India nudges the elephant

by Sharmila Gopinath, ACGA

24 November 2021

Can independent directors nominated by controlling shareholders, and essentially elected by them, be truly independent? This is a question Asian markets have been grappling with for two decades. India has some tentative answers.

Since the concept of the independent director was introduced into India in the late 1990s questions have been asked about the obvious elephant in the room: whether people nominated at the behest of the “promoter” (controlling shareholder) and requiring only a simple majority to be elected can ever be truly effective. For a majority of listed companies the voting outcome is a slam dunk, since 60% of listed companies comprising around 67% of total market capitalisation have promoter group shareholdings of more than 50%. Indian regulators have finally decided to act.

Following a consultation in February 2021, the Securities and Exchange Board of India (SEBI) passed a slew of initiatives, which will become effective in January 2022, aimed at empowering independent directors. In a first for the region, SEBI has mandated that any appointment, reappointment or removal of independent directors must be through a special resolution, requiring 75% of votes in favour to pass.

On the surface this appears to be a big win for corporate governance and minority shareholder rights. How do investors feel about it? We contacted some of the bigger foreign names and found them all to be fairly circumspect. Amar Gill, Head of Investment Stewardship APAC for BlackRock, warned that allowing promoters to vote could mean the outcome was “pretty much the current status quo” and the “whole effort then seems to come to naught”. He would prefer a “majority of the minority” vote, where only independent shareholders can vote and the threshold is the normal 50%.

Two other institutional investor members of ACGA agreed, with one referencing a September 2021 article by local proxy advisory service, Institutional Investor Advisory Services, that claimed just 8% of NSE-500 companies are institutionally owned and widely held, meaning that the new 75% rule is likely to have a meaningful impact at only around 40 issuers. Even companies with moderate levels of promoter ownership—there are about another 50 issuers where holding levels are 27% or below—the turnout of minority shareholders would need to be significant for the special resolutions to be effective.

The domestic investor perspective is, not surprisingly, somewhat more positive. Abhay Laijawala, Managing Director, Avendus Capital believes the new rule is a step in the right direction and should help to balance the power on company boards. It could also strengthen the independence of independent directors, since their appointment or removal would no longer be quite so subservient to the whim or fancy of a promoter. Yet Laijawala agreed that SEBI would have to address the preponderance of concentrated ownership in future.

Sticking with one-tier voting

One SEBI proposal that did not make it through the consultation phase was a suggestion to follow the UK’s two-tier voting structure, where independent directors must be approved first by all shareholders and then by minority shareholders only. Most respondents opposed this, citing such things as “practical difficulties in implementation, delays in appointment of ID in case of a deadlock, unintended voting skews due to a minority public shareholders having a significant shareholding” and so on. The regulator chose to be “pragmatic” and took a “balanced view” by introducing a simpler process that covered a larger segment of shareholders.

We would urge SEBI to revisit this decision and introduce two-tier voting for all independent director elections if it appears that the super-majority approach is not making a huge difference.

Where the rules may have more bite

While some investors are underwhelmed with the 75% rule, they are cautiously optimistic about SEBI’s new proposal for a nomination and remuneration committee (NRC), which would bring greater transparency to the process for selecting independent directors. NRCs will be required to disclose the range of skills and capabilities they are looking for in an independent director, and how a proposed individual fulfils that mandate. Moreover, the composition of NRCs will require at least a two-third independence ratio rather than the current proposal for 50%.

As one ACGA member said in a written reply: “We really welcome the move to 2/3rd independence for the nominating committee, our current standard looks for majority independence so this is an improvement in terms of the first hurdle encompassing the selection of INEDs i.e. there will be a more independent selection process of the candidates for INED roles in the first place. That said, ultimately when it comes to the vote the promoters still reign supreme.”

The truth is that the corporate sector in India has invariably needed a nudge from regulators to change its ways, and regulators have needed to monitor the rules regularly to ensure they do not become mere box-ticking exercises for companies. Shifting the cultural mindset can be difficult, but there have been incremental changes in the marketplace as regulators have created and then fine-tuned rules, and shareholders have steadily become more vocal. BlackRock’s Gill said: “Interestingly, I am getting slightly more positive responses from Indian companies about being able to access independent directors generally, but these are ad hoc arrangements.” This gives one hope, but there is also a desire for regulators to be more stringent and write rules from the start that will stand the test of time and not have to be amended in a few months or years.

About the Author(s)

Sharmila Gopinath
Research Director, India, ACGA

Sharmila Gopinath is a former journalist with a background in business writing and editing. During her career she has worked in Hong Kong, New York and Singapore, covering topics such as information technology, general business and finance. Sharmila was full-time with ACGA in Hong Kong from 2005 until December 2012, when she relocated to India. She continues to work for the Association on a part-time basis as ACGA’s Research Director, India.

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