed b" a multiple regulator" structure+ The Companies 1ct is administered b" the =inistr" of Corporate 1ffairs )=C1* and is currentl" enforced b" the Compan" <aw $oard )C<$*+ That is, the =C1, !&$I, and the stock e0changes share Curisdiction over listed companies, with the =C1 being the primar"

|,age

government bod" charged with administering the Companies 1ct of 7:?@, while !&$I has served as the securities market regulator since 7::2+ !&$I serves as a market6oriented independent entit" to regulate the securities market akin to the role of the !ecurities and &0change Commission )!&C* in the 3nited !tates+ The stated purpose of the agenc" is to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market+ The realm of !&$I%s statutor" authorit" has also been the subCect of e0tensive debate and some authors have raised doubts as to whether !&$I can make regulations in respect of matters that fall within the Curisdiction of the 'epartment of Compan" 1ffairs+ !&$I%s authorit" for carr"ing out its regulator" responsibilities has not alwa"s been clear and when Indian financial markets e0perienced massive share price rigging frauds in the earl" 7::0s, it was found that !&$I did not have sufficient statutor" power to carr" out a full investigation of the frauds+ 1ccordingl", the !&$I 1ct was amended in order to grant it sufficient powers with respect to inspection, investigation, and enforcement, in line with the powers granted to the !&C in the 3nited !tates+ 1 contentious aspect of !&$I%s power concerns its authorit" to make rules and regulations+ 3nlike in the 3nited !tates, where the !&C can point to the !arbanes6 0le" 1ct, which specificall" confers upon it the authorit" to prescribe rules to implement governance legislation, !&$I, on the other hand, cannot point to a similar piece of legislation to support the imposition of the same re,uirements on Indian companies through Clause+ Instead !&$I can look to the basics of its own purpose, as given in the !&$I 1ct, wherein it is granted the authorit" to Dspecif", b" regulations, the matters relating to issue of capital, transfer of securities and other matters incidental thereto + + + and the manner in which such matters shall be disclosed b" the companies+E In addition, !&$I is granted the broad authorit" to Dspecif" the re,uirements for listing and transfer of securities and other matters incidental thereto+E Recogni9ing that a problem arising from an overlap of Curisdictions between the !&$I and =C1 does e0ist, the !tanding Committee, in its final report, has recommended that while providing for minimum benchmarks, the Companies $ill should allow sectoral regulators like !&$I to e0ercise their designated Curisdiction through a more detailed regulator" regime, to be decided b" them according to circumstances+ Referring to a similar case of Curisdictional overlap between the R$I and the =C1, the Committee has suggested that it needs to be appropriatel" articulated in the $ill that the Companies 1ct will prevail onl" if the !pecial
3|,age

1ct is silent on an" aspect+ 2urther the Committee suggested that if both are silent, re,uisite provisions can be included in the !pecial 1ct itself and that the status ,uo in this regard ma", therefore, be maintained and the same ma" be suitabl" clarified in the $ill+ This, in the Committee%s view, would ensure that there is no Curisdictional overlap or conflict in the governing statute or rules framed there under+

Enforcement of Corporate Governance Norms

The issue of enforcement of Corporate Governance norms also needs to be seen in the broader conte0t of the substantial dela" in the deliver" of Custice b" the Indian legal s"stem on account of the significant number of cases pending in the Indian courts+ 1 research paper b" (R! <egislative Research8@ places the number of pending cases in courts in India, as of Ful" 200:, as ?8,000 pending with the !upreme Court, 4 million with various >igh Courts, and 2G million with various lower courts+ This signifies an increase of 78: per cent for the !upreme Court, 4@ per cent for the >igh Courts and 82 per cent for the lower courts, from the pending number of cases in each of them in Fanuar" 2000+ 2urthermore, in 2008, 2? per cent of the pending cases with >igh Courts had remained unresolved for more than ten "ears and in 200@, G0 per cent of all prisoners in Indian Cails were under trials+ !ince fresh cases outnumber those being resolved, there is obviousl" a shortfall in the deliver" of Custice, and a conse,uent increase in the number of pending cases+ In addition, the weight of the backlog of older cases creeps upward ever" "ear+ This backlog in the Indian Cudicial s"stem raises pertinent ,uestions as to whether the current regulator" framework in India, as enacted, is ade,uate to enable shareholders to recover their Cust dues+ This concern is also articulated in the recent pleadings )filed in Fanuar" 2070* in the 3nited !tates 'istrict Court, !outhern 'istrict of .ew Hork, on the matter relating to the fraud in the erstwhile !at"am Computer !ervices,8B wherein 3!6based investors were seeking damages from defendants that included, among others, !at"am and its auditors, (ricewaterhouseCoopers )(wC* and has thrown up some ver" interesting and relevant issues+ This case was filed on behalf of investors who had purchased or otherwise ac,uired !at"am%s 1merican 'epositor" !hares )1'!* listed on the .ew Hork !tock &0change and investors, residing in the 3nited !tates, who purchased or otherwise ac,uired !at"am common stock on the .ational !tock &0change of India or the $omba" !tock &0change+ In their pleadings, the plaintiffs submitted declarations of two prominent Indian securities law e0perts/ !andeep (arekh, former
#|,age

&0ecutive 'irector of !&$I, and (rofessor ;ikramadit"a 4hanna of the 3niversit" of =ichigan <aw !chool, a leading e0pert in the 3nited !tates on the Indian legal s"stem, who filed individual affidavits in which the" detailed ver" cogent and compelling reasons as to wh" Indian courts cannot redress the harm done to the Class plaintiffs and wh" India itself does not provide a viable alternative forum for settling the claims of Class members+ In their depositions, among other things, !andeep (arekh and ;ikramadit"a 4hanna have e0plained that/ I The substantive laws of India provide no means of individual or class recover" for private investors in securities fraud matters because the civil courts in India are barred from hearing such cases where, as here, !&$I is empowered to actI &ven if it did provide a substantive means of recover", Indian law provides no viable class action mechanism under which investors% claims can be litigated- and I Indian law does not recogni9e the fraud6on6the6market presumption of reliance in private civil actions, so that, even if both a substantive means of recover" and a viable class action mechanism e0isted under Indian law, investors would still be re,uired to demonstrate individual reliance, thus effectivel" depriving the vast maCorit" of Class members of an" prospect of relief+ 4hanna stated in his declaration48 that DThe length" dela"s in the Indian Fudicial !"stem would leave plaintiff shareholders with effectivel" no recover" even assuming, arguendothere might be a potential cause of action+E

Key Issues in Corporate Governance in India #!are!older$s% and t!e &romoter$s%

anaging t!e "ominant

The primar" difference between corporate governance enforcement problems in India and most western economies )on whose codes the Indian code is largel" modelled* is that the entire corporate governance approach hinges on disciplining the management and making them more accountable+ The Jagenc" gap% in western economies represents the gap between the interests of management and dispersed shareholders and corporate governance norms are aimed at reducing this gap+ >owever, in India the problemAsince the inception of Coint6stock companiesAis the stranglehold of the dominant or principal shareholder)s* who monopoli9e the maCorit" of the compan"%s resources to serve their own needs+ That is, the Jagenc" gap% is

-. | , a g e

actuall" between maCorit" shareholders and other stakeholders+ !econdl", much of global corporate governance norms focus on boards and their committees, independent directors and managing C& succession+ In the Indian business culture, boards are not as empowered as in several western economies and since the board is subordinate to the shareholders, the will of the maCorit" shareholders prevails+ Therefore, most corporate governance abuses in India arise due to conflict between the maCorit" and minorit" shareholders+ This applies across the spectrum of Indian companies with dominant shareholdersA(!3s )with government as the dominant shareholder*, multinational companies )where the parent compan" is the dominant shareholder* and private sector famil"6owned companies and business groups+ In public sector units (PSUs), members of the board and the Chairman are usuall" appointed b" the concerned ministr" and ver" often (!3s are led b" bureaucrats rather than professional managers+ !everal strategic decisions are taken at a ministerial level which ma" include political considerations of business decisions as well+ )The recent case of the (!3 oil companies not being allowed to increase the price of oil products in line with the changes in the international crude prices is an e0ample of how the dominant shareholder, the Indian Government, uses its dominance to force decisions that are not alwa"s linked to business interests+* Therefore, (!3 boards can rarel" act in the manner of an empowered board as envisaged in corporate governance codes+ This makes several provisions of corporate governance codes merel" a compliance e0ercise+ Multinational companies (MNCs) in India are perceived to have a better record of corporate governance compliance in its prescribed form+ >owever, in the ultimate anal"sis, it is the writ of the large shareholder )the parent compan"* which runs the Indian unit that holds swa", even if it is at variance with the wishes of the minorit" shareholders+ =oreover, the compliance and other functions in an =.C is alwa"s geared towards laws applicable to the parent compan" and compliance with local laws is usuall" left to the managers of the subsidiar" who ma" not be empowered for such a role+

-- | , a g e

Family businesses and business groups as a categor" are perhaps the most comple0 for anal"sing corporate governance abuses that take place+ The position as regards famil" domination of Indian businesses has not changed- on the contrar", over the "ears, families have become progressivel" more entrenched in the Indian business milieu+ 1s per a recent stud" b" the global financial maCor Credit !uisse, India ranks higher than most 1sian economies in terms of the number of famil" businesses and the market capitali9ation of Indian famil" businesses as a share of the nominal gross domestic product )G'(* has risen from : per cent in 2007 to 4@ per cent in 2070+ This surve", which also covered China, !outh 4orea, Taiwan, !ingapore, Thailand, >ong 4ong, Indonesia, =ala"sia and the (hilippines, contends that India, with a @G per cent share of famil" businesses, ranks first among the ten 1sian countries studied+ 2urthermore, @@8 of the :B8 listed Indian companies are famil" businesses and account for half of the total corporate hiring and are concentrated in the consumer discretionar", consumer staples and consumer healthcare sectors+ In addition to the corporate governance issues arising from the dominant famil" holding in the Indian business companies, there e0ists an additional comple0it" on account of the promoter control in Indian companies+ Promoters )who ma" not be holding is not to be included in the definition of the (romoter+ Indian law and regulation re,uire that controlling shares* usuall" e0ercise significant influence on matters involving their companies, even though such companies are listed on stock e0changes and hence have public shareholders+ (romoters ma" be in control over the resources of the compan" even though the" ma" not be the maCorit" shareholders and, because of their position, have superior information about the affairs of the compan" than that accessible to non6promoters+ 1s a corollar", in an organi9ation, promoters and non6promoters constitute two distinct groups that ma" have diverse interests+ The !at"am episode illustrated a scenario wherein a compan" with minimal promoter shareholding could still be subCect to considerable influence b" its promoters, thereb" re,uiring a resolution of the agenc" problem between the controlling shareholders and the minorit" shareholders, even though such problems were not normall" e0pected to arise at the low shareholding levels of the managing group+ n G Fanuar" 200:, when the Chairman of !at"am Computer !ervices, $+ Ramalinga RaCu, admitted that there had been a s"stematic inflation of cash on the compan"%s balance sheet over a period of some seven "ears,

-2 | , a g e

amounting to almost K7+? billion, the RaCu famil", who were the promoters of !at"am, held onl" about ? per cent of the shares+ 1 compan" with ? per cent promoter shareholding will usuall" be considered as belonging to the outsider model in terms of diffused shareholding, and hence would re,uire the correction of agenc" problems between shareholders and managers+ >owever, despite the gradual decrease in the percentage holdings of the controlling shareholders, the concept of Jpromoter% under Indian regulations made the distinction between an insider6t"pe compan" and an outsider6t"pe compan" somewhat ha9" in this conte0t, and the RaCu famil", as promoters, continued to wield significant powers in the management of the compan" despite a drastic drop in their shareholdings over the preceding few "ears+ 2urthermore, at !at"am, the diffused nature of the remaining shareholding of the compan" helped the promoter group to consolidate and e0ercise power that was disproportionate to their voting rights- while the institutional shareholders collectivel" held a total of @0 per cent shares as of 87 'ecember 200B in !at"am, the highest individual shareholding of an institutional shareholder was onl"+G@ per cent+ !hah believes that companies wherein controlling shareholders hold limited takes could be particularl" vulnerable to corporate governance failures and adds that promoters who are in the twilight 9one of control, that is, where the" hold shares less than those re,uired to comfortabl" e0ercise control over the compan", have a perverse incentive to keep the corporate performance and stock price of the compan" at high levels so as to thwart an" attempted takeover of the compan"+ The !at"am case clearl" demonstrates the inabilit" of the e0isting corporate governance norms in India to deal with corporate governance failures in famil"controlled companies, even where the level of promoter shareholding is relativel" low+ 2uture governance reforms thus need to address the matter of promoters with minorit" shareholding, who are in effective control of managements in such companies that lie at the cusp of insider and outsider s"stems+

Enforcement for non'compliance of Corporate Governance Norms

#hile much has been talked on the polic" aspect of the Corporate Governance, at present monitoring of the compliance of the same is done onl" through disclosures in the annual
-3 | , a g e

report of the compan" and periodic disclosures of the various clauses of Clause 4: of the <isting 1greement on the stock e0change website+ L 1s per Clause 4: of the <isting 1greement, there should be a separate section on Corporate Governance in the 1nnual Reports of listed companies, with detailed compliance report on Corporate Governance+ The companies should also submit a ,uarterl" compliance report to the stock e0changes within 7? da"s from the close of ,uarter as per the prescribed format+ The report shall be signed either b" the Compliance fficer or the Chief &0ecutive fficer of the compan"+ L The listed companies should obtain a certificate from either the auditors or practicing compan" secretaries regarding compliance with all the clauses of Clause 4: and anne0 the certificate with the directors% report, which is sent annuall" to all the shareholders of the compan"+ The same certificate shall also be sent to the !tock &0changes along with the annual report filed b" the compan"+ !tock e0changes are re,uired to send a consolidated compliance report to !&$I on the compliance level of Clause 4: b" the companies listed in the e0changes within @0 da"s from the end of each ,uarter+ L <isting 1greement is essentiall" an agreement between e0changes and the listed compan"+ $!& and .!& have listing departments, which oversee the compliances with the provisions of listing agreement+ .on6submission of corporate governance report ma" result in suspension in trading of the scrip+ 1s per the norms laid b" $!&, the securities of the compan" would trigger suspension for non6submission of Corporate Governance report for 2 consecutive previous ,uarters or late submission of Corporate Governance report for an" 2 out of 4 consecutive previous ,uarters+ 2or violations of the provisions of listing 1greement, following course of actions b" !&$I is possible/ 'elisting or suspension of securities 1dCudication for lev" of monetar" penalt" on companies5directors5promoters b" !&$I (rosecution 'ebarring directors5promoters from accessing capital market or being associated with listed companies+
-7 | , a g e

'elisting or suspension is generall" not considered an investor friendl" action and therefore, cannot be resorted to as a matter of routine and can be used onl" in cases of e0treme 5 repetitive non6compliance+ (rosecution, on the other hand, is a costl" and time6consuming process+ In order to strengthen the monitoring of the compliance, following measures ma" be considered/ Carr"ing out of Corporate Governance rating b" the Credit Rating 1gencies+ Inspection b" !tock &0changes5 !&$I5 or an" other agenc" for verif"ing the compliance made b" the companies+ Imposing penalties on the Compan"5its $oard of 'irectors5Compliance fficer54e"

=anagerial (ersons for non6compliance either in sprit or letter (resentl", provisions of listing agreement are being converted into Regulations for better enforcement+

Companies (ill) *+,, and its Impact on Corporate Governance in India

The foundations of the comprehensive revision in the Companies 1ct, 7:?@ was laid in 2004 when the Government constituted the Irani Committee to conduct a comprehensive review of the 1ct+ The Government of India has placed before the (arliament a new Companies $ill, 2077 that incorporates several significant provisions for improving corporate governance in Indian companies which, having gone through an e0tensive consultation process, is e0pected to be approved in the 2072 $udget session+ The new Companies $ill, 2077 proposes structural and fundamental changes in the wa" companies would be governed in India and incorporates various lessons that have been learnt from the corporate scams of the recent "ears that highlighted the role and importance of good governance in organi9ations+ !ignificant corporate governance reforms, primaril" aimed at improving the board oversight process, have been proposed in the new Companies $ill- for instance it has proposed, for the first time in Compan" <aw, the concept of an Independent 'irector and all listed companies are re,uired to appoint independent directors with at least one third of the $oard of such companies comprising of independent directors+ The Companies $ill, 2077 takes the concept of board independence to another level altogether as it devotes two sections@7 to deal with Independent 'irectors+ The definition of an Independent 'irector has been considerabl"
-2 | , a g e

tightened and the definition now defines positive attributes of independence and also re,uires ever" Independent 'irector to declare that he or she meets the criteria of independence+ In order to ensure that Independent 'irectors maintain their independence and do not become too familiar with the management and promoters, minimum tenure re,uirements have been prescribed+ The initial term for an independent director is for five "ears, following which further appointment of the director would re,uire a special resolution of the shareholders+ >owever, the total tenure for an independent director is not allowed to e0ceed two consecutive terms+ In order to balance the e0tensive nature of functions and obligations imposed on Independent 'irectors, the new Companies $ill, 2077 seeks to limit their liabilit" to matters directl" relatable to them and limits their liabilit" to Donl" in respect of acts of omission or commission b" a compan" which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligentl"E+ In the background of the current provisions in the Companies 1ct, 7:?@ which do not provide an" clear limitation of liabilit" and have left it to be interpreted b" Courts, it is helpful to provide a limitation of liabilit" clause+ The new $ill also re,uires that all resolutions in a meeting convened with a shorter notice should be ratified b" at least one independent director which gives them an element of veto power+ ;arious other clauses such as those on directors% responsibilit" statements, statement of social responsibilities, and the directors% responsibilities over financial controls, fraud, etc, will create a more transparent s"stem through better disclosures+ 1 maCor proposal in the new $ill is that an" undue gain made b" a director b" abusing his position will be disgorged and returned to the compan" together with monetar" fines+ ther significant proposals that would lead to better corporate governance include closer regulation and monitoring of related6part" transactions, consolidation of the accounts of all companies within the group, self6declaration of interests b" directors along with disclosures of loans, investments and guarantees given for the businesses of subsidiar" and associate companies+ 1 significant first, in the proposals under the new Companies $ill, is the provision that has been made for class action suits- it is provided that specified number of members ma" file an application before the Tribunal on behalf of members, if the" feel that the management or control of the affairs of the compan" are being conducted in a manner preCudicial to the interests of the compan" or its members+ The order passed b" the Tribunal would be binding
-6 | , a g e

on the compan" and all its members+ The enhanced investor protection framework, proposed in the $ill, also empowers small shareholders who can restrain management from actions that the" believe are detrimental to their interests or provide an option of e0iting the compan" when the" do not concur with proposals of the maCorit" shareholders+ The Companies $ill, 2077 seeks to provide clarit" on the respective roles of !&$I and the =C1 and demarcate their roles M while the issue and transfer of securities and non6pa"ment of dividend b" listed companies or those companies which intend to get their securities listed shall be administered b" the !&$I all other cases are proposed to be administered b" the Central Government+ 2urthermore, b" focusing on issues such as &nhanced 1ccountabilit" on the part of Companies, 1dditional 'isclosure .orms, 1udit 1ccountabilit", (rotection for =inorit" !hareholders, Investor (rotection, !erious 2raud Investigation Governance reforms in India+ ffice )!2I * in the new Companies $ill, 2077, the =C1 is e0pected to be at the forefront of Corporate

- |,age

IN#-I-.-I/N01 IN2E#-/R#
-opology of t!e institutional investors3 community in India "evelopment Financial Institutions
!tarting in 7:4B and throughout the 7:?0s and 7:@0s, the Government of India )G I* established three 'evelopment 2inancial Institutions )'2Is* to cater to the long6term finance needs of the countr"%s industrial sector+ These were I2CI, the first '2I set up in 7:4B, ICICI, established in 7:?? and I'$I, which was established in 7:@4+ The Reserve $ank of India )R$I* and the G I nurtured these three '2Is through financial incentives and other supportive polic" measures+ The" were provided with low6cost funds which the" on6lent to industr" at subsidi9ed rates+ The" were also allowed to issue bonds guaranteed b" the Government+ The Reserve $ank of India )R$I* allocated a substantial part of its .ational Industrial Credit )<ong Term perations* funds to I'$I+ 'uring the 7:G0s and 7:B0s, the availabilit" of subsidi9ed loans and ta0 incentives gave rise to mushrooming of new proCects with meagre capital inputs from promoters+ This created a moral ha9ard problem, and the resultant accumulation of nonperforming assets in the '2I portfolios+ 2or e0ample, I2CI reported 82+8 percent of total assets to be non6performing as of =arch 2004+ !ince the earl" 7::0s, there have been several changes in the Government%s attitude towards the '2Is when financial sector liberali9ation began+ The '2Is no longer have access to subsidi9ed funds or budgetar" support?+ In addition, the" faced competition in the areas of term finance from banks offering lower rates+ The change in operating environment coupled with accumulation of nonperforming assets caused serious financial stress to the term6lending institutions, particularl" for I2CI+ 1 restructuring package has been put into effect b" the G I and endorsed b" the I2CI $oard which has agreed in principle to a merger with (unCab .ational $ank+ In 2002, ICICI merged with ICICI $ank and is now a widel"6held listed bank with foreign institutional investors holding 48+@4 percent of the e,uit" as of =arch 87, 200?+ !imilarl", in 'ecember 2008, the I'$I )Transfer of 3ndertaking and Repeal* 1ct 2008 was passed b" (arliament to transform I'$I into a banking compan"+ I'$I <td+ is now registered as a compan" under the Companies 1ct, 7:?@ to carr" out banking business in accordance with the provisions of the $anking Regulation 1ct, 7:4:+
-3 | , a g e

Two other maCor groups of Government6owned financial institutions have had a maCor impact on e,uit" investment trends in India+ The first group consists of state6owned life and non6life insurance corporations- the second group is made up of the public sector mutual funds+

#tate'owned insurance companies

The nationali9ation of insurance business in India resulted in the establishment of the <ife Insurance Corporation )<IC* in 7:?@ as a wholl"6owned corporation of the Government of India+ The Government of India consolidated 240 private life insurers and provident societies, and <IC came into being+ <IC currentl" offers over ?0 plans to cover life at various stages through a network of 2,04B branches+ $esides conducting insurance business, <IC invests a maCor portion of its funds in Government and other approved securities, e0tends assistance to infrastructure proCects and provides financial assistance to the corporate sector through term loans and underwriting5direct subscription to corporate shares and debentures+ The nationali9ation of the non6life insurance sector resulted in the formation of the General Insurance Corporation )GIC* in 7:G8+ GIC was set up as a holding compan" ith four subsidiaries )de6linked since 2000*, .ew India 1ssurance ).I1*, .ational Insurance Corporation ).IC*, riental India Insurance ) IC*, and 3nited India Insurance )3II*+ .IC, incorporated in 7:0@, was nationali9ed in 7:G8 following the amalgamation of 22 foreign and 77 Indian insurance companies+ .I1, incorporated in 7:7: and nationali9ed in 7:G8, had a pioneering presence in the Indian insurance sector+ It insured India%s first domestic airlines and was responsible for the entire satellite insurance program of the countr"+ 3II was formed in 7:G8 following the merger of 22 private insurance companies+ 1s of =arch 87, 2004, it had a market share of 22 percent among (!3 insurers+ IC was incorporated in 7:4G and nationali9ed in 7:G8+ It offers special covers for large proCects like power plants, petrochemical, steel and chemical plants+ GIC and its erstwhile subsidiaries also provide financial assistance to the corporate sector through term loans and direct subscription to corporate shares and debentures+

-# | , a g e

&rivate sector insurance companies

In 7::8, the =alhotra Committee was set up to evaluate the insurance industr" and recommend future directions+ The committee submitted its report in 7::4+ Its maCor recommendations included )i* )ii* reduction of Government shareholding in the state owned insurance companies to ?0 percent, and a break up of GICallowing private companies with a minimum paid up capital of I.R 7 billion to enter industr", as well as foreign companies in collaboration with domestic companies- and )iii* setting up an insurance regulator" bod"77+ In 2000, GIC%s supervisor" role over its subsidiaries was e0tinguished and GIC was re6designated DIndian Re6insurerE to function e0clusivel" as life and non6life re6insurer+ In =arch 2002, GIC ceased to be a holding compan" for its subsidiaries and their ownership was vested with the Government of India+ In 1pril 2002, the Insurance Regulator" and 'evelopment 1uthorit" )IR'1* came into being+ IR'1 is responsible for registering private insurance companies and framing regulations for the industr"+ The Insurance Regulator" and 'evelopment 1uthorit" )IR'1* 1ct allows foreign companies a 2@ percent e,uit" stake in Indian insurance companies+ 1s on Fune 200?, there were 74 life insurance companies, 74 non6life insurance companies, and one reinsurer )GIC* registered with IR'1+ The <ife Insurance Corporation of India )<IC* is the onl" life insurer in the public sector+ &leven of the 78 private companies have an 2'I owning 2@ percent of their e,uit", one )>'2C* has an 7B+@0 percent foreign shareholder, and !ahara India is wholl" Indian owned+ !even of the eight private companies in the general insurance sector have foreign e,uit" holdings of 2@ percent+ The onl" one that does not is Reliance General Insurance Co+ <td+ f the 78 companies in the private life insurance sector, onl" one, namel" !ahara India, does not have a foreign promoter+ The public sector still holds the overwhelming market share of premiums underwritten+ f

the total premiums )first "ear premiums and renewal premiums* in 2002608, the <IC had
2. | , a g e

:?+2: percent of the market share while the private sector had Cust 4+G7 percent+ In the non6 life segment, the new insurers held a market share of 78 percent+

utual funds and FIIs

The Indian mutual fund industr" came into being in 7:@8 with the formation of 3nit Trust of India, at the initiative of the Government of India and R$I+ The histor" of mutual funds in India can be broadl" divided into four distinct phases7@+ In the first phase from 7:@4 to 7:BG, 3TI was the onl" mutual fund operating in India+ In the second phase between 7:BG and 7::8, public sector banks and insurance companies were permitted to set up mutual funds+ !tate $ank of India, (unCab .ational $ank, Canara $ank, Indian $ank, $ank of $aroda, $ank of India, <IC and GIC all set up mutual funds+ The third phase between 7::8 and 2008 saw the entr" of private sector mutual funds+ 1s of Fanuar" 2008, there were 88 mutual funds with total assets of I.R 727B+0? billion+ The 3nit Trust of India with I.R 44?+47 billion of assets under management was the largest+ The fourth phase starting in 2008 saw the beleaguered 3TI being split into two separate entities+ India opened its stock markets to foreign institutional investors )2II* in !eptember 7::2+ 2II include, among others, pension funds, mutual funds, asset management companies, investment trusts, institutional portfolio managers, banks and insurance companies, proposing to invest in India as Dbroad6based fundsE )with at least 20 investors, each of them not holding no more than 70 percent of the 2II fund*+ The total number of 2II registered with !&$I crossed G00 in =a" 200?+ The entr" and dominance of private sector mutual funds and 2IIs in the last decade completes the transition from a highl" leveraged Indian corporate sector heavil" dependent on the '2Is, to an increasingl" market6based s"stem+

2- | , a g e

1EG01 0N" REG.10-/R4 FR0 E5/RK F/R IN#-I-.-I/N01 IN2E#-/R#

Institutional #tructure of Regulation (anks and "FIs
$anks and '2Is fall under the oversight of the R$I, with an implicit regulator" role pla"ed b" the =inistr" of 2inance+ The main legislation governing banks and '2Is is the Reserve $ank 1ct, 7:84 and the $anking Regulation 1ct )7:4:*+ 1s discussed in the previous sections, the 1cts of (arliament governing I'$I and 3TI were repealed in 2002 and 2004 to facilitate conversion of I'$I into a banking entit" and into market6linked mutual fund respectivel"+

Insurance companies
In the insurance sector, the two largest government6owned insurance companies6 <IC and GIC were set up under 1cts of (arliament+ $oth these institutions fall under the regulation and supervision of both the =inistr" of 2inance and the insurance regulator, the Insurance Regulator" and 'evelopment 1uthorit" )IR'1*+ regulator IR'1 in 7:::+ ther public sector insurers and private sector insurers fall under the purview of the Insurance 1ct and regulations issued b" the

utual Funds and Foreign Institutional Investors

The regulator" framework for domestic mutual funds and foreign institutional investors consists of the =utual 2und Regulations )7::2* and the 2II Regulations )7::4*, issued and enforced b" !&$I+ The regulations la" down the minimum eligibilit" criteria for entr", net worth standards, and disclosure norms+ In addition mutual funds and foreign institutional investors are e0pected to follow a code of conduct that conforms to guidelines issued b"
22 | , a g e

!&$I+ The code of conduct la"s out the broad principles of proper business conduct and functioning of the intermediaries+ In 7::@, all mutual funds e0cept 3TI came within the purview of the !&$I )=utual 2und* Regulations, 7::@+ 3TI which was set up under an 1ct of (arliament was not under the regulator" purview of !&$I until 2002 when the 3TI 1ct was repealed and the fund was split into 3TI6I and 3TI6II+ Thereafter, 3TI I and II were brought under the regulator" purview of !&$I+ The 1ssociation of =utual 2unds of India )1=2I* is the self6regulator" organi9ation )!R * set up in 7::G+ It is involved in a* recommending and promoting best business practices and code of conduct to be followed b" mutual funds- and b* interacting with !&$I on all matters concerning the industr"+ In addition 1=2I is addresses specific technical issues faced b" the mutual fund industr" such as developing valuation norms for illi,uid securities+ 1mongst other activities conducted b" the 1=2I are administering the certification e0aminations for persons involved in the mutual fund industr" which includes emplo"ees of the asset management companies and the various brokers, distributors of mutual fund products+ The 1=2I is also involved in investor education and awareness building+ !&$I issued the 2II regulations in .ovember 7::?, based on guidelines issued b" the G I in 7::2+ The regulations mandate the registration of foreign institutional investors with !&$I+ The 2IIs were initiall" permitted access to primar" and secondar" markets for securities and mutual fund products, with a stipulated minimum G0 percent investment in e,uit"+ The initial ceilings on the ownership of an" firm were ? percent for a single 2II and 24 percent for all 2IIs taken as a group+ Individual ceiling on ownership has been eased to 70 percent since 2ebruar" 2000, and the overall ceiling for all 2IIs was removed in !eptember 2007 in favor of sectoral caps subCect to shareholder resolution+ 2IIs have also been permitted to invest in corporate and government bonds, and in derivative securities+ 2urther, foreign firms and individuals have been permitted access to the Indian markets through 2IIs as Dsub6accountsE since 2ebruar" 2000+ In the "ear 2008, earlier limitations on 2II hedging currenc" risk using currenc" forwards were removed, and 2II approval was streamlined and vested solel" in !&$I, instead of !&$I and R$I as re,uired earlier+

23 | , a g e

&ension Funds Industry

1 new 'efined Contribution pension s"stem has been introduced, which is applicable to all Government emplo"ees recruited after Fanuar" 7, 2004+ This .ew (ension !"stem will be regulated b" (ension 2und Regulator" and 'evelopment 1uthorit" )(2R'1* promulgated through an ordinance on 'ecember 80, 2004+ The (2R'1%s role is to license and supervise pension fund managers, la" down guidelines on the number of market participants, prudential norms, investment criteria and capital re,uirements of pension fund managers+ (2R'1 is also e0pected to issue 2'I caps for the pension sector+ It is e0pected that initial investments in e,uit" will be somewhat limited+ 1ll pre6Fanuar" 2004 emplo"ees can also voluntaril" Coin the new scheme to get an additional benefit+ !imilarl", all those covered b" the &mplo"ees (rovident 2und )&(2* will continue in it, but can voluntaril" Coin the new scheme to+ To a large e0tent, the new pension schemes will resemble mutual funds, and subscribers will have a choice of parking their savings )a* predominantl" in e,uit", )b* debt N e,uit" mi0, or )c* entirel" in debt instruments and Government paper+ =an" of the maCor pla"ers in the mutual fund and the insurance industr" are set to enter the pension sector, e0pected to grow to I.R ?00 billion b" 2070+

27 | , a g e

(oard representation6Clause 78
The regulator" framework governing the boards of directors of Indian corporations is set out in Chapter II )sections 2?2 to 2@:* of the Companies 1ct, 7:?@+ In addition, Clause 4: of the <isting Rules issued b" !&$I, which is implemented on a Dcompl" or e0plainE basis, also provides a framework for the board of directors of listed companies+ $oard members have a fiduciar" obligation to treat all shareholders fairl"+ 1t least two6thirds of the board of directors should be rotational+ ne6third of the board consists of permanent directors+ These include promoters, e0ecutive directors and nominee directors+ Clause 4: applies to all listed companies with paid up share capital of at least I.R 80 million8@ )3!' @@0,000* or that have had a net worth of I.R 2?0 million )3!' ?+? million*+ There are mandator" and non6 mandator" re,uirements+

Independent "irectors
ne of the fundamental innovations of Clause 4: was to introduce the concept of independent directors in the Indian corporate governance framework, further to the recommendation of the 4umaramangalam $irla Committee Report on Corporate Governance )The 4umaramangalam Committee* in 2000, and the additional recommendations of The .ara"ana =urth" Committee in 2008+ In this framework, the members of the modern Indian board are Cointl" and severall" accountable to all shareholders without distinction, and hold the fiduciar" position of a trustee for the compan"+ The" ensure the strategic guidance of the compan" and monitor management+ !takeholders, including creditors, are protected b" contract law and specific legislation+ !ection I1 of Clause 4: re,uires issuers to have at least one6third independent directors on their boards, if the functions of chairman of the board and C& are decoupled, and ?0 percent otherwise+ The updated Clause 4: defines an independent director as a non6e0ecutive director who, )a* apart from receiving director%s remuneration, does not have an" material pecuniar" relationships or transactions with the compan", its promoters, its senior management or its holding compan", its subsidiaries and associated companies)b* is not related to promoters or management at the board level or at one level below the board22 | , a g e

)c* has not been an e0ecutive of the compan" in the immediatel" preceding three financial "ears)d* is not a partner or an e0ecutive of the statutor" audit firm or the internal audit firm that is associated with the compan", and has not been a partner or an e0ecutive of an" such firm for the last three "ears+ This will also appl" to legal firm)s* and consulting firm)s* that have a material association with the entit")e* is not a supplier, service provider or customer of the compan"+ This should include lessor6 lessee t"pe relationships also- and )f* is not a substantial shareholder of the compan", i+e+ owning two percent or more of the voting shares+ It also caps to three terms of three "ears the mandates of independent directors+

Nominee "irectors
1s discussed earlier, a series of '2Is were created b" 1cts of (arliament to support the development of industrial companies, b" e0tending loans to the latter or subscribing to debentures issues+ To protect the public institutions% investments and e,uip it with effective risk management tools, each founding 1ct of (arliament of the '2I stipulated that the latter should insert two specific clauses in their loan agreements, s"stematicall"/ )7* a convertibilit" clause, which allowed the '2I to convert its loan5debenture into e,uit" and hence allowed the '2I to take control of the corporation*, if the compan" defaulted on its debt obligation to the '2I- and )2* a Dnominee director clauseE, which gave the '2I the right to appoint one or more directors to the board of the borrowing compan"+ In =arch 7:B4, the $anking 'ivision of the =inistr" of 2inance, 'epartment of Compan" 1ffairs issued its (olic" Guidelines relating to !tipulation of Convertibilit" Clause and 1ppointment of .ominee 'irectors+ The guidelines specified that DI'$I, I2CI, ICICI and IRCI should create a separate Cell the e0clusive and whole6time function of which would be to represent the institutions on the $oards of Companies+ nominee directors onl" as additional directors were needed+ .ominee directors should be appointed on the $oards of all =RT( companies assisted b" the institutions+ 1s regard non6=RT( companies, nominee directors should be appointed on a selective basis, especiall" when one or more of the following conditions prevail/ )a* the unit is running into problems and is likel" to become sick)b* institutional holding is more than 2@ percent- and
26 | , a g e

utsiders should be appointed as

)c* where the institutional stake b" wa" of loans5investment e0ceeds I.R ?0 million+ The Guidelines further stipulated that Dnominee directors should be given clearl" identified responsibilities in a few areas which are important for public polic"E+ 1n illustrative list of such responsibilities was provided, including / )a* financial performance of the compan")b* pa"ments of dues to the institutions)c* pa"ment of government dues, including e0cise and custom duties, and statutor" dues)d* inter6corporate investment in and loans to or from associated concerns in which the promoter group has significant interest)e* all transaction in shares)f* e0penditure being incurred b" the compan" on management group- and )g* policies relating to the ward of contracts and purchase and sale of raw materials, finished goods, machiner", etc+ In addition the Guidelines specified that Dthe nominee directors should ensure that the tendencies of the companies towards e0travagance, lavish e0penditure and diversion of funds are curbed+ #ith a view to achieve this obCect, the institutions should seek constitution of a small 1udit sub6committee of the board of directors for the purpose of periodic assessment of e0penditure incurred b" the assisted compan", in all cases where the paid6up capital of the compan" is I.R ?0 million or more+ The institutional nominee director will invariabl" be a member of this 1udit !ub6committee+ Considering that the practice of audit committees onl" became accepted internationall" as best practice in the late 7::0s, the =inistr" of 2inance )= 2* Guidelines were in some respect ahead of their time+ >owever, !ection 80+1 of of the Industrial 'evelopment $ank of India 1ct, )7:@4* stipulated that nominee directors would not )7* be subCect to Dthe provisions of the Companies 1ct, or to provisions of the memorandum, articles of associations or an" other instrument relating to the industrial concern, nor an" provisions regarding share ,ualifications, age6limit, number of directorships, or removal from officeE- and )2* incur an" obligation or liabilit" be reason onl" of his being a director or for an"thing done or omitted to be in good faith in the discharge of his duties as a director or an"thing in relation theretoE+ >ence, nominee directors were not Cointl" and severall" responsible to shareholders for the actions of the board+

2 |,age

In 7::7, the =onopolies and Restrictive Trade (ractices 1ct, 7:@: )=RT( 1ct* was amended+ (rovisions relating to concentration of economic power and pre6entr" restrictions with regard to prior approval of the Central Government for establishing new undertaking, e0panding on e0isting undertaking, amalgamations, mergers and takeovers of undertakings were all deleted from the statute through the amendments+ The causal thinking in support of the 7::7 amendments is contained in the !tatement of 7::7 1mendment $ill in the (arliament47+ 2inall", in 'ecember 2008, the Industrial 'evelopment $ank )Transfer of 3ndertaking and Repeal* 1ct, 2008 provided for the transfer and vesting of the undertaking of the Industrial 'evelopment $ank of India to, and in I'$I $ank+ >owever, !ection 7? of 1ct ?8 grandfathered the immunit" e0tended to nominee directors+ !pecificall", section 7? stipulated that Dnotwithstanding the repeal of the Industrial 'evelopment 1ct, 7:@4, the provisions of !ection 801 of the 1ct so repealed will continue to be applicable in respect of the arrangement entered into b" the 'evelopment $ank with an industrial concern up to the appointed da" and the Compan" OIndustrial 'evelopment $ank of IndiaP will be entitled to act upon and enforce the same as full" and effectuall" as if this 1ct has nor been repealedE+ In 2008, The 4umara =angalam $irla Committee recommended that institutions should appoint nominees on the boards of companies onl" on a selective basis, where such appointment is pursuant to a right under loan agreements or where such appointment is considered necessar" to protect the interest of the institution+ It further recommended that when a nominee of an institution is appointed as a director of the compan", he should have the same responsibilit", be subCect to the same discipline and be accountable to the shareholders in the same manner as an" other director of the compan"+ In addition, if the nominee director reports on the affairs of the compan" to a department of the institution that nominated him on the board of the portfolio compan", the institution should ensure that there e0ist Chinese walls between such department and other departments which ma" be dealing in the shares of the compan" in the stock market+ The .ara"an =urth" Committee felt that the institution of nominee directors whether from investment institutions or lending institutions creates a conflict of interest+ The Committee recommended that nominee directors should not be considered as independent and stressed that it is necessar" that all directors, whether representing institutions or otherwise, should have the same responsibilities and liabilities as other directors+ bCects and Reasons appended to the

23 | , a g e

>owever, as discussed in !ection ;, the final guidelines issued b" !&$I in Clause 4: suggest that nominee directors whether from lending or investment institutions shall be deemed to be independent directors+

R/1E /F IN#-I-.-I/N01 IN2E#-/R#

Corporate governance codes and guidelines have long recognised the important role that institutional investors have to pla" in corporate governance+ The effectiveness and credibilit" of the entire corporate governance s"stem and the compan" oversight to a large e0tent depends on the institutional investors who are e0pected to make informed use of their shareholders% rights and effectivel" e0ercise their ownership functions in companies in which the" invest+ Increased monitoring of Indian listed corporations b" institutional investors will drive the former to enhance their corporate governance practices, and ultimatel" their abilit" to generate better financial results and growth for their investors+ 1t present, there are four main issues with role of institutional investor and corporate governance/ Issues relating to disclosure b" institutional investors of their corporate governance and voting policies and voting records Issues relating to the disclosure of material conflicts of interests which ma" affect the e0ercise of ke" ownership rights 2ocus on increasing the si9e of assets under management rather than on improving the performance of portfolio companies+ Institutional investors are becoming increasingl" short6term investors+

!everal countries mandate their institutional investors acting in a fiduciar" capacit" to disclose their corporate governance policies to the market in considerable details+ !uch disclosure re,uirements include an e0planation of the circumstances in which the institution will intervene in a portfolio compan"- how the" will intervene- and how the" will assess the effectiveness of the strateg"+ In most &C' countries, Collective Investment !chemes )CI!* are either re,uired to disclose their actual voting record, or it is regarded as good practice and implemented on an Dcompl" or e0plainE basis+ In addition, (rinciple 7G of the &C' (rinciples calls for institutional investors acting in a fiduciar" capacit" to disclose their overall corporate governance and voting policies with
2# | , a g e

respect to their investments, including the procedures that the" have in place for deciding on the use of their voting rights+ !&$I has recentl" re,uired listed companies to disclose the voting patterns to the stock e0changes and 1sset =anagement Companies of =utual 2unds to disclose their voting policies and their e0ercise of voting rights on their web6sites and in 1nnual Reports+ =inistr" of Corporate 1ffairsQ )=C1* initiative on &6voting will also enable scattered minorit" shareholders to e0ercise voting rights in General =eetings+ a) Institutional in estors s!ould !a e a clear policy on oting and disclosure o" oting acti ity Institutional investors should seek to vote on all shares held+ The" should not automaticall" support the board+ If the" have been unable to reach a satisfactor" outcome through active dialogue then the" should register an abstention or vote against the resolution+ In both instances, it is good practice to inform the compan" in advance of their intention and the reasons thereof+ Institutional investors should disclose publicl" voting records and if the" do not, the reasons thereof+ b) Institutional in estors to !a e a robust policy on managing con"licts o" interest 1n institutional investorQs dut" is to act in the interests of all clients and5or beneficiaries when considering matters such as engagement and voting+ Conflicts of interest will inevitabl" arise from time to time, which ma" include when voting on matters affecting a parent compan" or client+ Institutional investors should formulate and regularl" review a polic" for managing conflicts of interest+ c) Institutional in estors to monitor t!eir in estee companies Investee companies should be monitored to determine when it is necessar" to enter into an active dialogue with their boards+ This monitoring should be regular and the process should be clearl" communicable and checked periodicall" for itseffectiveness+ 1s part of these monitoring, institutional investors should/ !eek to satisf" themselves, to the e0tent possible, that the investee compan"Qs board and committee structures are effective, and that independent directors provide ade,uate oversight, including b" meeting the chairman and, where appropriate, other board members =aintain a clear audit trail, for e0ample, records of private meetings held with companies, of votes cast, and of reasons for voting against the investee compan"Qs

3. | , a g e

management, for abstaining, or for voting with management in a contentious situation- and 1ttend the General =eetings of companies in which the" have a maCor holding, where appropriate and practicable+ Institutional investors should consider carefull" the e0planations given for departure from the Corporate Governance Code and make reasoned Cudgements in each case+ The" should give a timel" e0planation to the compan", in writing where appropriate, and be prepared to enter a dialogue if the" do not accept the compan"Qs position+ Institutional investors should endeavor to identif" problems at an earl" stage to minimise an" loss of shareholder value+ If the" have concerns the" should seek to ensure that the appropriate members of the investee compan"Qs board are made aware of them+ Institutional investors ma" not wish to be made insiders+ The" will e0pect investee companies and their advisers to ensure that information that could affect their abilit" to deal in the shares of the compan" concerned is not conve"ed to them without their agreement+ d) Institutional in estors to be #illing to act collecti ely #it! ot!er in estors #!ere appropriate 1t times collaboration with other investors ma" be the most effective manner to engage+ Collaborative engagement ma" be most appropriate during significant corporate or wider economic stress, or when the risks posed threaten the abilit" of the compan" to continue+ Institutional investors should disclose their polic" collective engagement+ #hen participating in collective engagement, institutional investors should have due regard to their policies on conflicts of interest and insider information+ e) Institutional in estors to establis! clear guidelines on #!en and !o# t!ey #ill escalate t!eir acti ities as a met!od o" protecting and en!ancing s!are!older alue Institutional investors should set out the circumstances when the" will activel" intervene and regularl" assess the outcomes of doing so+ Intervention should be considered regardless of whether an active or passive investment polic" is followed+ Initial discussions should take place on a confidential basis+ >owever, if boards do not respond constructivel" when institutional investors intervene, then institutional investors will consider whether to escalate their action, for e0ample, b" L holding additional meetings with management specificall" to discuss concerns e0pressing concerns through the compan"Qs advisers-

3- | , a g e

meeting with the chairman, senior independent director, or with all independent directorsintervening Cointl" with other institutions on particular issuesmaking a public statement in advance of the 1G=submitting resolutions at shareholdersQ meetings- etc+ oting

") Institutional in estors to report periodically on t!eir responsibilities and acti ities

Those who act as agents should regularl" report to their client%s details of how the" have discharged their responsibilities+ !uch reports ma" comprise of ,ualitative as well as ,uantitative information+ The particular information reported, including the format in which details of how votes have been cast are presented, should be a matter for agreement between agents and their principals+ Those that act as principals, or represent the interests of the end6investor, should report at least annuall" to those to whom the" are accountable on their polic" and its e0ecution+ <ike 3! funds, Indian asset management funds are now re,uired to disclose their general policies and procedures for e0ercising the voting rights in respect of the shares held b" them on their websites as well as in the annual report distributed to the unit holders from the financial "ear 2070677+ >owever, there is onl" a marginal increase in for5against votes and man" funds fail to even attend meetings and have abstention as a polic"+ &ven among funds that voted, there is little alignment between the votes and the voting polic"+ In view of above, e0isting polic" need to be e0amined+ It ma" be deliberated on how to create incentives for institutional investors that invest in e,uities to become more active in the e0ercise of their ownership rights, without coercion, without imposing illegitimate costs on them, and given India%s specific situation+ 2und houses should be mandated to adopt the global practice of ,uarterl" vote reporting and fund6wise vote reporting and to adopt detailed voting policies+ 2urther, vote reporting b" fund houses should also be subCect to audit+

32 | , a g e

-!e role of institutional investors in ot!er countries:

!everal countries mandate their institutional investors acting in a fiduciar" capacit" to disclose their corporate governance policies to the market in considerable details+ !uch disclosure re,uirements include an e0planation of the circumstances in which the institution will intervene in a portfolio compan"- how the" will intervene- and how the" will assess the effectiveness of the strateg"+ In most &C' countries, Collective Investment !chemes )CI!* are either re,uired to disclose their actual voting record, or it is regarded as good practice and implemented on an Dappl" or e0plainE basis+ Table 2 below summari9es current practices in 1ustralia, 2rance, Ital", (ortugal, !weden, !wit9erland, the 34, and the 3!+

33 | , a g e

Country $ustralia

France

Italy

Portugal

S#eden

S#it%erland

U&

US

37 | , a g e

Current practice There is no obligation under applicable law for fund managers or trustees to attend shareholders meetings or vote on resolutions+ >owever, the Investment and 2inancial !ervices 1ssociation )I2!1* recommends that its members, as a matter of good practice, should ORP vote on all material issues at all 1ustralian compan" meetings where the" have the voting authorit" and responsibilit" to do so- and have a written polic" on the e0ercise of pro0" voting+, 2rance The 2rench association 12G61!22I considers it ver" The 2rench association 12G61!22I considers it ver" important for asset management portfolio companies to develop voting guidelines, including voting criteria on resolutions+ The 12G61!22I also strongl" encourages CI! operators to e0ercise voting rights and account for this e0ercise in CI! annual reports+ The Italian 1sset management 1ssociation has issued guidelines Dre,uiring asset management companies to formali9e and keep appropriate records showing the decision6making process followed in e0ercising the voting and other rights attached to financial instruments under management and the reasons for the decisions where the vote concerns a compan" belonging to the same group as the !GR+ The position adopted in a shareholders% meeting shall be reported, in relation to their importance, to investors in the CI! annual report or in some other appropriate manner previousl" establishedE+ CI! must disclose to the C=;=, the regulator" agenc", and the market, how the CI! e0ercised its voting rights when the latter holds more than 2 percent of the voting rights of an issuer+ In addition, its annual report, the management compan" must identif" and Custif" an" deviation on the voting polic", when it holds more than 7 percent of the voting rights of an issuer+ 'isclosure is either to their clients )onl" with respect to the securities of each client* or, in the case of investment advisor, to the registered investment companies, or to the market, which is less costl"+ The !wedish 1ssociation recommends that CI! operators ORP establish and publici9e policies on corporate governance containing principles for e0ercising voting rights and for electing board members+ CI! operators should also disclose to investors their standpoint in certain corporate issues and the reason for their position+ !wit9erland The !wiss 2und 1ssociation )!21* emphasi9es The !wiss 2und 1ssociation )!21* emphasi9es the obligation of CI! operators to e0ercise shareholders rights pertaining to the investments of the CI! independentl" and e0clusivel" in the interest of investors+ CI! are re,uired to be able to provide investors with information on their e0ercise of their rights+ 'elegation is permitted to custodian banks or other third parties, e0cept where the e0ercise of the right could have lasting impact on the interest of the investors+ In such cases the CI! operator is to e0ercise the rights itself or give e0plicit directions to its delegates+ The 34 1ssociation of 3nit Trusts and Investment 2unds )13TI2* emphasi9es in its Code of good (ractice that fund managers should become involved in governance matters and should report to their investors on their polic" on voting and other governance issues+ 3! The !&C recentl" issued a ruling mandating CI! to disclose their The !&C recentl" issued a ruling mandating CI! to disclose their pro0" voting policies and pro0" voting records+ The ruling re,uires registered management investment companies to file with the !&C and to make available to shareholders the specific pro0" votes that the" cast in shareholder meetings of issuers of portfolio securities+

!ource/ I !C

andate for Conflicts of interests in /EC" Countries'

Country $ustralia Current Practices Hes, in the prospectuses, the annual report and (roduct 'isclosure !tatements+ In addition, when the operator of the CI! seeks to confer a financial benefit on itself or a related part", it ma" onl" do so with the prior approval of the scheme members+ $ustria .o+ (elgium Hes, in the annual reports+ Canada Hes, in the prospectus, the annual and semi6annual financial statements+ In certain circumstances, prior approval is re,uired for investors in advance of the transaction+ C%ec! )epublic Hes, in the prospectus+ *enmar+ Hes, in the annual reports+ The prospectus must disclose information on contracts with related parties, including the management compan" Finland Hes, in semi6annual and annual reports+ France Hes, in the annual reports+ ,ermany Hes, in semi6annual and annual reports ,reece .o+ -on+ &ong Hes, in the annual reports and offering documents+ C!ina -ungary Italy .o+ Hes, the directors% statements accompan"ing the CI! annual reports must include a description of the dealings with other companies belonging to the same group, and information on participation in placements carried out b" companies within the group+ Hes, in the financial statements Hes, the Trust (ropert" =anagement Report is provided to investors ever" si0 months+ The report includes the details of management of trust propert", details on investment in securities issued b" an affiliated compan", and details on transactions made b" a management compan" or connected part" with trust propert"+ .o Hes, in the prospectus+ Hes, in the prospectus, semi6annual and annual reports Hes, in the prospectus, semi6annual and annual reports Hes, in the prospectus, semi6annual and annual reports Hes+ Hes, in the prospectus, semi6annual and annual reports Hes, in the semi6annual and annual reports+

.apan &orea

/u0emburg Me0ico Net!erlands Nor#ay Poland Portugal Singapore Slo a+ia

32 | , a g e

&/1IC4 REC/

EN"0-I/N#

1!e recommendations o" t!e &umaramangalam (irla Committee on t!e issue o" Institutional s!are!olders pro ide t!e "rame#or+ "or policy ma+ers inter ention in India+ The Committee highlighted that institutional shareholders, who own shares largel" on behalf of the retail investors, have ac,uired large stakes in the share capital of listed Indian companies- the" have or are in the process of becoming maCor shareholders in man" listed companies and own+ The Committee called for institutional investors to pla" a bigger role in the corporate governance of their portfolio companies, and stressed that retail investors are rel"ing on them for positive use of their voting rights+ The Committee highlighted practices elsewhere in the world where institutional shareholders influence the corporate policies of their portfolio companies to ma0imi9e shareholder value, and recommended that institutional investors follow suit+ The Committee stressed that it is important that institutional shareholders should put to good use their voting power+ The Committee recommends that the institutional shareholders should take an active interest in the composition of the board of directors of their portfolio companies- be vigilant- maintain regular and s"stematic contact at senior level for e0change of iews on management, strateg", performance and the ,ualit" of management- ensure that voting intentions are translated into practice- and evaluate the corporate governance performance of their portfolio companies+ These were non6mandator" recommendations+ Incenti es "or institutional in estors to play a more acti e role in t!e corporate go ernance o" t!eir port"olio companies' It has long been recogni9ed that institutional
36 | , a g e

investors, especiall" those acting in a fiduciar" capacit", are better positioned than retail investors to pla" a monitoring role in their portfolio companies because the" do not face the collective action )free rider* problem to the same e0tent )!ee $o067 for a description on free rider and collective action*+ The potential returns from their e,uit" investment can outweigh the monitoring costs+ >owever, as discussed in !ection I;, at present most Indian institutional investors take a passive role in the corporate governance of their portfolio companies+ &ven those institutions who e0ercise their ownership rights more activel", to a large e0tent share the same view with regard to the monitoring of management+ =anagement is primaril" screened ex-ante, at the time of deciding to take an e,uit" position in a compan"+ nce an institution has taken the decision to invest in a compan", it supports its management+ If and when it loses confidence in management, it sells its shares+ 2rom a cost5benefit standpoint, institutional investors consider that the potential benefits of taking an active role in the corporate governance of their portfolio companies are not commensurate with the costs associated with such monitoring role+ This approach ma" be legitimate, given the concentrated ownership structure of listed companies, the small e,uit" stakes of each individual institutional investor, and the lack of cooperation between institutional investors+ >owever, the e0perience of &C' countries and the most d"namic emerging market Countries suggests that corporate governance practices of listed companies and their voluntar" compliance with Clause 4:, and ultimatel" the protection of shareholders rights, could be improved if institutional investors acting in a fiduciar" capacit" could be induced to participate more activel" in the corporate governance of their portfolio companies+ 2rom a polic" standpoint, it is desirable that institutions acting in a fiduciar" capacit", such as pension funds, collective investment schemes and insurance companies should consider the right to vote an intrinsic part of the value of the investment being undertaken on behalf of their client+ 2ailure to e0ercise the ownership rights could result in a loss to their investors who should therefore be made aware of the polic" followed b" the institutional investors+ In the 3nited !ates, under the &mplo"ee Retirement Income !ecurit" 1ct )&RI!1*, a pension plan fiduciar" obligation includes the voting of pro0ies+ In addition, the 'epartment of <abour considers that Da pension plan sponsor%s fiduciar" dut" in managing plan assets includes a dut" to vote pro0ies in the interests of plan beneficiaries, and a positive dut" to actuall" vote on issues that ma" affect the value of the plan%s investments+ (ension plans are
3 |,age

urged to develop written voting guidelines+ The 'epartment of <abour also advocates that pension plan sponsors undertake activities value of the plan%s investmentsE+ The 3! re,uirement to vote is most appropriate for pension funds that have long term assets and liabilities on their balance sheets, and must therefore follow long term investment strategies+ The" have less of an incentive than mutual funds to ma0imi9e short term returns+ ;oting with their feet is onl" one possible strateg" if the" are dissatisfied with the management of a portfolio compan"+ It can be more appropriate instead to induce management to change its behaviour+ 2or e0ample institutions might become concerned about potential conflicts of interests on the board of their portfolio compan"+ r the" might wish to intervene to obCect to a proposed restructure of the board or to a particular transaction that the compan" proposes to enter into, or e0press concerns about e0ecutive share option schemes or the level of benefits being given to non6e0ecutive directors+ 1t present, there are no private pension funds in India, although the (ension 2und Regulator" and 'evelopment 1uthorit" has been established and is currentl" developing regulations for the private pension fund industr"+ The establishment of private pension funds is e0pected in the near future+ Currentl", the main public pension fund is not allowed to invest in e,uit"+ 1n obligation for Indian institutional investors to e0ercise voting rights would therefore not be appropriate in India+ In the 34, the ="ners Report of =arch 2007 recommended that the principles of the 3! 'epartment of <abour regarding the e0ercise of voting rights b" pension funds be embedded in the law of the land+ To pre6empt government action, in 2004, the .ational 1ssociation of (ension 2unds issued its guidelines of voting which recommended that pension funds e0ercise their voting rights?7+ 1s a result, the government decided to wait and see if a voluntar" approach would work+ This approach seems to have been successful+ In its (rogress Report of =arch 200?, =r+ (aul ="ners commented that Dof the 84 OfundP managers that were asked about voting, 82 had a polic" to vote all their 34 shares and, in the maCorit" of instances, this polic" was public+ The" also report ,uarterl" to their clients and e0plain their voting decisions, particularl" when voting against the recommendations of the board, or consciousl" withholding their vote+E The ,uestion for Indian polic" makers is how to create incentives for those institutional investors that invest in e,uities to become more active in the e0ercise of their ownership
33 | , a g e

rights, without coercion, without imposing illegitimate costs on them, and given India%s specific situationS Policy )ecommendation 2 3' (ased on discussions #it! policy ma+ers, mar+et regulators and mar+et participants, and ta+ing into account t!e current topology o" Indias institutional in estment community, a least cost, oluntary approac! to compliance #it! 45C* Principle 36, seems most appropriate "or India, at least "or t!e ne0t "e# years6 Suc! an approac! #ould introduce 7so"t8 incenti es "or institutional in estors to di""erentiate t!emsel es "rom eac! ot!er and lea e mar+et "orces to dri e t!e process6 It is t!ere"ore recommended t!at t!e Securities and 50c!ange (oard o" India "or mutual "unds and FIIs, and t!e Insurance )egulatory and *e elopment $ut!ority "or insurance companies, and t!e Pension Fund )egulatory and *e elopment $ut!ority "or pension "unds )when these are set up* issue some guidelines, on a standalone basis or as part o" t!eir code o" conduct as appropriate, recommending t!at t!e institutions t!at "all under t!eir o ersig!t, s!ould disclose to t!e mar+et, on a comply or e0plain basis, ia t!eir company #ebsite, t!eir o erall corporate go ernance and oting policies #it! respect to t!eir in estments, including t!e procedures t!at t!ey !a e in place "or deciding on t!e use o" t!eir records, on an e09post basis6 2or deciding on the use of its voting rights to avoid window dressing+ Indeed, unless an institution has made the necessar" investments in terms of financial and human resources to implement its corporate governance and voting policies in an informed manner, such policies would become empt" words+ ne of the advantages of this approach is that it sets the framework for institutional investors to start cooperating more activel" with each other+ Indeed, an institutional investor inclined to vote against management on a specific issue could more easil" contact those institutional investors who have e0pressed the same prima facie concerns on this t"pe of issue, publicl"+ !uch discussions would allow the institutional investor to establish with greater certaint" the likelihood that his vote would be DpivotalE, with the support of those institutional investors with whom he has spoken+ might be encouraged to cast his vote+ n this basis, he oting rig!ts6 It s!ould also be recommended t!at t!ese institutions post annually on t!e same #ebsite, t!eir oting

3# | , a g e

ver the medium term, as the market starts pa"ing attention to the manner in which institutional investors e0ercise their voting rights, new incentives could be introduced so that institutional investors start disclosing their voting intentions ahead of shareholders meetings, i+e+ on e06ante basis+ This practice could in time, foster the emergence in the market place, of an independent private organi9ation )perhaps an offshoot of the financial anal"st industr"*, that would aggregate voting records information for the benefit of all investors, including retail investors, who could then align their votes with those of institutional investors, without having to perform costl" sophisticated anal"sis themselves, rather than abstaining or s"stematicall" supporting incumbent management+ This might also introduce more efficienc" in the market for corporate control, as an added disciplinar" mechanism+ In addition, the disclosure of voting records b" institutional investors acting in a fiduciar" capacit" could foster the emergence of one or several private watchdog institutions, similar to Institutional !hareholder !ervices Inc, a 3! based compan", or (IRC in the 34, that issue informed research and obCective vote recommendations on listed companies+ Con"licts o" interest/ ver the last decade and a half, market forces have driven Indian

financial services companies to seek critical mass+ <arge financial conglomerates have been created that include insurance companies, commercial banks, investment banks, non banks financial institutions, and mutual funds+ #hilst this transformation created vast s"nergies, and made the groups more competitive, it also created potential conflicts of interests between a group%s fiduciar" institution and its other components+ !uch conflicts of interest occurs when a fiduciar" institution which is a subsidiar" or an affiliate of an integrated financial group, holds and interest in a portfolio compan", whilst the latter has a contractual relationship with another compan" of the group+ 2or e0ample, a mutual fund belonging to a financial conglomerate that includes a commercial bank, an investment bank, and an insurance compan", ma" face conflicts of interests if the insurance compan" manages the provident fund of the portfolio compan"- or if the commercial bank is also a lender to the portfolio compan", or if the investment bank is underwriting an issue of shares b" the portfolio compan"?2+ In such cases, its voting decision might be influenced b" the interests of other companies within the group+

7. | , a g e

$nd 50c!ange (oard o" India "or Mutual Funds and t!e Insurance )egulatory and *e elopment $ut!ority "or Insurance Companies s!ould mandate t!e disclosure by institutions under t!eir o ersig!ts o" !o# t!ey manage material con"licts o" interests t!at may a""ect t!e e0ercise o" +ey o#ners!ip rig!ts regarding t!eir in estments6 More generally suc! disclosure s!ould e0tend to all institutional in estors acting in a "iduciary capacity6 1!e disclosure s!ould be made in t!e prospectuses and in t!e periodic "inancial statements6 Facilitating t!e e0ercise o" s!are!olders rig!ts' To support the previous recommendation, it is essential that polic" makers ensure that the e0ercise of ownership rights b" shareholders is facilitated+ ;oting should be made as eas" as possible to encourage institutional investors to e0ercise their voting rights+ The following deficiencies have been identified in this respect/ )7* The 2004 CG R !C assessment mentioned that some companies have taken advantage of 1rticle of the Companies 1ct, which stipulates that shareholders meetings must be convened at the location where the compan" is registered, to deter shareholders from attending shareholders meetings+ These companies register their administrative head,uarters in remote locations, and choose the most inconvenient dates and times for their shareholders meetings, to dissuade shareholders from attending the meetings+ 1ccording to interviewees, this conspiratorial practice continues to occur+ )2* ver the last ten "ears, electronic communication has profoundl" transformed the means &C' governments have recogni9ed

through which shareholders can cast their votes+ =ost

this and have introduced legislation to enable electronic voting+ In the words of epon"mous =r+ (aul ="ners, Delectronic voting lies at the heart of a more efficient voting s"stemE+ International good practice consists of allowing the electronic appointment of pro0ies instead of organi9ing electronic polls+ This practice does not e0ist in India at present+ )8* In addition, the 2004 CG R !C assessment mentioned that holders of depositor" receipts do not have the same rights and opportunities to vote as holders of underl"ing shares+ 2inall", a complementar" approach to participating at shareholders meetings is to engage in a continuous dialogue, on a one to one basis, with the management of portfolio companies+ This approach allows investors to increase their level of comfort with management and to better understand the conte0t in which the compan" operates+ It also routinel" in the most
7- | , a g e

developed securities markets+ In some

&C' countries there are also principles calling for

the nomination of a contact person on the board who retains close contact with such investors and form an intermediar" between the institutions and the management+ The &C' (rinciples emphasi9e that such Da dialogue between institutional investors and

companies should be encouragedE and stress that unnecessar" regulator" barriers should be lifted, notwithstanding the need for issuers to treat all shareholders e,uall" and not to divulge information to the institutional investors which is not in the public domain+ 1s discussed in section I;, Indian institutional investors seldom convene such meetings although most of them do attend anal"sts meetings+ >owever, when ,uestioned about a h"pothetical disagreement with management, all respondents answered that the" would endeavour to e0press their views to the former privatel"+ If a satisfactor" compromise could not be reached in private, the" would prefer to sell their shares rather than making their views public+ 1s Indian institutional investors start e0ercising their ownership rights more activel", it is to be e0pected that such meetings will occur more fre,uentl"+ Policy recommendation 2 :' (3) Consider including a pro ision in t!e Companies $ct currently under to re ie# to pre ent companies to con ene s!are!olders meeting in "ar a#ay locations6 (;) Policy ma+ers s!ould re ie# t!e In"ormation $ct ;<<< to ensure t!at t!ere are no legal impediments to t!e electronic appointment o" pro0ies6 (:) In line #it! 45C* Principle II6$6:, policy ma+ers s!ould ensure t!at !olders o" depository receipts are pro ided #it! t!e same ultimate rig!ts and practical opportunities to participate in corporate go ernance as are accorded to !olders o" t!e underlying s!ares, in line #it! t!e recommendations o" t!e International Corporate ,o ernance Net#or+6 (=) S5(I s!ould issue a directi e to clari"y t!e nature o" t!e in"ormation t!at can be e0c!anged at meetings bet#een institutional in estors and companies, in compliance #it! t!e Insider 1rading )egulations o" 3>>; and its ;<<; amendment6 1!e directi e
72 | , a g e

s!ould stress t!at it does not condone t!e selecti e disclosure o" in"ormation by companies to institutions and clearly set t!e principle o" e?uality o" treatment o" all s!are!olders by corporations6 Facilitating cooperation bet#een institutional in estors #!ile sa"eguarding mar+et integrity' Institutional investors do not face the collective action )free rider* problem to the same e0tent as retail investors because the" have the capacit" to make larger investments+ .evertheless, the free rider problem can never be eliminated completel"+ If an institution invests resources in monitoring activities, others will gain without having contributed+ ne wa" around this problem is for institutions, particularl" those acting in a fiduciar" capacit", to increase their ownership stakes in individual companies to more economic levels, rather than simpl" diversif"+ The potential returns from their e,uit" investment can then outweigh the monitoring costs+ >owever, in man" countries, including India, the" are prevented from doing this for prudential reasons+ In addition, it ma" be difficult for institutions that are unhapp" with the corporate governance of a compan" simpl" to sell their investment+ $ecause of the si9e of their shareholdings, it ma" be not be possible to sell the holding ,uickl" and also obtain a reasonable price+ r the shares ma" be trading below the compan"%s asset backing )possibl" due to the ver" conduct about which the institution is unhapp"* and this ma" mean that selling is not an attractive option+ The abilit" of inde0 funds to sell ma" be limited b" the e0tent to which the" can depart from the inde0 + ne solution around this problem is to allow and even facilitate shareholders to cooperate in e0ercising a strong monitoring role in a target compan"+ This approach allows institutions to increase their leverage over management without having to ac,uire more shares+ The practice has become ,uite common in 1ustralia, the 3! and the 34 in particular+ !uch practice is to be encouraged since it provides a means of overcoming the free rider problem+ 1s discussed in section I;, Indian institutional investors currentl" almost never consult with each other on matters of corporate governance of their portfolio companies+ The danger, however, is that such cooperation could be used to manipulate markets and to obtain control of a compan" without being subCect to takeover regulations+ To prevent such occurrence !&$I, like other market regulators around the world, has issued a series of
73 | , a g e

takeover rules and market manipulations guidelines?G+ <ike the !&C in the 3! and the 2!1 in the 34, !&$I allows cooperation where it is not for the purpose of obtaining control of the compan"+ >owever, some countries, for e0ample 1ustralia, have issued specific guidelines for collective actions b" institutional investors+

Policy recommendation 2 =' S5(I mig!t consider issuing a ruling clari"ying t!e circumstances under #!ic! consultation and oting agreements bet#een institutional in estors may ta+e place #it!out triggering t!e pro isions o" t!e S5(I $ct 3>>; regarding substantial ac?uisitions o" s!ares, or t!ose concerning mar+et manipulation6 Nominee directors/ Stricto censo, a lending institution is a service provider to the compan"+ Therefore, a board member representing a lending institution should not be deemed to be independent+ >owever, &0planation )ii* to the definition of independent director in Clause 4: stipulates that Dinstitutional directors on the boards of companies shall be considered as independent directors whether the institution is an investing institution or a lending institutionE+ This annotation is somewhat confusing and needs to be clarified+ The .ara"an =urth" Committee of 2008 considered that the institution of nominee directors whether from investment institutions or lending institutions creates a conflict of interest and should not be considered as independent+ It further argued that it is necessar" that all directors, whether representing institutions or otherwise, should have the same responsibilities and liabilities+ There is also a debate on the special treatment accorded to nominee directors+ 1s mentioned in !ection III, nominee directors appointed b" 2inancial Institutions are not subCect to retirement b" rotation, as are directors appointed b" shareholders+ The appointment, retirement and functions of nominee directors of 2Is are governed b" the respective parent 1cts+ In addition, it has been argued that nominee directors sometimes conve" the confidential price6sensitive information the" have received at board meetings to other departments of their own institution, involved in bu"ing and selling securities+ The recentl" released report of the =inistr" of Compan" 1ffairs on Compan" <aw has raised the debate on these issues+ The =inistr" is e0pected to factor in public comments received on this report before presenting a revised compan" law legislation for ratification b" (arliament later this "ear+ !ome of the salient recommendations of this report which have a bearing on the role and responsibilities of the non6e0ecutive directors are/
77 | , a g e

Nominee directors appointed b" an" institution or in pursuance of an" agreement or Government appointees representing Government shareholding should not be deemed to be independent directors+ /iabilities o" independent and non9e0ecuti e directors6 1 none0ecutive5 independent director should be held liable onl" in respect of a violation of the law which had taken place with his knowledge )attributable through $oard processes* and where he has not acted diligentl", or with his consent or connivance+ &no#ledge 1est6 If the independent director does not initiate an" action upon knowledge of an" wrong, such director should be held liable+ 4nowledge should flow from the processes of the $oard+ 1dditionall", upon knowledge of an" wrong, follow up action5dissent of such independent directors from the commission of the wrong should be recorded in the minutes of the board meeting+ Policy recommendation 2 @' It is di""icult to reconcile !o# nominee directors o" "inancial institutions, #!ic! are ser ice pro iders to a company or !old signi"icant e?uity sta+es, can be considered 7independent8, according to t!e de"inition o" Clause =>6 It is t!ere"ore recommended t!at t!e e0planation to t!e de"inition o" independent directors o" Clause => s!ould be amended to recti"y t!is point6 /ending Institutions may legitimately #is! to continue to negotiate t!e appointment board members on t!e boards o" companies in #!ic! t!ey !old a signi"icant e?uity sta+e or !a e lent signi"icant sums o" money6 (ut suc! directors s!ould not be counted as independent6 Suc! clari"ication #ould create an incenti e "or lending institutions to ta+e an acti e part in t!e nomination o" ?uali"ied independent directors, capable o" protecting t!eir rig!ts6 1!e internal corporate go ernance of institutional in estors' 2inall", as highlighted at the beginning of this polic" paper, the #orld $ank%s terms of reference for this stud" did not include a review of the corporate governance of institutional investors themselves+ .evertheless, it impossible to consider the role of institutional investors in the corporate governance of their portfolio companies without being confronted to several features of their own internal corporate governance+ 2rom the limited amount of information gathered during
72 | , a g e

this e0ercise, it appears that Chinese walls between lending and investing activities of the same financial institution are not alwa"s strictl" enforced, and that several t"pes of related part" transactions, such as the sales and purchases of funds units from insiders and affiliated entities, or dealings with affiliated entities such as brokers, ma" not be ade,uatel" covered b" the e0isting legislation or enforced b" regulator" agencies+ #ithout detailed anal"sis, it is impossible opine on whether the risk management s"stems of mutual funds and insurance companies, including their supervisor" structures, internal controls, and the procedures for approving new investment strategies and instruments, and the standards of financial reporting, compl" with international best practice+ 2urthermore, polic" makers are currentl" preparing the legislation that will permit the Introduction of private pension funds in the institutional landscape+ It is reasonable to &0pect that the integrit" and efficienc" of the Indian capital market improves markedl" over the ne0t few "ears+ It will then become desirable to allow public and private pension funds to invest in domestic e,uities+ Therefore, over the medium term, it is likel" that these institutions will become maCor investors in the domestic capital market, including the e,uit" market+ It therefore is important that corporate governance considerations be included in their investment guidelines and code of conduct+ Policy recommendation 2A' t!e corporate go ernance o" institutional in estors acting in a "iduciary capacity s!ould be a !ig! priority "or t!e ,4I +

76 | , a g e

References:
7+ $anaCi, Fairus and Gautam =od"+ DCorporate Governance and the Indian (rivate !ector,E T&> #orking (aper !eries6T&>#(!G8, =a" 2007+ 2+ .achane, ' =, !aibal Ghosh and (artha Ra"+ D$ank .ominee 'irectors and Corporate (erformance/ =icro6&vidence for India,E Economic and Political Weekly, =arch 7:, 200?+ 8+ (atibandla, =urali+ D&,uit" (attern, Corporate Governance and (erformance/ 1 !tud" of India%s Corporate !ector,E 2orthcoming, Journal of Economic Behavior and Organization 4+ !arkar, !ubrata and Fa"ati !arkar+ D<arge !hareholder 1ctivism in Corporate Governance in 'eveloping Countries/ &vidence from India,E !nternational "evie# of $inance, 7)8*, !eptember 2000+ ?+ ;arma Fa"anth+ DCorporate Governance in India/ 'isciplining the 'ominant !hareholderE, !!%B %anagement "evie#, ctober6'ecember 7::G+

7 |,age