A letter to the Board Members
June 07, 2020
Institutional shareholder can no longer be a mute spectator: Stewardship governance in India
The voice of a shareholder, specifically an institutional shareholder must be heard and can no longer be ignored and as India Inc. changes its hues, one thing that remains clear is the growing need for shareholders to speak up and the need for a company to listen. Rightly or wrongly, these voices have now started emerging through various forums – the media, via regulators, at shareholder meetings, in quiet conference rooms leading us to believe that shareholder activism, specifically institutional shareholder activism, is a key aspect of the gradual convergence of India’s corporate governance praxis with global best practices.
Shareholder activism in other jurisdictions
Shareholder activism evolved in more-mature securities markets, such as the U.S., as a result of unique mix of regulation and the presence of investors with large risk-appetites1. Institutional shareholders – largely, pension funds, mutual funds, and retirement funds - came into prominence by the late-1980s for their growing investible corpuses and their ability to collaborate in pressuring management to take up governance matters which, in their view, would be most value accretive2. Similarly, in the U.K., the trend of the activist shareholder came about in the late-2000s and well into the 2010s. In the recent past, major U.K. companies have been targeted by activist shareholders3 for matters relating to board representation and governance4, managerial remuneration, business strategy, capital structure, and other social and environmental demands5. With the rising influence of stakeholder-focused corporate governance, fund managers are increasingly focusing on the long-term sustainability of business models of their portfolio companies6. With that, the Financial Reporting Council, U.K., has instituted the U.K. Stewardship Code 2020, as an overhaul of the U.K. Stewardship Code 2012. There is a strong focus on the activities and outcomes of stewardship, not just policy statements. There are new expectations about how investment and stewardship is integrated, including environmental, social and governance (ESG) issues. The Code asks investors to explain how they have exercised stewardship across asset classes7.
The ‘conscientious’ institutional shareholder
Institutional shareholders, which group includes mutual funds, insurance companies, financial institutions, foreign portfolio investors, and other pooling vehicles, control a significant portion of the capital flows in the capital markets. Companies with fairly dispersed shareholdings have significant institutional investor presence8.
Traditionally, institutional shareholders, with mutual funds and insurance companies being the largest players, have been viewed as passive investors with little to show for positive effect on company value9. Institutional shareholders deploy public wealth in different concerns, and, in doing so, are accountable as a fiduciary to its constituents. Short-term financial returns were key to institutional investors’ investment rationale. In recent years, however, there has been a slow, but definite, shift away from short-termism and passivist approach to investments. Significantly, institutional investors have started voting against remuneration packages offered to key management10 and against certain re-appointments11. Significantly, foreign portfolio investors also voted against managerial appointments in adherence with advice from offshore proxy advisory firms. The effective exercise of ownership rights, such as voting on shares held, is viewed as part of the value-creation exercise being undertaken on behalf of the constituent; the failure to exercise voting rights appropriately could result in a loss to the constituents12.
That institutional investors such as, mutual funds, insurance companies, alternative investment funds are required to act as responsible investors is not novel; each of these institutions are meant to act as fiduciaries of their respective constituents, be it policyholders (in the case of insurance companies) or unitholders (in the case of mutual funds and alternative investment funds). The Supreme Court has, in various cases, reiterated that in dealing with public money, persons or institutions must demonstrate the highest degree of integrity and trust-worthiness13 and that employees and financial institutions must discharge their fiduciary role for public confidence in financial systems to be retained14.
The growing shareholder activism15 comes in the backdrop of economic woes in India16. Fund managers are finding it increasingly difficult to keep up sustained returns for its unitholders17 and insurance companies are heavily reliant on investment profits at a time when profits are falling on the back of underwriting losses18. The assertive institutional shareholder might be a product of commercial considerations – short-termism and passivity are no longer bringing in the bacon. What is significant, however, is the regulatory push towards accountability in the institutional investors’ engagement with the management of the companies in its portfolio.
Stewardship code: Focus on greater accountability
The Insurance Regulatory and Development Authority of India (IRDAI) has in the case of insurance companies, and the Security and Exchange Board of India (SEBI) has in the case of mutual funds and alternative investment funds, mandated the implementation of ‘stewardship codes’19. It is intended that these financial institutions discharge their ‘stewardship responsibilities’ to maximize the wealth of their policyholders (in the case of insurance companies) and their unitholders (in the case of mutual funds and alternative investment funds), who are the ultimate beneficiaries of the investments made. While insurance company were already implementing a stewardship policy since 2017, the IRDAI’s revised circular dated February 8, 2020 mandates insurance companies to step up engagement with investee companies. The implementation of the stewardship code for mutual funds and alternative investment funds have now been pushed to July 1, 2020, and for insurance companies have now been pushed to May 31, 2020.
Broadly, the circulars require the institutional investors to adhere with the following investment principles:
The overall goal of the stewardship code is to push institutional investors to be responsible stewards in managing their stakeholders’ money.
Challenges that remain:
It may, however, be too optimistic to focus on the opportunities alone. The effective implementation of the stewardship code will need to surmount several challenges:
Stakeholder-driven corporate governance is where corporate governance praxis is headed. The gradual rise of the conscientious institutional investor is to be welcomed as it eases Indian companies into the new normal of ESG-driven governance agenda and of stakeholder-value maximization. As the process of salvaging the economy begins in the latter half of this year, businesses may be judged not on profitability alone but on its role in the larger re-building process. Institutional shareholders may be given the herculean task to ensure businesses are not devoid of the greater social goal. As Mr. Larry Fink, CEO, Blackrock, stated in his annual letter to CEOs, 2018, “Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders. It will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth.”
– Supratim Guha, Poonam Pal Sharma, Parag Srivastava & Simone Reis
You can direct your queries or comments to the authors
1 Gillan, Stuart L. and Starks, Laura T., The Evolution of Shareholder Activism in the United States (2007). Available at SSRN: https://ssrn.com/abstract=959670 or https://dx.doi.org/10.2139/ssrn.959670
3 Activists target dozens of UK’s biggest companies; The Times (July 23, 2019); available at: https://www.thetimes.co.uk/article/activists-target-dozens-of-uk-s-biggest-companies-8ws66lpsn?mod=article_inline
4 Investor Edward Bramson concedes early defeat for seat on Barclays board; The Guardian (May 2, 2019); available at: https://www.theguardian.com/business/2019/may/02/investor-edward-bramson-concedes-early-defeat-for-seat-on-barclays-board
5 Filatotchev, I., Dotsenko, O. Shareholder activism in the UK: types of activists, forms of activism, and their impact on a target’s performance. J Manag Gov 19, 5–24 (2015). Available at: https://doi.org/10.1007/s10997-013-9266-5
6 Vanguard, “An open letter to directors of public companies worldwide”. Available at: https://theboardinstitute.com/vanguard-ceo-open-governance-letter-companies/
7 UK Stewardship Code; available at: https://www.frc.org.uk/investors/uk-stewardship-code
8 Major listed companies have significant institutional holdings, which makes their positions crucial to decision-making. See: https://www.moneycontrol.com/bse/shareholding/institutional_holding.php?type=1
9 “Corporate Governance in India”; Jayati Sarkar and Subrata Sarkar, SAGE Publications, 2012
10 Institutional investors find their voice, India Inc takes note, The Economic Times (October 22, 2018); available at: https://economictimes.indiatimes.com/markets/stocks/news/institutional-investors-find-their-voice-india-inc-takes-note/articleshow/66310372.cms?from=mdr
11 46% of Apollo Tyres’ institutional shareholders oppose re-appointment; Financial Express (March 27, 2019); available at: https://www.financialexpress.com/industry/46-of-apollo-tyres-institutional-shareholders-oppose-re-appointment/1528650/
12 G20/OECD Principles of Corporate Governance; OECD 2015; available at: https://www.oecd.org/corporate/ca/Corporate-Governance-Principles-ENG.pdf
13 Regional Manager, U.P.S.R.T.C. v. Hoti Lal (2003) 3 SCC 605
14 Burdwan Central Cooperative Bank Limited v. Asim Chatterjee (2012) 2 SCC 641
15 Institutional Activism Grows At Shareholder Meetings; Bloomberg|Quint (September 28, 2017); available at: https://www.bloombergquint.com/law-and-policy/institutional-activism-grows-at-agms
16 Asia’s Short Sellers, Activists Go After Bigger Fish, The Wall Street Journal (November 6, 2015); Available at: https://www.wsj.com/articles/asias-short-sellers-go-after-bigger-fish-1446799385
17 Coronavirus impact: Franklin Templeton Mutual Fund shuts six schemes, Rs 30,800 crore investor wealth stuck, Business Today, (April 24, 2020); available at: https://www.businesstoday.in/money/mutual-fund/coronavirus-crisis-franklin-templeton-mutual-fund-shuts-six-schemes/story/401900.html
DHFL Crisis: Debt Scheme Loses 50% in a Single Day; Money Life (June 5, 2019); available at: https://www.moneylife.in/article/dhfl-crisis-debt-scheme-loses-50-percentage-in-a-single-day/57355.html
18 General insurers see their profits fall 90% in FY19, The Economic Times (December 20, 2019); available at: https://economictimes.indiatimes.com/markets/stocks/earnings/general-insurers-see-their-profits-fall-90-in-fy19/articleshow/72895093.cms?from=mdr
19 See: IRDAI circular dated February 7, 2020 (Ref: IRDAI/F&A/GDL/CPM/045/02/2020), which replaced the IRDAI circular dated March 20, 2017 (Ref: IRDAI/ F&A/GDL/CPM/059/03/2017), as applicable to investments by insurance companies, and the SEBI circular dated December 24, 2019 (Ref: CIR/CFD/CMD1/168/2019), as applicable to investments by mutual funds and alternative investment funds.
20 INDIA’S NATIONAL ACTION PLAN ON BUSINESS & HUMAN RIGHTS; available at: https://www.mca.gov.in/Ministry/pdf/NationalPlanBusinessHumanRight_13022019.pdf
21 Fortis shareholders vote to oust Brian Tempest from the company's board, The Economic Times (May 23, 2018); available at:
22 Bain Capital moves HC to make public Lilliput books (Financial Express) (April 20, 2012); available at: https://www.financialexpress.com/archive/bain-capital-moves-hc-to-make-public-lilliput-books/939085/
23 What are foreign proxy firms? This HDFC case spurts demand to regulate outside advisories in India; Financial Express (August 9, 2018); available at: https://www.financialexpress.com/market/what-are-foreign-proxy-firms-this-hdfc-case-spurts-demand-to-regulate-outside-advisories-in-india/1275028/
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