Corporate governance regime in the UK
As a result of the banking crisis, a review of the corporate governance regime in the UK was carried out by the Financial Reporting Council (FRC). The review resulted in two principal changes to the regime.
Following a review of the Combined Code on Corporate Governance, the FRC issued a new edition of the Code- the “UK Corporate Governance Code”. The UK Corporate Governance Code applies for accounting periods beginning on or after 29 June 2010 and is the key source of corporate governance recommendations for companies with a premium listing of equity shares in UK (regardless of the country of their incorporation) and is kept under review by the FRC. Certain parts of the UK Corporate Governance Code apply only to FTSE 350 companies.
The Combined Code on Corporate Governance continues to apply to quoted companies for accounting periods prior to 29 June 2010.
In addition, the Companies Act 2006 sets out certain principles of corporate governance, and is supplemented by the Listing Rules, Prospectus Rules and the Disclosure and Transparency Rules. The Listing Rules require that companies to whom these codes apply must either comply with the relevant code or explain the reasons for non-compliance in their annual reports. The UK Corporate Governance Code encourages chairmen of the board to report personally in their annual statements on compliance with certain aspects of the Code.
The second change is the introduction of the UK Stewardship Code. The UK Stewardship Code is borne out of the Walker review and aims to enhance the quality of engagement between institutional investors and investee companies by setting out good practice on engagement of institutional shareholders with investee companies. Like companies, under the UK Stewardship Code, institutional shareholders are being asked to adopt a ‘comply or explain’ approach, by publishing details of their compliance with the code on their websites.
Bribery and anti-corruption is an important facet of corporate conduct. The recently enacted Bribery Act, 2010 (due to come into force in April 2011) could have a significant impact on the conduct of business of UK based companies and companies which carry on business in the UK.
Corporate governance regime in India
The listing agreement between quoted companies and Indian stock exchanges is the principal source of corporate governance norms. The securities market regulator, Securities and Exchange Board of India (SEBI) prescribes and implements the norms. SEBI has made numerous changes to the corporate governance regime over the years, to align the same with market realities.
The case of Satyam Computers where the promoters falsified Satyam’s accounts, despite the company being listed on the Indian and New York stock exchange has re-ignited the corporate governance debate in India. As an aftermath of Satyam, the Ministry of Corporate Affairs published voluntary corporate governance guidelines in December 2009. These guidelines are designed to encourage companies to adopt better practices in the running of boards and board committees, the appointment and rotation of external auditors and seek to create a whistle-blowing mechanism.
The Companies Bill, 2009, which proposes to amend the Indian Companies Act, 1956 deals with several aspects of corporate governance such as director’s duties and related party transactions.
The Prevention of Corruption Act, 1988 principally deals with corruption by public officers, but prosecution under this Act has been impeded by requirements for the Government to grant approval for prosecution under the Act.
Comparison between the regimes in the UK and India
We have set out below a high-level comparison of the principal corporate governance issues in India and the UK.
|Director’s duties||Codified by the Companies Act, 2006||- Currently rely on common law duties. - Codification of director’s duties is proposed by the Companies Bill, 2009, though extent of proposed codification is not as extensive as in the UK.|
|Board composition||- Half of the board of larger quoted companies must comprise of independent non-executive directors. Smaller quoted companies (below FTSE 350) must have at least two independent non-executive directors. - Same individual must not be the chairman and chief executive. - Requires formal, rigorous annual evaluation of board performance, performance of committees and directors. - The search for board candidates should be conducted and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender. - All directors of FTSE 350 companies must be annually elected by the shareholders.||- There is no distinction between large and small quoted companies. Half of the board of all quoted companies must comprise of non- executive directors. - If the chairman of the board is an independent director, 1/3rd of the non-executive directors must be independent and if the chairman is not independent, half of the non-executive directors must be independent. - Same individual can act as chairman and chief executive. - No requirement for a board evaluation process. - There is no requirement for annual re-election of all directors. Appointment and election of directors is governed by the Companies Act, 1956.|
|Nomination committee||- Nomination committee leads the process for board appointments and makes recommendations to the board. - Must consist of a majority of independent non-executive directors.||- Nomination committee is not mandatory, though some companies have voluntarily set up a nomination committee.|
|Audit committee||- Quoted companies must have an audit committee comprising of 3 members. Audit committees of smaller quoted companies need only have 2 members. - All members of the audit committee must be independent non-executive directors.||- There is no distinction between small and large quoted companies. All quoted companies must have an audit committee comprising of 3 members. - Unquoted public companies with a paid up capital of more than Rs. 50,000,000 must also have an audit committee. - 2/3rd of the audit committee must comprise of independent directors.|
|Remuneration committee||- Quoted companies must have a remuneration committee comprising of 3 members (2 members for below FTSE 350 companies) and all members must be independent. - Chairman must be an independent, non-executive director. - The committee should have delegated responsibility of setting remuneration for all executives, the chairman, and recommending level of remuneration for senior management. - The Code discourages all forms of performance-related remuneration for non-executive directors, not only share options.||- Remuneration of directors of public companies (listed or unlisted), within specified limits, must be approved by a remuneration committee if the company has no or inadequate profits. - Committee must consist of at least 3 non-executive independent directors including nominee directors.|
Corporate governance issues are not unique in the Indian context, but as Indian companies acquire or establish operations outside India or access the international financial markets, corporate governance issues are becoming increasingly relevant for Indian companies. Even domestic Indian companies need to focus on corporate governance, to gain confidence of capital market investors or while engaging in commercial transactions with multinational companies.
Legislations such as the Sarbanes Oxley Act, 2002, the Foreign Corrupt Practices Act, 1977 in the United States and the recent Bribery Act, 2010 in the UK, have extra-territorial application. As Indian companies become global in their approach and operations they must be sensitive to the global consequences of their conduct that may fall foul of anti-corruption. Companies need to consider the corporate governance norms that apply to them in different jurisdictions and adopt a standard that can meet the differing requirements of each jurisdiction, even if that means voluntarily adopting higher standards in certain jurisdictions. Failure to adequately comply with the applicable norms can have enormous cost, time and reputational consequences.
Further, a vigilant approach to corporate governance is warranted as bribery and corruption issues are an area of investigation in the due diligence process relating to M&A transactions, joint ventures or other commercial contracts and representations and warranties are sought in contractual documents on compliance with legislations like the FCPA and Sarbanes Oxley Act. As the Bribery Act comes into force from April 2011, similar approaches for compliance with the Act are expected to the adopted.
Within India we can expect that corporate governance norms will evolve with the growth in Indian financial markets, increase in public shareholding (recent amendments require public float of traded Indian companies to increase to 25% of a company’s capital) and as institutional shareholders take a proactive role in their dealings with investee companies. The voluntary corporate governance guidelines issued by the Ministry of Corporate Affairs and SEBI’s recent instructions to asset management companies and mutual funds requiring them to make disclosures concerning exercise of their voting rights in investee companies are relevant examples.
Indian corporate governance norms have come a long way since the pre-liberalisation era of the Indian economy. While the development of these norms is an evolutionary process, expansion by Indian companies outside India can provide impetus for implementation of norms that result in good governance and transparency, ultimately leading to the successful growth of corporate India.
This article appeared in issue 10 of our India Watch bulletin.