Institutional investors have begun to actively participate in decision-making at shareholders’ meetings of listed companies
Anuj Sah & Rohan Singh
Increasingly, corporate governance is becoming a focus area for Indian companies and regulators alike. In the context of listed companies, corporate governance has evolved from the erstwhile clause 49 of the listing agreement to the recent notification of the Securities and Exchange Board of India (Listing Obligations and Disclosures Requirements) Regulations 2015.
The Securities and Exchange Board of India has brought corporate governance back into focus on 2 June 2017 by setting up a committee to examine various key issues to further increase the levels of corporate governance - from ensuring independence of independent directors, improving safeguards and disclosures pertaining to related party transactions and addressing issues faced by investors in voting and participation in meetings.
In recent years, institutional investors have begun to actively participate in decision-making at shareholders’ meetings (and where they have a nominee, at the level of the board of directors) of listed companies. Accordingly, there are recent examples of the positive influence of institutional investors on corporate governance in listed companies when they actively participate and remain involved in key decisions concerning their investee companies.
Insurance companies are some of the largest institutional investors in listed companies. The key contributing factors to this is that one of the major options available for investment of insurance company funds are shares of listed companies.
The Insurance Regulatory and Development Authority of India (Investment) Regulations 2016 restrict the ability of insurance companies to invest beyond certain prescribed instruments (and instruments that may be separately permitted). Hence, insurance companies have the funds, the regulatory mandate and the ability to pump in significant amounts of capital into listed companies.
Given this background, insurance companies can accumulate substantial minority shareholdings in listed companies, and, if applied appropriately, positively influence decision-making, in particular, and corporate governance, in general, at such companies.
The Insurance Regulatory and Development Authority of India (IRDA) took a substantial step towards improving corporate governance in Indian public listed companies by notifying the ‘Guidelines on Stewardship Code for Insurers in India’ (Code) on 20 March 2017.
The Code applies to all ‘insurers’ (including Life Insurance Corporation of India) and requires insurance companies to prepare a board-approved policy based on the Code within 6 months from date of issue of the Code (i.e. by 19 September 2017). Such board-approved policy should be made available to the public by disclosure within 30 days of board approval by placing the policy on the insurance company’s website.
While the IRDAI had released an updated version of the corporate governance guidelines for insurance companies in 2016, it had not issued any guidelines on regulating the extent of involvement of insurance companies in their listed investee companies.
The IRDAI was of the view that this was an important factor, both in terms of the need for insurance companies to be proactive investors and also, leveraging their ability as significant institutional investors in listed companies to be able to have a significant impact on improving corporate governance in listed companies where they invest.
Another substantial consideration is that the IRDAI believes that insurance companies are custodians of policyholder funds and, therefore, investments made by insurance companies should be undertaken in such manner that the insurance company’s invested funds are protected, preserved and grow. The ultimate objective of the Code is to ensure that all insurance companies -make well-informed decisions, in order to improve return on their investments.
In this article, we have examined the stewardship principles introduced by the IRDAI, and its potential implications on corporate governance of listed companies.
Under the Code, the IRDAI has provided that ‘stewardship activities’ would include monitoring and engaging with investee companies (whether through the appointment of nominee directors or otherwise) on strategy, social and economic matters, performance, risk, capital structure, corporate governance (including performance, culture, leadership effectiveness, succession planning and remuneration) amongst other matters.However, the Code leaves it to the discretion of the insurance companies to decide whether or not to obtain board seats in their investee listed companies in order to fulfil their stewardship duties. The IRDAI has prescribed seven stewardship principles to be adhered by insurers. Accordingly, in addition to monitoring their investee companies and periodically reporting their stewardship activities (two of the principles), insurers are required to formulate and adopt:
- stewardship policy: a publicly disclosed policy on the discharge of their stewardship responsibilities;
- conflict management policy: a clear publicly disclosed policy on managing conflicts of interest which arise when they try to fulfil their stewardship responsibilities;
- intervention policy: a clear policy on intervention in their investee companies;
- collaboration policy: a publicly disclosed policy for collaboration with other institutional investors in order to preserve the interest of its policyholders; and
- voting policy: a clear policy on voting and disclosure of voting activity.
The stewardship policy should include details on how the insurer intends to fulfil such responsibilities and protect and enhance policyholder wealth; as well as provide whether the insurer proposes to engage external service providers (eg institutional advisors) to assist in carrying out the stewardship responsibilities (although, the ultimate responsibility for compliance with the Code would be on the insurer). The conflict management policy is required to set out scenarios where conflict of interest is likely, and a protocol on how to address such conflicts. The intervention policy is required to provide thresholds or criteria pursuant to which insurers will intervene in decision-making of their investee companies.
Insurers can intervene by holding confidential meetings with the investee company, and upon failure of such meetings to resolve the issue, to have pre-defined steps on escalation of the issue. One of the more significant policies is the voting policy, in relation to which the IRDAI has stated that insurers should exercise their own judgment rather than automatically supporting proposals of the board of directors of their investee company, in order to ensure that the decisions target the promotion of overall growth of investee companies.
In order to give teeth to the aforementioned principles, the IRDAI has mandated that all insurers should submit to the IRDAI a board-approved (and Compliance Officer endorsed) annual report on compliance with the Code on a ‘comply or explain’ basis (ie reasons for any deviation or non-compliance from the Code should be provided in the annual report).
Given the large participation of the insurance companies in Indian capital markets, the notification of the Code by the IRDAI, can help in significantly bolstering corporate governance in listed companies. IRDAI has made its intent clear that if insurance companies invest in listed companies, they should actively manage such investments and that they should increasingly engage with the management of such companies on key issues affecting the performance, efficiency and sustained growth of listed companies.
However, the devil lies in the details here, as we will need to wait and observe how insurance companies implement these policies, whether they engage external institutional advisors or handle stewardship responsibilities on their own, and to what extent insurance companies choose to intervene and collaborate with other institutional investors in order to uphold corporate governance standards in their investee companies and thereby preserve shareholder, and consequently, policyholder value.
Also, there is no prescribed exemption for situations in which insurance companies hold a small stake in a listed company. In fact, the IRDAI has, in its guidance for the first stewardship principle, clarified that the insurance company’s board-approved stewardship policy should clearly identify the threshold (ie level of investment or other board-approved criteria) for intervention in its investee companies.
Accordingly, the Code grants flexibility to insurance companies to decide the extent of potential involvement in insurance companies where they do not hold a significant minority investment (eg 1 percent stake). On an overall analysis of the implications of the Code, while insurance companies may incur short term costs and require management and board time in implementing their stewardship policy, the long-term effects of such policy will be improvement in corporate governance in listed companies, increased accountability of insurance companies in effectively managing their investments and enhancing their ability to maximise returns on their investments in listed companies.
Authors are Anuj Sah (Partner) and Rohan Singh (Senior Associate)
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