Jaimini Bhagwati: Independent directors & corporate governance

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Jaimini Bhagwati: Independent directors & corporate governance

Jaimini Bhagwati / New Delhi April 18, 2008

Does the ministry of corporate affairs have the mandate or the staff to regulate companies?

In the last two decades there have been various studies aimed at improving corporate governance including Cadbury 1992, US Blue Ribbon 1999, Tokyo Stock Exchange 2000, SEBI 2003 and OECD 2004. In concert with this movement towards better corporate governance, SEBI stipulated that listed companies in India have to comply with the provisions of Clause 49 in the listing agreement. One of the requirements of Clause 49 is that 50% of the directors on a listed company’s board should be “independent” (unless the chairman is non-executive and is not a promoter or related to management).

The deadline for implementing this requirement has been repeatedly pushed back by SEBI in the face of stiff opposition. One of the arguments for postponement is that we do not have the required number of qualified independent professionals to fill 50% of seats on boards. Separately, public sector companies maintain that they should be exempt because government nominees on their boards provide the required independence. These appear to be self-serving arguments to maintain the status quo.

Under the 1956 Companies Act, all Indian companies are covered by the regulatory oversight of the Ministry of Corporate Affairs (MCA) and listed companies are also regulated by SEBI. The ICAI, which was established under the 1949 Chartered Accountants Act, regulates the accounting profession. Clearly, SEBI can take action under Clause 49. However, what is not obvious is whether the principal responsibility for enforcing better corporate governance rests with the MCA or the regulator concerned depending on the nature of the company. Currently, SEBI can prescribe rules under Section 55A of the 1956 Companies Act. It is this type of overlap, despite the coordination committees between the MCA and SEBI, which provides the environment in which regulatory accountability slips between cracks.

Press reports in the last two weeks have commented extensively on the exposure of corporates to FX derivatives. These media stories raise questions about timely financial reporting since the mark-to-market (MTM) losses are estimated to be over Rs 20,000 crore. The questions that spring to mind are: (a) were these transactions plain vanilla currency swaps/FX forwards meant to hedge underlying exposures or highly leveraged bets on FX movements?; (b) if the latter is true, were these transactions unwound?; (c) were banks marketing FX derivatives aggressively — particularly to unlisted companies? Investors deserve answers to these questions even if most of the companies involved are not listed. However, media reports have not carried any comments from the MCA or SEBI about the nature or quantum of MTM losses on derivatives transactions and whether any provisioning has been made for the losses incurred.

The ICAI has indicated that the recommendatory and mandatory requirements of AS-30 would kick in from 2009 and 2011, respectively. In the interim, the institute has urged companies to declare their derivatives’ losses. It is surprising that seven years after the Securities and Contracts Regulation Act was amended in 2001 to allow trading in exchange-traded derivatives and the Reserve Bank of India (RBI) had formulated guidelines for over-the-counter currency derivatives even earlier, MTM accounting norms for derivatives have not caught up with international standards.

Is this lack of transparent (to investors) norms for derivatives accounting symptomatic of a wider malaise? That is, in corporate governance terms (e.g. financial reporting, derivatives accounting, appointments of board members, deposit taking, liquidation procedures, etc.), are Indian firms lagging behind internationally acknowledged best practices? Further, is this primarily because there is no statute-based autonomous (from government) regulator for companies? This is not to blame the MCA, SEBI or ICAI for patchy and delayed reporting on MTM accounting for derivatives transactions. All things considered, it seems that the existing framework for regulating companies in India is flawed.

In this context, the MCA’s J.J. Irani “Expert Committee on Company Law” submitted its findings at the end of May 2005. According to the Irani report, “it is important that the basic principles guiding the operation of corporate entities from registration to winding up or liquidation should be available in a single, comprehensive, centrally administered framework” (Chapter II, paragraph 5 of the report). Having recognised the need for a single centre of control, the report goes off on a tangent on this issue. For instance, about the need to demarcate the respective jurisdictions of the MCA and SEBI, the Irani report states that “this perception is misplaced”. More importantly, the report does not recommend which government or regulatory agency should be held principally accountable if there is gross incompetence or worse in the management of companies. Almost three years have passed since the Irani report was finalised and the following are examples of issues on which there is continuing lack of agreement: (a) age limit for directors; (b) number of boards on which the same director can serve; and (c) insolvency law which provides for bankruptcy, trustees to be appointed and liquidation.

The MCA is responsible for administering the 1956 Companies Act for all firms, irrespective of the nature of their activities and whether these are listed or not. However, does the MCA have the appropriate mandate and the required number of adequately trained staff to regulate all companies? It is a ministry and not a regulator. To carry out regulatory functions, as distinct from the role of a ministry, which is accountable to Parliament, it is a pre-requisite that the personnel concerned have the required expertise, both educational and professional, and sufficiently long tenures in the same area of work.

Returning to the issue of independent directors — would such directors be impervious to the machinations of corporate boardrooms? A complementary approach could be to focus on the working of specific board committees which are important. For example, the transparency and efficiency with which an audit committee works is important for better levels of corporate governance. Consequently, attention needs to be paid to ensure that the head of an audit committee is a professional without any connection, past or present, with the company, its promoters or management. It should be obligatory for the head of an audit committee to provide written disclosure to this effect and for the chairman to confirm this in the company’s annual report. To summarise, it is time to assign the responsibility of regulating companies and reviewing current rules to an existing regulator or to set up a separate autonomous regulator as distinct from a ministry.

The views expressed are personal

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