On December 24, 2019, Securities and Exchange Board of India ("SEBI") released a circular setting up a stewardship code for Asset Management Companies ("AMCs"), Mutual Funds ("MFs") and all the categories of Alternative Investment Funds ("AIFs") investing in listed Indian companies ("Stewardship Code" or "Code"). In keeping with global trends, SEBI has made it necessary for the power wielding cash-rich institutional investors, to act in accordance with the responsibilities that invariably accompany and behoove such powers and formulate a policy adopting the principles enshrined in the Code.
The Stewardship Code prescribes certain principles which, aim at enhancing the responsibilities of the AMCs/ AIFs to protect the interests of their investors/beneficiaries. The requirements pertaining to the Stewardship Code shall come into effect on April 1, 2020.
The Stewardship Code significantly relies upon the UK Stewardship Code ("UK Code"), which follows the 'comply or explain' approach.
The idea of a stewardship code for Indian financial sector was originally mooted in 2015 in the fifth meeting of International Advisory Board of SEBI on May 6, 2015 and was reiterated by the Kotak Committee on Corporate Governance dated October 5, 2017.
Stewardship Code for Insurers
Before delving into the Code, its relevant to note that similar requirements had been stipulated by the Insurance Regulatory and Development Authority of India ("IRDAI") in 2017, when it had acknowledged the need of stewardship code owing to the fiduciary responsibilities bestowed upon the insurance companies, by the virtue of being investors on behalf of the policyholders. Accordingly, the IRDAI stewardship code was introduced, which prescribed principles similar to those in the recent Stewardship Code.
Existing requirements cast upon Mutual Funds
SEBI issued a circular in 2010, which is the genesis of the requirement cast upon AMCs to formulate policies, by mandating a disclosure of the rationale for exercise of voting rights by the MFs on their websites.
On March 24, 2014, SEBI issued another circular pertaining to disclosure and transparency, which modified the 2010 circular and encouraged MFs to undertake voting decisions taking into account the interests of their unitholders. MFs were also mandated to make quarterly disclosures of rationale behind each decision for / against the proposal and publish a summary of all the votes.
Under the new Stewardship Code, these requirements have been subsumed, with the additional onus of undertaking prior, in-depth research for any voting decision.
Stewardship Code – A step ahead towards institutional responsibility
Stewardship Code enshrines principles which must have an underpinning in the policies framed by the AMCs, MFs and all the categories of AIFs. The principles of the Code revolve around the following themes-
The policy of AMCs and AIFs must cover areas on which the investor deems important to warrant continuous oversight, such as, operational strategies, financial performance, management quality, corporate governance issues (i.e., independent directors, related party transactions), etc. This is in addition to the onus placed on listed companies in terms of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
In doing so, SEBI has directed all AMCs and AIFs to remain mindful of market-conduct laws dealing with access to non-public inside information, but steers clear from providing more prescriptive guidelines around this issue. Both companies and investors will have to formulate a mechanism that draws a fine balance between providing investors enough information to ensure effective monitoring, without impeding information symmetry in the market at large. It will also be critical for AMCs and AIFs to monitor their trading activity and create robust Chinese walls internally in course of such continuous engagement with listed companies.
SEBI has also mandated these AMCs, MFs and AIFs to identify and disclose circumstances that merit intervention into the affairs of the investee companies in ways like engaging through meetings with the management, collaboration with other investors, etc. The underlying principle appears to be providing greater clarity on the objective parameters that will aid fund managers to monitor the progress and governance of listed companies, and in turn, provide clarity to their unit holders. The policy must incorporate regular assessment of the outcome of these interventions.
Avoiding conflict of interest
The policy should also identify foreseeable situations where conflict may arise between the investee company and the institutional investor. The policy shall include steps to ensure that the said conflict is resolved through specific identified processes, including (a) prohibition on investments in scenarios of conflict, (b) formation of any committee for redressal of such conflicts and, (c) recusal of interested persons.
The policies formulated by AMCs/MFs/AIFs should disclose: (a) the manner in which stewardship responsibilities would be discharged as well as the protocol for monitoring the investee companies, (b) circumstances and foreseeable situations of conflict of interest where intervention must be undertaken as well as the matrix of actions and escalation framework which may be followed in specific situations and, (c) voting activities, including: (i) the mechanisms to be used for voting, i.e., e-voting, through physical attendance, proxy voting, etc. and, (ii) guidelines on how to vote and factors to be considered while voting on proposals.
AMCs/MFs/AIFs are also required to publish a report to their clients/ beneficiaries periodically on the implementation of the above principles. The Code suggests that details of voting be disclosed on a quarterly basis, while implementation of conflict of interest policy may be disclosed annually.
This will be akin to an action-taken report, providing updates to investors on how the fund houses have discharged the stewardship obligations cast upon them by SEBI.
It is relevant to note that the UK Code, which serves as the blueprint for the Stewardship Code, does not prescribe a common approach for all the institutional investors for being an effective steward. Instead, it allows organisations to meet the expectations of the Code in a manner that is aligned with their own business model and strategy. Further, the reporting expectations do not require disclosure of stewardship activities on a fund-by-fund basis or for each investment strategy. The Stewardship Code as formulated by SEBI, however, requires greater granularity from institutional investors.
The Stewardship Code is clearly a long awaited measure, one that adds a much-needed element of enfranchisement for unit holders in funds and recognizes the need to channelize the financial clout wielded by large institutions into a participative corporate ecosystem. AMCs and AIFs will, therefore, form a collective voice at both ends and help augment standards of investor democracy as well as corporate transparency. It is pertinent to note that the Stewardship Code though not prescriptive and rule based, is still mandatory, not following the 'comply or explain' model prevalent in the UK. It remains to be seen how mutual funds and AIFs can bring about structural changes in the next three months, in a manner that modifies the underlying grammar of their interaction with listed companies and expands their fiduciary roles to investors. This will be particularly tested where group company investments are involved. It will be very interesting to see how institutions draft, implement and enforce this code in the coming years as well as how SEBI stress tests these efforts.
* The authors were assisted by Shubham Sancheti, Associate.
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