Stewardship code aims greater investor, India Inc engagement. Will it work?

In 2014, seven domestic mutual funds (MFs) came together to oppose Maruti Suzuki’s plan to set up a plant in Gujarat. In 2017, a bunch of institutional shareholders wrote to Infosys seeking the return of co-founder Nandan Nilekani on the company’s board after the sudden resignation of chief executive Vishal Sikka.
 
Instances of shareholder activism such as these are rare in India. But, the adoption of the Companies Act, 2013, the introduction of e-voting, rise in institutional ownership of Indian equities, emergence of proxy advisory firms and the regulatory nudge to formulate a stewardship code are goading investors to engage with boards of listed companies more closely.
 
The Securities and Exchange Board of India (Sebi) now wants mutual funds and alternative investment funds to mandatorily adopt a stewardship code from April 1. Insurance Regulatory and Development Authority of India and Pension Fund Regulatory and Development Authority have also enunciated principles that their regulated entities need to adopt.
 
“A mandatory code may nudge mutual funds to take their stewardship role a lot more seriously,” says Navneet Munot, executive director and chief investment officer, SBI Mutual Fund.
 
Stewardship responsibilities include engaging investee companies on ma­tters ranging from corporate governance and financial performance to capital structure and strategy. Such engagement may be through detailed discussions with management, interaction with investee company boards and voting in board or shareholders’ meetings.
 
Will it work?
 
Sebi’s revised stewardship code provides a framework to monitor listed co­mpanies and it specifically provides that regulations on insider trading should be considered while seeking information. The inability to access unpublished price-sensitive information is likely to limit the ability of institutions to monitor listed companies, say experts.
 
“Monitoring the investee companies may be a challenge. One of the areas of monitoring is strategy and information relating to strategy is usually both un­published and price sensitive. Further, fact-finding and intervention could be limited due to the restriction on sharing information with institutional investors from an insider trading perspective,” says Vaneesa Agrawal, founder of law firm Thinking Legal.
 
According to her, the requirement that institutional investors should formulate a policy for the identification of situations that can trigger communication of insider trading appears impractical. “The investee companies' boards should be responsible for such identification as well as dealing with such situations. Having said that, institutional investors can consider active intervention in cases where there is an alleged insider trading breach,” says Agrawal.
 
One of the principles for stewardship stipulated by Sebi is to identify possible situations where conflict of interest may arise — such as in the case of investee companies being associates of the entity. Avoiding investment in associate companies is not a solution, reckon experts. Rather, the institutions should refer such decisions to an independent committee and ensure that those with a potential conflict of interest are not included in decision making.
 
According to Shriram Subramanian, founder and managing director of InGovern Research Services, a proxy advisory firm, institutional investors should take a stand on important corporate matters such as appointment of directors and auditors, rather than confining themselves to matters pertaining to change in capital structure such as issuance of equity or raising debt.
 
“Institutional shareholders can engage better with companies on the quality of disclosures, especially those with regard to related party transactions and other issues that don’t come for voting,” says Munot, adding that the number of issues that global shareholders deal with is far greater.
 
Matters related to environmental, social and governance (ESG) are among them. In India, the concept is yet to gain ground and most ESG decisions are taken by company boards without consulting minority shareholders.
 
“With increasing pressure from their own investors, asset managers will soon start engaging with companies on issues such as plastic usage, water stewardship, decarbonisation initiatives, emissions reduction and delivering a positive environmental impact,” says Abhay Laijawala, managing director, Avendus Capital Public Markets Alternate Strategies and fund manager of Avendus India ESG Fund, a category III AIF.
 
Chris Hodge, advisor to the International Corporate Governance Network, a leading authority on global standards of corporate governance and investor stewardship, cautions that it can be difficult to tell from public reports whether signatories to the code are engaging with companies actively or not. The stewardship code in the UK was revised last year to address this issue and gather evidence on how the investors have implemented their stewardship policies in practice.

Does size matter?
 
Historically, promoter holding in Indian companies has been in excess of 50 per cent, making it difficult for minority shareholders to intervene in matters of corporate governance. Another common refrain is that the domestic institutional investors do not have the kind of heft that their global peers have in influencing company decisions. The tenth largest asset manager in the world, PIMCO, for instance, is about five times the Rs 28 trillion MF industry in India.
 
Joydeep Roy, partner at PwC India believes that the insurance industry — barring a few players such as LIC — is still a small investor in direct equities, which is why the stewardship of private sector insurance companies may have insignificant influence over governance in companies they want to invest in.
 
Hodge says that size is not necessarily a barrier to engagement, but it may influence the way an institution can engage with companies.
 
“Resources are clearly a constraint for smaller asset managers, but they are for the big global managers as well. The likes of BlackRock hold shares in thousands of companies worldwide, and even they do not have the resources to engage regularly with all those companies. So they have to prioritise,” he says.
 
According to Hodge, global investors tend to prioritise engagement with those companies where they have an ability to achieve a good outcome, where they have a significant shareholding and are therefore able to exercise some influence. In these cases, it is the size of the holding, not the size of the manager that matters, he says.
 
Institutional ownership of Indian equities, however, has been rising rapidly in the past few years (see table).
 
“There is far greater institutional awareness today about shareholder minority rights. Indian corporates understand that collectively, institutional investors can engage with controlling promoter shareholders almost as equals,” says Laijawala.
 
According to Munot, the "against" votes can matter even in companies where institutions have a small stake and where shareholder resolutions are likely to go overwhelmingly in the company’s favour. “Such votes can pose a reputational risk, which is why companies are now more willing to engage with institutions before and after putting forth a proposal,” he says.
 
Agrawal concurs and adds that several important decisions require a special majority under the Companies Act and the role of institutional investors in such decisions can be significant.
 
Roy, for his part, feels that smaller insurance players will have to introduce technological solutions to facilitate information flow and take investment and divestment decisions accordingly. Another solution could be to take the help of industry bodies, Life Insurance Council and General Insurance Council to facilitate stewardship activity.