Shareholder Stewardship Efforts: A Mixed BagBloombergQuintOpinion
The shareholding of institutional investors in companies around the world, India including, has been on a rapid ascendancy. At the same time, there has been a longstanding complaint from governance enthusiasts against the passivity of institutional investors who fail to engage adequately with the managements of companies in which they invest. To address this concern, the concept of stewardship emanated a decade ago to provide a framework that encourages institutional investors to adopt a more active role and engage with corporate managements to enhance the long-term sustainable value for their own investors. Such an approach, it is expected, will in turn improve corporate governance in the investee companies. The idea of stewardship, which emanated in the United Kingdom, has now acquired near-universal status.
In India, since the turn of the century, the government introduced measures to ensure ease of access for institutional investors to participate in corporate decision-making. A key milestone occurred in 2010 when measures introduced by the Securities and Exchange Board of India compelled mutual funds to take a more active and considered role while exercising their voting rights in companies.
More recently, a slew of Indian regulators have issued stewardship codes for different types of investors:
- The Insurance Regulatory and Development Authority of India in 2017 for insurance companies;
- The Pension Fund Regulatory and Development Authority in 2018 for pension funds; and
- SEBI in 2019 for mutual funds and alternative investment funds.
These represent an important step, as several large institutional investors either have adopted or are in the process of adopting stewardship policies on terms indicated by their respective regulators.
All three stewardship codes follow a somewhat common approach. They require institutional investors to monitor their investments and engage with investee companies on governance-related matters. If institutional investors suffer from conflicts of interest, they identify and manage them. Where necessary, the institutions are called upon to intervene in investee companies that face poor financial performance, leadership issues, and other risks. The codes require institutional investors to exercise independent judgment while casting their votes at shareholders’ meetings and to disclose their voting policies as well as voting trends. Finally, the investors must report on their stewardship activities, such that their track record becomes evident.
The Indian regulators’ efforts towards formalising shareholder stewardship in India is commendable. No longer can institutional investors adopt a passive stance. On the contrary, they are now required to be active in the governance of companies in which they have invested by engaging with corporate managements. To that extent, India has joined the bandwagon of jurisdictions embracing shareholder stewardship. However, despite these efforts, several challenges remain and must be addressed.
While most jurisdictions have a common stewardship code that encompasses all types of institutional investors, India has adopted the path of fragmentation whereby there are three codes, one for each investor type. Different regulators have not only issued these different codes, but they also are individually responsible for monitoring compliance by the specific type of investors over which they have regulatory oversight.
Unsurprisingly, this incongruity is a result of default rather than design.
The original intention, undoubtedly, was to have a common stewardship code for all types of investors. In 2016, the Financial Stability and Development Council expressed the need for such a code, as did several recommendations that followed from committees considering corporate governance issues in India. Displaying a lack of regulatory coordination, the individual regulators appear to have acted on their own. Each remains determined to exercise control over their respective constituent investors, such as the IRDAI over insurance companies, the PFRDA over pension funds and SEBI over mutual funds and alternative investment funds. Overall, the evolution of stewardship codes in India represents a rather unusual, unexpected and arguably undesirable trajectory of events.
Stewardship And Concentrated Shareholding
The impact of stewardship bears a direct correlation to the degree to which institutional investors can exercise influence over company managements. While the exertion of such influence is easier in companies with dispersed shareholding, it is likely to be substantially limited in jurisdictions such as India where controlling shareholders, or promoters, play a dominant role in listed companies. This is because institutional investors would be hard-pressed to affect the outcome of decisions made at shareholders’ meetings due to the outsized influence of the promoters.
This leads us to a key question in companies with concentrated shareholding that are replete in India: who exactly are the stewards? The current paradigm ascribes the stewardship role to institutional investors, and this requires careful reconsideration. The undue focus on institutions is myopic, and might even point reform efforts in the wrong direction.
In contrast to the present efforts, in jurisdictions such as India that are replete with promoter-controlled companies, the concept of stewardship must also be extended to promoters.
For example, in family-owned companies, the concept of stewardship comes to the forefront given the multigenerational considerations involved and the promoters’ aim for the continued success of the company in the long term. Similarly, the broader concept of stewardship applies to state-owned enterprises as well, where the government is the promoter.
Some may find the idea of promoters as stewards to be outlandish, but it does have some precedent. For example, in Singapore, the relevant body, viz., Stewardship Asia, has already published a set of stewardship principles applicable to family businesses, which considers family controllers as stewards. Such a reorientation of the stewardship concept will indeed be more beneficial than a narrow focus on institutional shareholders.
There is no doubt that the stakeholder approach has remained the mainstay of corporate governance in India, whereby the company is to serve the interests of various stakeholders, and not merely shareholders. However, the stewardship codes focus largely on the beneficiaries of the respective institutional investors, such as policyholders for insurance companies, subscribers’ wealth for pension funds and clients’ wealth for mutual funds and alternative investment funds. Although the codes allude to the need for investors to engage with companies on opportunities or risks relating to environmental, social and governance matters, they lack the requisite detail for meaningful implementation.
A well-designed stewardship regime could help address some of the concerns emanating from the structure of the stakeholder approach in Indian corporate law and governance.
The general trend around the world has been to use stewardship code as ‘soft law’ to encourage institutional investors to engage with companies. This is unlike ‘hard law’ that comes with consequences for non-compliance. The Indian stewardship codes exhibit some level of ambiguity. For instance, while the 2017 version of IRDAI’s code was explicitly on a ‘comply-or-explain’, basis the PFRDA and SEBI codes are designed to be mandatory in nature. However, the revisions to the IRDAI code in February 2020 signal a shift from the comply-or-explain approach towards a mandate, thereby resulting in convergence among all three codes. Even so, there is a lack of clarity on how the regulators will deal with instances of non-compliance, and what the regulatory machinery for imposing sanctions might be.
Hence, unless accompanied by appropriate consequences that operate as deterrence against a breach, even the supposedly mandatory codes lack legal bite.
Historically, Indian regulators have used soft law only as an interim measure and disregarded it in the longer term. However, the peculiarity of the stewardship code experiment is that it seems embedded in the soft law approach. It remains to be seen whether the transitory nature of soft law will affect stewardship efforts as well. A more robust compliance mechanism is necessary, failing which the regulatory push towards stewardship is unlikely to cut ice.
Overall, while the stewardship efforts in India thus far are laudatory, they are still work in progress. There is a need for a consolidated regulatory framework for stewardship that covers varying types of investors, one that also considers stakeholder interests that are germane to Indian corporate law and governance, and in a form capable of implementation in tangible terms.
Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.