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Corporate governance series- Part 4: SEBI reforms on Corporate Governance. - Gaurav Bansal

  • Category
    Economy
  • Published
    28th Dec, 2018
  • The Kotak Committee on Corporate Governance (hereinafter referred to as 'The Committee') was constituted in June, 2017, under the chairmanship of Uday Kotak.
  • Its primary objective was improving standards concerning corporate governance of listed companies in India.

Issue

Context

  • The Kotak Committee on Corporate Governance (hereinafter referred to as 'The Committee') was constituted in June, 2017, under the chairmanship of Uday Kotak.
  • Its primary objective was improving standards concerning corporate governance of listed companies in India.

About:

The Committee gave following recommendations:

  1. It proposed more powers for independent directors, limiting chairmanship to non-executive directors, and called for a greater focus on transparency and disclosures to improve corporate governance.
  2. It recommended that a listed company should have at least six directors on its board. Current SEBI regulations do not mandate a minimum number. It has suggested at least one independent director be a woman.
  3. It also proposed that directors attend at least half the total board meetings held in a financial year. If they fail to do so, they would require shareholders’ nod for continuing.
  4. Companies have asked to make public the relevant skills of directors, and the age of non-executive directors has been capped at 75 years.
  5. In addition, the chairperson of a listed company will be a non-executive director to ensure that s/he is independent of the management.
  6. An independent director cannot be in more than eight listed companies and a managing director can hold the post of an independent director in only three listed companies.
  7. The number of independent directors on a company board be increased from 33% to 50%.
  8. The minimum sitting fees of independent directors has been halved from the current Rs1 lakh per meeting as stipulated by the Companies Act 2013 to Rs50, 000 for the top 100 companies by market capitalization.
  9. Detailed reasons would need to be furnished when an independent director resigns. This is to ensure that they remain independent of the company management.
  10. An audit committee is being proposed with the mandate to look into utilization of funds infused by a listed entity into unlisted subsidiaries, including foreign subsidiaries in cases where the total investment is at least Rs100 crore or 10% of the asset size of the subsidiary.
  11. It recommended that SEBI should have clear powers to act against auditors under the securities law.
  12. For government companies, the board have final say on the appointment of independent directors and not the nodal ministry.
  13. It has also proposed to tweak the definition of a “material” subsidiary to one whose net worth or income exceeds 10% (currently 20%) of the consolidated income, or net worth of the listed entity. This has been done to improve disclosure, since only the activities of material subsidiaries are disclosed to shareholders.

Key Recommendations of the Committee approved by SEBI with their explanation and importance:

  1. Increasing Transparency -Enhanced Disclosure Requirements

Corporate governance norms are aimed at reduction of agency costs for residual owners of a corporation (its shareholders) incurred by them in monitoring and ensuring effective functioning of a corporation as per its objectives (by the management). Effective disclosures, thus, are fundamental to corporate governance. The Committee had made various recommendations pertaining to enhancing disclosure requirements of listed entities. Recommendations approved by SEBI pertain to the following-

  • Disclosure of Utilization of Funds from Qualified Institutional Placement (QIP) /Preferential Issues-Full disclosure of utilization of funds rose through Preferential Allotment and QIPs undertaken in the relevant financial year have to be made in the Annual Report of the listed company until such funds are fully utilized.
  • Disclosures of Auditor Credentials, Audit Fee, Reasons for Resignation of Auditors-A listed entity will now be required to disclose in its Annual Report, the details of all fees paid by the listed entity and its subsidiaries (on a consolidated basis) to the statutory auditor and to all other entities in the network firm/network entity of which the auditor is a part.

Apart from the above, detailed reasons for resignation of an auditor as given by the said auditor has to now be disclosed to the stock exchanges.

  • Disclosure of Expertise/Skills of Directors-The listed entity is required to disclose a chart or a matrix setting out the skills/expertise/competence of the board of directors in its Annual Report containing a list of core skills/expertise/competencies identified by the board of directors as required in the context of its business and sector(s) for it to function effectively, and those actually available with the board in the Financial Year -2018-2019.

Further, detailed disclosures of competencies of every board member, along with their names have to be disclosed in the Annual Report for the Financial Year 2019-2020.

  • Enhanced Disclosure of Related Party Transactions (RPT)-A listed entity has to submit within 30 days of publication of its standalone and consolidated financial results for the half year, disclosures of RPTs on a consolidated basis, in the format prescribed in the relevant accounting standards for annual results, to the stock exchanges and to publish the same on its website.
  • Mandatory Disclosure of Consolidated Quarterly Results with effect from Financial Year 2019-2020
  1. Reshaping the Institution of the Board of Directors and Enhancing the Role of Committees of the Board

The board of directors of a company, being entrusted to keep a check on the management, is its primary governance body. The board of directors owe a fiduciary duty to a company as a whole, and have the function of protecting the interests of various stakeholders. Therefore, institutionalizing a board of directors is of primal importance to effective corporate governance. To strengthen the institution of the board of directors, SEBI has approved following recommendations of the Committee:

  • Separation of the office of the chairperson (i.e. the leader of the board) and CEO/MD (i.e. the leader of the management)- The top 500 listed entities (by market capitalization) having a public shareholding of 40 per cent or more, have to separate the office of CEO/MD and Chairperson with effect from April 1, 2020.
  • Augmenting board strength and diversity- The top 1000 listed entities (by market capitalization), and the top 2000 listed entities, have to mandatorily have a minimum of six directors on their boards by April 1, 2019 and April 1, 2020 respectively. The top 500 listed entities (by market capitalization) and the top 1000 listed entities have to have a minimum of one woman independent director by April 1, 2019 and April 1, 2020 respectively.
  • Enhanced Quorum-Quorum of the board of directors will be one-third of the total strength of the board of directors or three directors, whichever being higher, from April 1, 2019 for the top 1000 listed entities (by market capitalization) and from April 1, 2020 for the top 2000 listed entities.
  • Capping the Maximum Number of Directorships–No person will be allowed to hold the office of director in more than eight listed entities at the same time (of which independent directorships are capped at seven) with effect from April 1, 2019. Further, with effect from April 1, 2020, such number will be capped at seven.
  • Expanded Eligibility Criteria for Independent Directors–No person who is a part of the promoter group can be appointed as an Independent Director. Further, to avoid the problem of ‘board interlocks’, a person who is a non-independent director of another company on the board of which any non-independent director of the listed entity is an independent director, will not be eligible to be an independent director in the listed entity.
  • Enhanced Role of committees

(i) Audit Committee - The Audit Committee will have to review the utilization of loans and/or advances from/investment by the holding company in the subsidiary exceeding Rs 100 crore or 10 percent of the asset size of the subsidiary, whichever is lower.

(ii) Nomination and Remuneration Committee–It shall now be the duty of the Nomination and Remuneration Committee specifically to recommend to the board, all remuneration, in whatever form, payable to members of the senior management.

(iii) Risk Management Committee - Its functions shall now specifically cover cyber security.

  1. Down-streaming Corporate Governance

In light of the increasingly complex corporate structures being used by businesses, which function through a web of subsidiaries incorporated in India/abroad, governance practices at subsidiary level is of increased importance to the shareholders of a listed entity. SEBI, in recognition thereof, has approved the following recommendations of the Kotak Committee:

  • Enhanced Obligations on Listed Entities w.r.t Subsidiaries– One independent director from the board of directors of a listed entity should also be a director on the board of directors of its unlisted foreign material subsidiary (as opposed to the extant requirement pertaining to an unlisted material subsidiary incorporated in India). Additionally, the board of all listed entities will now have to be appraised of significant transactions involving all unlisted subsidiaries (as opposed to the extant requirement of significant transactions of only unlisted material subsidiaries). A material subsidiary is defined as a subsidiary, whose income or net worth exceeds 10 percent (as opposed to 20 percent) of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.
  • Secretarial Audit to be Mandatory for Listed Entities and their Material Unlisted Subsidiaries
  1. Shareholder Participation and Involvement

It is widely considered and acknowledged that a key connection between decision-making and accountability, is the effective engagement between shareholders and the board of directors of a company. Further, shareholders, being owners of a company, are stakeholders for the primary benefit of whom corporate governance norms are envisaged. In light of the same, SEBI has approved the following recommendations of the Kotak Committee to increase shareholder participation and engagement in the affairs of a listed company:

The top 100 listed entities by market capitalization have to hold their AGM within five months from the date of closing of the Financial Year 2018-2019 i.e. by August 31, 2019.

Mandatory webcast of AGMs has been mandated for top 100 entities by market capitalization with effect from Financial Year 2018-19.

Assessment of Uday Kotak Committee recommendations

The approved changes to corporate governance norms are aimed towards aligning corporate governance standards to global best practices. Most of the approved recommendations, are firmly rooted in local business realities, where most listed entities are promoter-led as opposed to being professionally managed, thus increasing risks of promoter-raj at the cost of minority shareholders.

Some of the approved recommendations, such as the enhanced disclosure requirements, will have the effect of reducing information asymmetry between the managers of a company and its shareholders. To conclude, while there may exist certain issues and glitches, such as various recommendations of the Kotak Committee which have been approved have been made applicable to top companies in terms of market capitalization, precluding smaller listed entities from such compliance requirements even though it is usually some of the smaller listed entities wherein corporate governance standards are found to be wanting, the approved recommendations are indeed welcome and are expected to extol corporate India to a leadership position with regards to corporate governance.

Some argue that added compliance requirements are de factor abdication of the regulators role and will have the effect of increasing regulatory burden on listed companies, and consequently increase transaction costs/agency costs; in terms of cost benefit analysis for the Indian securities markets at large, it is clearly a move forward. Enhanced monitoring and disclosures arising out of structural modifications will benefit all shareholders, especially the smallest.  Needless to add, robust governance will enhance the credibility of the entire public markets and attract more investors in the long term.

Learning Aid

Practise question:
Analyse the recommendations of the Kotak committee and examine how they are aimed at improving the interest of investors and ensuring long-term corporate health.

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