The Indian Stewardship Codes and the Mirage of Corporate Governance Convergence in the ESG Era

Rudresh Mandal

 

In a post-COVID world focused on environmental, social, and governance (‘ESG’) metrics and market volatility, investor stewardship codes have become increasingly relevant,[1] as governments and institutional shareholders firmly emphasize sustainability.[2] Stewardship codes impose soft law duties on institutional shareholders to actively engage with, and monitor the governance of, their portfolio companies,[3] promoting long-term value and corporate sustainability.[4]

The United Kingdom (‘UK’) was the first country to adopt a stewardship code in 2010 (‘UK Code’),[5] which was later revised in 2020.[6] Thereafter, over 20 countries adopted their versions of stewardship codes.[7] The Indian insurance, pension, and securities regulators instituted their stewardship codes in 2017 (revised in 2021), 2018, and 2019, respectively. More recently, in August 2023, the securities regulator amended both the real estate infrastructure trust and infrastructure investment trust regulations, requiring unitholders with at least 10% of the total outstanding units of a REIT or InvIT to comply with stewardship principles and accordingly formulate a comprehensive stewardship policy (collectively, the ‘Indian Codes’).[8] However, the Indian Codes suffer from two critical design flaws, casting doubt over their intended impact.

First, while their text overwhelmingly tracks the UK Code, the context of the Indian capital markets[9] and the identity of the steward fundamentally diverge from the UK. The UK Code was designed to solve the problem of “rationally passive” institutional shareholders[10] who did not curb the excessive risk-taking and short-termism of their portfolio companies.[11] In contrast, Indian companies are characterized by “rationally active”[12] promoters (controlling shareholders), who often extract private benefits of control to the detriment of minority shareholders.[13] Ignoring such realities, the Indian Codes impose stewardship obligations solely on institutional shareholders, who collectively held only 26% of shares on the NIFTY500 in 2021, playing minor roles in corporate governance, compared to promoters, who held 55% in the same year.[14]

Second, voluntary soft law corporate governance measures have been historically successful in the UK, where reputational incentives are significant,[15] unlike in India, where voluntary soft law has not translated into consistent compliance.[16] From the mandatory corporate governance requirements contained in the Companies Act of 2013 to the securities regulator’s microscopic listing rules, Indian corporate law has traditionally been defined by prescriptive regulation.[17] Accordingly, it is puzzling that the Indian Codes are soft law codes that lack enforcement mechanisms and systems to monitor the quality of compliance.

The implications of the aforesaid design flaws for comparative corporate law are revealing. In two impactful articles,[18] Professors Hansmann and Kraakman argued that corporate law had globally converged (and would continue converging) around a uniform model.[19] Consequently, Western literature viewed the global diffusion of UK-style stewardship codes as stemming from similar corporate governance concerns that gave rise to the UK Code.[20] While a superficial textual analysis suggests that the Indian Codes have ‘converged’ with the UK Code, this ‘convergence’ is only skin-deep, representing formal convergence but functional divergence.

The intended function of the Indian and UK Codes differ. The UK Code intended to solve problems of institutional shareholder passivity[21] that are absent in India, where promoters are majority shareholders and are deeply involved with their companies. This presents distinct governance challenges. In fact, the Economist recently noted that “India is still a relative black hole for investor campaigns, with a single-digit number of activist proposals counted by Diligent Market Intelligence each year.”[22] For developing countries like India seeking to attract foreign investors in the ESG era, stewardship codes are uncontroversial, cost-effective devices which do not disturb the status quo and are intended to signal membership within the ‘good’ corporate governance club.[23]

Anglo-American scholarship and supranational institutions, like the OECD and World Bank, have developed a ‘good’ governance toolbox[24] and subliminally shaped comparative corporate law. As a result, foreign investors prefer countries where corporate governance has (at least) formally converged with Anglo-American and supranational norms.[25] Stewardship codes are the latest manifestation of this preference in India, where regulators adopted ill-fitting UK-style stewardship to push their ESG-signalling agenda. In doing so, they failed to address problems more relevant to their national corporate governance context.

If, as Indian regulators claim,[26] contemporary Indian corporate law strives to encourage ESG-based governance, stewardship in its current form is inadequate. In fiscal year 2023, amongst companies listed on the National Stock Exchange’s main board, Prime Database noted a 44% increase in the percentage of dissenting votes cast by more than 20% of institutional shareholders voting. However, 97% of these resolutions were nonetheless passed, because of high promoter shareholding. [27] As such, stewardship obligations must be directly imposed through hard law that applies to promoters, not institutional shareholders, as Singapore has done for family businesses, albeit through voluntary principles.[28] While a voluntary code is unlikely to be effective in India, imposing stewardship obligations on promoters is arguably the next logical step in tightening corporate governance standards. In fact, the August 2023 amendments to the REIT and InvIT regulations hint towards the imposition of stewardship requirements on all who hold units beyond a particular percentage (which would therefore cover both institutional unitholders and sponsors[29]). If indeed the regulator was intentional in this approach, it must strongly consider applying the logic to the other stewardship codes and introduce stewardship obligations on promoters. Undoubtedly, this would be met with strong resistance from the powerful Indian business lobby.

The Indian Codes must innovate, accommodate new actors, and also mandate clear disclosure of how promoters have (i) exercised voting rights and identified voting rationale; (ii) meaningfully engaged with independent directors, minority shareholders, and society; and (iii) mitigated risk and implemented long-term strategies to promote effective stewardship.[30] Substantive stewardship disclosure requirements will cultivate increased transparency and preserve the credibility of the Indian Codes. These disclosures must be qualitatively tiered by the regulators[31] to disincentivize check-the-box compliance and to develop a market where institutional shareholders allocate capital to companies with top-tier stewards. By incentivizing stewardship, these measures will steer the Indian Codes toward being functionally relevant for corporate governance.

 

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[1]Benjamin Colton & Ryan Nowicki, The Role of Long-Term Shareholder Voice, Harvard Law School Forum on Corp. Governance (Nov. 7, 2022), corpgov.law.harvard.edu/2022/11/07/the-role-of-long-term-shareholder-voice/.

[2]Dionysia Katelouzou & Dan W. Puchniak, Global Shareholder Stewardship: Complexities, Challenges and Possibilities, in Global Shareholder Stewardship 3, 35-40 (Dionysia Katelouzou & Dan W. Puchniak eds., 2022).

[3]Lucian Bebchuk & Scott Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy, 119 Colum. L. Rev. 2029, 2029-34 (2019).

[4]Paul L. Davies, The UK Stewardship Code 2010-2020: From Saving the Company to Saving the Planet?, 21-25 (Eur. Corp. Governance Initiative, Law Working Paper No. 506/2020).

[5]Fin. Reporting Council, The U.K. Stewardship Code (July 2010).  

[6]Fin. Reporting Council, The U.K. Stewardship Code (Oct. 2020).

[7]Dionysia Katelouzou & Mathias Siems, The Global Diffusion of Stewardship Codes, in Global Shareholder Stewardship 631, 633 (Dionysia Katelouzou & Dan W. Puchniak eds., 2022).

[8] Pension Fund Regulatory and Development Authority, Common Stewardship Code, PFRDA/2018/01/PF/01 (Issued on May 4, 2018); Securities and Exchange Board of India, Stewardship Code for all Mutual Funds and all categories of AIFs, in relation to their investment in listed equities, CIR/CFD/CMD1/168/2019 (Issued on Dec 24, 2019); Insurance Regulatory and Development Authority of India, Revised Guidelines on Stewardship Code for Insurers in India, IRDAI/F&A/GDL/CPM/045/02/2020 (Issued on Feb. 7, 2020).; SEBI (Infrastructure Investment Trusts) (Second Amendment) Regulations, 2023, Reg. 3(II), 3(IX); SEBI (Real Estate Investment Trusts) (Second Amendment) Regulations, 2023, Reg. 3(II), 3(VI).

[9]Guy R. Jubb & Nirmal Mohanty, An Indian Stewardship Code: Imperatives and Challenges, NSE Ctr. for Excellence in Corp. Governance (Oct. 2017), www1.nseindia.com/research/content/res_QBOctober17.pdf.

[10]Dan W. Puchniak, The False Hope of Stewardship in the Context of Controlling Shareholders: Making Sense Out of the Global Transplant of a Legal Misfit 5, 16, (Eur. Corp. Governance Initiative, Law Working Paper No. 589/2021).

[11]Arad Reisberg, The UK Stewardship Code: On the Road to Nowhere?, 15 J. Corp. L. Stud. 217, 221-24 (2015).

[12] Puchniak, supra note 10 at 6, 22.

[13]Umakanth Varottil, Shareholder Stewardship in India: The Desiderata, in Global Shareholder Stewardship 360, 370-72 (Dionysia Katelouzou & Dan W. Puchniak eds., 2022).

[14]Institutional Investor Advisory Services, Voting Outcomes for the NIFTY 500 Companies: FY20-21 (Dec. 2021), iias-cms.s3.ap-south-1.amazonaws.com/F1_1_Voting_Outcomes_Ii_AS_report_Final_Version_8c592733ca.pdf.

[15]Davies, supra note 4, at 18-19.

[16]Varottil, supra note 13, at 375-76; Afra Afsharipour, Corporate Governance Convergence: Lessons from the Indian Experience, 29 Nw. J. Int'l L. & Bus. 335, 367-68 (2009).

[17]Umakanth Varottil, Corporate Governance in India: The Transition from Code to Statute, in Corporate Governance Codes for the 21st Century 97, 109-11 (Jean du Plessis & Chee Keong Low eds., 2017).

[18]Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 Geo. L.J. 439 (2001); Henry Hansmann & Reinier Kraakman, Reflections on the End of History for Corporate Law, in The Convergence of Corporate Governance, 32 (Abdul A. Rasheed & Toru Yoshikawa eds., 2012)

[19]Id.

[20]Iris Chiu & Dionysia Katelouzou, From Shareholder Stewardship to Shareholder Duties: Is the Time Ripe?, in Shareholder Duties 131, 131 (Hanne S. Birkmose ed., 2017); Prepping for the Trend: Stewardship Code Coming to Asia, ISS Corporate Solutions (2019), www.isscorporatesolutions.com/prepping-for-the-trend-stewardship-code-coming-to-asia/; Jeffrey N. Gordon, Convergence and Persistence in Corporate Law and Governance, in Oxford Handbook Of Corporate Law And Governance 28, 54 (Jeffrey N. Gordon & Wolf-Georg Ringe eds., 2018).

[21]Bobby V. Reddy, The Emperor's New Code? Time to Re-Evaluate the Nature of Stewardship Engagement Under the UK's Stewardship Code, 84 Mod. L. Rev. 842, 842-47 (2021).

[22] The rise of the Asian activist investor, The Economist (Aug. 31, 2023), https://www.economist.com/business/2023/08/31/the-rise-of-the-asian-activist-investor.

[23]Dan W. Puchniak & Samantha S. Tang, Singapore's Puzzling Embrace of Shareholder Stewardship: A Successful Secret, 53 Vand. J. Transnat’l L. 989, 995-97 (2021).

[24]Gen Goto, Alan Koh & Dan W. Puchniak, Diversity of Shareholder Stewardship in Asia: Faux Convergence, 53 Vand. J. Transnat’l L. 829, 877 (2021).

[25]Jeffrey N. Gordon & Mark J. Roe, Introduction, in Convergence and Persistence in Corporate Governance 1, 2 (Jeffrey N. Gordon & Mark J. Roe eds., 2004).

[26]Ministry of Corporate Affairs, Report of the Committee on Business Responsibility Reporting (2020), www.mca.gov.in/Ministry/pdf/BRR_11082020.pdf; Securities and Exchange Board of India, Business responsibility and sustainability reporting by listed entities, SEBI/HO/CFD/CMD-2/P/CIR/2021/562 (May 10, 2021).

[27] Moneycontrol News, Institutional shareholders’ activism surged 44% in FY23: Prime Database, Moneycontrol (June 29, 2023), https://www.moneycontrol.com/news/business/markets/institutional-shareholders-activism-surged-44-in-fy23-prime-database-10877901.html.

[28]Stewardship Asia, Stewardship Principles For Family Businesses (2018) www.stewardshipasia.com.sg/sites/default/files/SSP-brochure0913_approved%20for%20printing.pdf.

[29] It is relevant to note that REITs and InvITs do not have ‘promoters’ but instead have ‘sponsors’ who set up the REIT or InvIT. These are not families or individuals but typically institutions like KKR, Blackstone, or Brookfield.

[30]Ernest Lim & Dan W. Puchniak, Can a Global Legal Misfit be Fixed? Shareholder Stewardship in a Controlling Shareholder and ESG World, in Global Shareholder Stewardship 599, 606 (Dionysia Katelouzou & Dan W. Puchniak eds., 2022).

[31]Financial Reporting Council, Tiering of Signatories to the Stewardship Code (Nov. 14, 2016), www.frc.org.uk/news/november-2016/tiering-of-signatories-to-the-stewardship-code.