Institutional Investors and Corporate Governance in India

Abstract

Using nineteen measures of corporate governance, we develop a corporate governance index
in this paper. We find that this corporate governance index is positively associated with
financial performance measures like Tobins Q and industry-adjusted excess stock returns.
We find that the development financial institutions have lent money to companies with better
corporate governance measures. We also find that mutual funds have invested money in
companies with better corporate governance record. Using a simultaneous equation approach
we find that this positive association is both because the mutual funds (development financial
institutions) have invested (lent money) in companies with good governance records, and also
because their investment has caused the financial performance of the companies to improve.

Corporate governance in india

Corporate governance in India gained prominence in the wake of liberalization during the
1990s and was introduced, by the industry association Confederation of Indian Industry (CII),
as a voluntary measure to be adopted by Indian companies. It soon acquired a mandatory
status in early 2000s through the introduction of Clause 49 of the Listing Agreement, as all
companies (of a certain size) listed on stock exchanges were required to comply with these
norms. In late 2009, the Ministry of Corporate Affairs has released a set of voluntary
guidelines for corporate governance, which address a myriad corporate governance issues.
These voluntary guidelines mark a reversal of the earlier approach, signifying the preference
to revert to a voluntary approach as opposed to the more mandatory approach prevalent in the
form of Clause 49. However in a parallel process, key corporate governance norms are
currently being consolidated into an amendment to the Companies Act, 1956 and once the
Companies Bill,2011 is approved the corporate governance reforms in India would have
completed two full cycles - moving from the voluntary to the mandatory and then to the
voluntary and now back to the mandatory approach.
The Anglo-Saxon model of governance, on which the corporate governance framework
introduced in India is primarily based on, has certain limitations in terms of its applicability
in the Indian environment. For instance, the central governance issue in the US or UK is
essentially that of disciplining management that has ceased to be effectively accountable to
the owners who are dispersed shareholders.

However, in contrast to these countries, the main issue of corporate governance in India is
that of disciplining the dominant shareholder, who is the principal block-holder, and of
protecting the interests of the minority shareholders and other stakeholders.

This issue and the complexity arising from the application of alien corporate governance
model in the Indian corporate and business environment is further compounded by the weak
enforcement of corporate governance regulations through the Indian legal system.
Furthermore, given that corporate governance is essentially a soft issue, whose essence
cannot be captured by quantitative and structural factors alone, one of the challenges of
making corporate governance norms mandatory is the need to differentiate between form and
content; for instance, how do we determine whether companies actually internalize the
desired governance norms or whether they look at governance as a check-the-box exercise to
be observed more in letter than in spirit.

Currently, corporate governance reforms in India are at a crossroads; while corporate
governance codes have been drafted with a deep understanding of the governance standards
around the world, there is still a need to focus on developing more appropriate solutions that
would evolve from within and therefore address the India-specific challenges more
efficiently.

Corporate governance is perhaps one of the most important differentiators of a business that
has impact on the profitability, growth and even sustainability of business. It is a multi-level
and multi-tiered process that is distilled from an organizations culture, its policies, values
and ethics, especially of the people running the business and the way it deals with various
stakeholders.

Creating value that is not only profitable to the business but sustainable in the long-term
interests of all stakeholders necessarily means that businesses have to runand be seen to be
runwith a high degree of ethical conduct and good governance where compliance is not
only in letter but also in spirit.

Regulatory Framework for Corporate Governance in India

As a part of the process of economic liberalization in India, and the move toward further
development of Indias capital markets, the Central Government established regulatory
control over the stock markets through the formation of the SEBI. Originally established as
an advisory body in 1988, SEBI was granted the authority to regulate the securities market
under the Securities and Exchange Board of India Act of 1992 (SEBI Act).

Public listed companies in India are governed by a multiple regulatory structure. The
Companies Act is administered by the Ministry of Corporate Affairs (MCA) and is currently
enforced by the Company Law Board (CLB). That is, the MCA, SEBI, and the stock
exchanges share jurisdiction over listed companies, with the MCA being the primary
government body charged with administering the Companies Act of 1956, while SEBI has
served as the securities market regulator since 1992.

SEBI serves as a market-oriented independent entity to regulate the securities market akin to
the role of the Securities and Exchange Commission (SEC) in the United States. The stated
purpose of the agency is to protect the interests of investors in securities and to promote the
development of, and to regulate, the securities market. The realm of SEBIs statutory
authority has also been the subject of extensive debate and some authors have raised doubts
as to whether SEBI can make regulations in respect of matters that fall within the jurisdiction
of the Department of Company Affairs. SEBIs authority for carrying out its regulatory
responsibilities has not always been clear and when Indian financial markets experienced
massive share price rigging frauds in the early 1990s, it was found that SEBI did not have
sufficient statutory power to carry out a full investigation of the frauds. Accordingly, the
SEBI Act was amended in order to grant it sufficient powers with respect to inspection,
investigation, and enforcement, in line with the powers granted to the SEC in the United
States.

A contentious aspect of SEBIs power concerns its authority to make rules and regulations.
Unlike in the United States, where the SEC can point to the Sarbanes-Oxley Act, which
specifically confers upon it the authority to prescribe rules to implement governance
legislation, SEBI, on the other hand, cannot point to a similar piece of legislation to support
the imposition of the same requirements on Indian companies through Clause. Instead SEBI
can look to the basics of its own purpose, as given in the SEBI Act, wherein it is granted the
authority to specify, by regulations, the matters relating to issue of capital, transfer of
securities and other matters incidental thereto . . . and the manner in which such matters shall
be disclosed by the companies. In addition, SEBI is granted the broad authority to specify
the requirements for listing and transfer of securities and other matters incidental thereto.
Recognizing that a problem arising from an overlap of jurisdictions between the SEBI and
MCA does exist, the Standing Committee, in its final report, has recommended that while
providing for minimum benchmarks, the Companies Bill should allow sectoral regulators like
SEBI to exercise their designated jurisdiction through a more detailed regulatory regime, to
be decided by them according to circumstances. Referring to a similar case of jurisdictional
overlap between the RBI and the MCA, the Committee has suggested that it needs to be
appropriately articulated in the Bill that the Companies Act will prevail only if the Special
Act is silent on any aspect. Further the Committee suggested that if both are silent, requisite
provisions can be included in the Special Act itself and that the status quo in this regard may,
therefore, be maintained and the same may be suitably clarified in the Bill. This, in the
Committees view, would ensure that there is no jurisdictional overlap or conflict in the
governing statute or rules framed there under.

Enforcement of Corporate Governance Norms

The issue of enforcement of Corporate Governance norms also needs to be seen in the
broader context of the substantial delay in the delivery of justice by the Indian legal system
on account of the significant number of cases pending in the Indian courts. A research paper
by PRS Legislative Research36 places the number of pending cases in courts in India, as of
July 2009, as 53,000 pending with the Supreme Court, 4 million with various High Courts,
and 27 million with various lower courts. This signifies an increase of 139 per cent for the
Supreme Court, 46 per cent for the High Courts and 32 per cent for the lower courts, from the
pending number of cases in each of them in January 2000. Furthermore, in 2003, 25 per cent
of the pending cases with High Courts had remained unresolved for more than ten years and
in 2006, 70 per cent of all prisoners in Indian jails were under trials. Since fresh cases
outnumber those being resolved, there is obviously a shortfall in the delivery of justice, and a
consequent increase in the number of pending cases. In addition, the weight of the backlog of
older cases creeps upward every year. This backlog in the Indian judicial system raises
pertinent questions as to whether the current regulatory framework in India, as enacted, is
adequate to enable shareholders to recover their just dues. This concern is also articulated in
the recent pleadings (filed in January 2010) in the United States District Court, Southern
District of New York, on the matter relating to the fraud in the erstwhile Satyam Computer
Services,38 wherein US-based investors were seeking damages from defendants that
included, among others, Satyam and its auditors, PricewaterhouseCoopers (PwC) and has
thrown up some very interesting and relevant issues. This case was filed on behalf of
investors who had purchased or otherwise acquired Satyams American Depository Shares
(ADS) listed on the New York Stock Exchange and investors, residing in the United States,
who purchased or otherwise acquired Satyam common stock on the National Stock Exchange
of India or the Bombay Stock Exchange. In their pleadings, the plaintiffs submitted
declarations of two prominent Indian securities law experts: Sandeep Parekh, former
Executive Director of SEBI, and Professor Vikramaditya Khanna of the University of
Michigan Law School, a leading expert in the United States on the Indian legal system, who
filed individual affidavits in which they detailed very cogent and compelling reasons as to
why Indian courts cannot redress the harm done to the Class plaintiffs and why India itself
does not provide a viable alternative forum for settling the claims of Class members.

In their depositions, among other things, Sandeep Parekh and Vikramaditya Khanna have
explained that:
The substantive laws of India provide no means of individual or class recovery for private
investors in securities fraud matters because the civil courts in India are barred from hearing
such cases where, as here, SEBI is empowered to act;
Even if it did provide a substantive means of recovery, Indian law provides no viable class
action mechanism under which investors claims can be litigated; and
Indian law does not recognize the fraud-on-the-market presumption of reliance in private
civil actions, so that, even if both a substantive means of recovery and a viable class action
mechanism existed under Indian law, investors would still be required to demonstrate
individual reliance, thus effectively depriving the vast majority of Class members of any
prospect of relief.
Khanna stated in his declaration43 that The lengthy delays in the Indian Judicial System
would leave plaintiff shareholders with effectively no recovery even assuming, arguendo;
there might be a potential cause of action.

Key Issues in Corporate Governance in India Managing the Dominant
Shareholder(s) and the Promoter(s)

The primary difference between corporate governance enforcement problems in India and
most western economies (on whose codes the Indian code is largely modelled) is that the
entire corporate governance approach hinges on disciplining the management and making
them more accountable. The agency gap in western economies represents the gap between
the interests of management and dispersed shareholders and corporate governance norms are
aimed at reducing this gap. However, in India the problemsince the inception of joint-stock
companiesis the stranglehold of the dominant or principal shareholder(s) who monopolize
the majority of the companys resources to serve their own needs. That is, the agency gap is
actually between majority shareholders and other stakeholders. Secondly, much of global
corporate governance norms focus on boards and their committees, independent directors and
managing CEO succession. In the Indian business culture, boards are not as empowered as in
several western economies and since the board is subordinate to the shareholders, the will of
the majority shareholders prevails.

Therefore, most corporate governance abuses in India arise due to conflict between the
majority and minority shareholders. This applies across the spectrum of Indian companies
with dominant shareholdersPSUs (with government as the dominant shareholder),
multinational companies (where the parent company is the dominant shareholder) and private
sector family-owned companies and business groups.

In public sector units (PSUs), members of the board and the Chairman are usually appointed
by the concerned ministry and very often PSUs are led by bureaucrats rather than
professional managers. Several strategic decisions are taken at a ministerial level which may
include political considerations of business decisions as well. (The recent case of the PSU oil
companies not being allowed to increase the price of oil products in line with the changes in
the international crude prices is an example of how the dominant shareholder, the Indian
Government, uses its dominance to force decisions that are not always linked to business
interests.) Therefore, PSU boards can rarely act in the manner of an empowered board as
envisaged in corporate governance codes.

This makes several provisions of corporate governance codes merely a compliance
exercise.

Multinational companies (MNCs) in India are perceived to have a better record of corporate
governance compliance in its prescribed form. However, in the ultimate analysis, it is the writ
of the large shareholder (the parent company) which runs the Indian unit that holds sway,
even if it is at variance with the wishes of the minority shareholders. Moreover, the
compliance and other functions in an MNC is always geared towards laws applicable to the
parent company and compliance with local laws is usually left to the managers of the
subsidiary who may not be empowered for such a role.

Family businesses and business groups as a category are perhaps the most complex for
analysing corporate governance abuses that take place. The position as regards family
domination of Indian businesses has not changed; on the contrary, over the years, families
have become progressively more entrenched in the Indian business milieu. As per a recent
study by the global financial major Credit Suisse, India ranks higher than most Asian
economies in terms of the number of family businesses and the market capitalization of
Indian family businesses as a share of the nominal gross domestic product (GDP) has risen
from 9 per cent in 2001 to 46 per cent in 2010. This survey, which also covered China, South
Korea, Taiwan, Singapore, Thailand, Hong Kong, Indonesia, Malaysia and the Philippines,
contends that India, with a 67 per cent share of family businesses, ranks first among the ten
Asian countries studied. Furthermore, 663 of the 983 listed Indian companies are family
businesses and account for half of the total corporate hiring and are concentrated in the
consumer discretionary, consumer staples and consumer healthcare sectors.

In addition to the corporate governance issues arising from the dominant family holding in
the Indian business companies, there exists an additional complexity on account of the
promoter control in Indian companies. Promoters (who may not be holding is not to be
included in the definition of the Promoter. Indian law and regulation require that controlling
shares) usually exercise significant influence on matters involving their companies, even
though such companies are listed on stock exchanges and hence have public shareholders.
Promoters may be in control over the resources of the company even though they may
not be the majority shareholders and, because of their position, have superior information
about the affairs of the company than that accessible to non-promoters. As a corollary, in an
organization, promoters and non-promoters constitute two distinct groups that may have
diverse interests.

The Satyam episode illustrated a scenario wherein a company with minimal promoter
shareholding could still be subject to considerable influence by its promoters, thereby
requiring a resolution of the agency problem between the controlling shareholders and the
minority shareholders, even though such problems were not normally expected to arise at the
low shareholding levels of the managing group. On 7 January 2009, when the Chairman of
Satyam Computer Services, B. Ramalinga Raju, admitted that there had been a systematic
inflation of cash on the companys balance sheet over a period of some seven years,
amounting to almost $1.5 billion, the Raju family, who were the promoters of Satyam, held
only about 5 per cent of the shares.

A company with 5 per cent promoter shareholding will usually be considered as belonging to
the outsider model in terms of diffused shareholding, and hence would require the correction
of agency problems between shareholders and managers. However, despite the gradual
decrease in the percentage holdings of the controlling shareholders, the concept of promoter
under Indian regulations made the distinction between an insider-type company and an
outsider-type company somewhat hazy in this context, and the Raju family, as promoters,
continued to wield significant powers in the management of the company despite a drastic
drop in their shareholdings over the preceding few years. Furthermore, at Satyam, the
diffused nature of the remaining shareholding of the company helped the promoter group to
consolidate and exercise power that was disproportionate to their voting rights; while the
institutional shareholders collectively held a total of 60 per cent shares as of 31 December
2008 in Satyam, the highest individual shareholding of an institutional shareholder was
only.76 per cent. Shah believes that companies wherein controlling shareholders hold limited
takes could be particularly vulnerable to corporate governance failures and adds that
promoters who are in the twilight zone of control, that is, where they hold shares less than
those required to comfortably exercise control over the company, have a perverse incentive to
keep the corporate performance and stock price of the company at high levels so as to thwart
any attempted takeover of the company. The Satyam case clearly demonstrates the inability
of the existing corporate governance norms in India to deal with corporate governance
failures in familycontrolled companies, even where the level of promoter shareholding is
relatively low.

Future governance reforms thus need to address the matter of promoters with minority
shareholding, who are in effective control of managements in such companies that lie at the
cusp of insider and outsider systems.

Enforcement for non-compliance of Corporate Governance Norms

While much has been talked on the policy aspect of the Corporate Governance, at present
monitoring of the compliance of the same is done only through disclosures in the annual
report of the company and periodic disclosures of the various clauses of Clause 49 of the
Listing Agreement on the stock exchange website.
As per Clause 49 of the Listing Agreement, there should be a separate section on
Corporate Governance in the Annual Reports of listed companies, with detailed compliance
report on Corporate Governance. The companies should also submit a quarterly compliance
report to the stock exchanges within 15 days from the close of quarter as per the prescribed
format. The report shall be signed either by the Compliance Officer or the Chief Executive
Officer of the company.
The listed companies should obtain a certificate from either the auditors or practicing
company secretaries regarding compliance with all the clauses of Clause 49 and annex the
certificate with the directors report, which is sent annually to all the shareholders of the
company. The same certificate shall also be sent to the Stock Exchanges along with the
annual report filed by the company. Stock exchanges are required to send a consolidated
compliance report to SEBI on the compliance level of Clause 49 by the companies listed in
the exchanges within 60 days from the end of each quarter.
Listing Agreement is essentially an agreement between exchanges and the listed company.
BSE and NSE have listing departments, which oversee the compliances with the provisions
of listing agreement. Non-submission of corporate governance report may result in
suspension in trading of the scrip. As per the norms laid by BSE, the securities of the
company would trigger suspension for non-submission of Corporate Governance report for 2
consecutive previous quarters or late submission of Corporate Governance report for any 2
out of 4 consecutive previous quarters.

For violations of the provisions of listing Agreement, following course of actions by SEBI is
possible:
o Delisting or suspension of securities
o Adjudication for levy of monetary penalty on companies/directors/promoters by SEBI
o Prosecution
o Debarring directors/promoters from accessing capital market or being associated with listed
companies.
Delisting or suspension is generally not considered an investor friendly action and therefore,
cannot be resorted to as a matter of routine and can be used only in cases of extreme /
repetitive non-compliance. Prosecution, on the other hand, is a costly and time-consuming
process.

In order to strengthen the monitoring of the compliance, following measures may be
considered:
Carrying out of Corporate Governance rating by the Credit Rating Agencies.
Inspection by Stock Exchanges/ SEBI/ or any other agency for verifying the compliance
made by the companies.
Imposing penalties on the Company/its Board of Directors/Compliance Officer/Key
Managerial Persons for non-compliance either in sprit or letter Presently, provisions of listing
agreement are being converted into Regulations for better enforcement.

Companies Bill, 2011 and its Impact on Corporate Governance in India

The foundations of the comprehensive revision in the Companies Act, 1956 was laid in 2004
when the Government constituted the Irani Committee to conduct a comprehensive review of
the Act. The Government of India has placed before the Parliament a new Companies Bill,
2011 that incorporates several significant provisions for improving corporate governance in
Indian companies which, having gone through an extensive consultation process, is expected
to be approved in the 2012 Budget session. The new Companies Bill, 2011 proposes
structural and fundamental changes in the way companies would be governed in India and
incorporates various lessons that have been learnt from the corporate scams of the recent
years that highlighted the role and importance of good governance in organizations.

Significant corporate governance reforms, primarily aimed at improving the board oversight
process, have been proposed in the new Companies Bill; for instance it has proposed, for the
first time in Company Law, the concept of an Independent Director and all listed companies
are required to appoint independent directors with at least one third of the Board of such
companies comprising of independent directors. The Companies Bill, 2011 takes the concept
of board independence to another level altogether as it devotes two sections61 to deal with
Independent Directors. The definition of an Independent Director has been considerably
tightened and the definition now defines positive attributes of independence and also requires
every Independent Director to declare that he or she meets the criteria of independence.

In order to ensure that Independent Directors maintain their independence and do not become
too familiar with the management and promoters, minimum tenure requirements have been
prescribed. The initial term for an independent director is for five years, following which
further appointment of the director would require a special resolution of the shareholders.
However, the total tenure for an independent director is not allowed to exceed two
consecutive terms. In order to balance the extensive nature of functions and obligations
imposed on Independent Directors, the new Companies Bill, 2011 seeks to limit their liability
to matters directly relatable to them and limits their liability to only in respect of acts of
omission or commission by a company which had occurred with his knowledge, attributable
through board processes, and with his consent or connivance or where he had not acted
diligently. In the background of the current provisions in the Companies Act, 1956 which do
not provide any clear limitation of liability and have left it to be interpreted by Courts, it is
helpful to provide a limitation of liability clause.

The new Bill also requires that all resolutions in a meeting convened with a shorter notice
should be ratified by at least one independent director which gives them an element of veto
power. Various other clauses such as those on directors responsibility statements, statement
of social responsibilities, and the directors responsibilities over financial controls, fraud, etc,
will create a more transparent system through better disclosures.

A major proposal in the new Bill is that any undue gain made by a director by abusing his
position will be disgorged and returned to the company together with monetary fines. Other
significant proposals that would lead to better corporate governance include closer regulation
and monitoring of related-party transactions, consolidation of the accounts of all companies
within the group, self-declaration of interests by directors along with disclosures of loans,
investments and guarantees given for the businesses of subsidiary and associate companies. A
significant first, in the proposals under the new Companies Bill, is the provision that has been
made for class action suits; it is provided that specified number of members may file an
application before the Tribunal on behalf of members, if they feel that the management or
control of the affairs of the company are being conducted in a manner prejudicial to the
interests of the company or its members. The order passed by the Tribunal would be binding
on the company and all its members. The enhanced investor protection framework, proposed
in the Bill, also empowers small shareholders who can restrain management from actions that
they believe are detrimental to their interests or provide an option of exiting the company
when they do not concur with proposals of the majority shareholders.

The Companies Bill, 2011 seeks to provide clarity on the respective roles of SEBI and the
MCA and demarcate their roles while the issue and transfer of securities and non-payment
of dividend by listed companies or those companies which intend to get their securities listed
shall be administered by the SEBI all other cases are proposed to be administered by the
Central Government. Furthermore, by focusing on issues such as Enhanced Accountability on
the part of Companies, Additional Disclosure Norms, Audit Accountability, Protection for
Minority Shareholders, Investor Protection, Serious Fraud Investigation Office (SFIO) in the
new Companies Bill, 2011, the MCA is expected to be at the forefront of Corporate
Governance reforms in India.









Institutional investors:

Topology of the institutional investors community in India

Development Financial Institutions

Starting in 1948 and throughout the 1950s and 1960s, the Government of India (GOI)
established three Development Financial Institutions (DFIs) to cater to the long-term
finance needs of the countrys industrial sector. These were IFCI, the first DFI set up
in 1948, ICICI, established in 1955 and IDBI, which was established in 1964.
The Reserve Bank of India (RBI) and the GOI nurtured these three DFIs through
financial incentives and other supportive policy measures. They were provided with
low-cost funds which they on-lent to industry at subsidized rates. They were also
allowed to issue bonds guaranteed by the Government. The Reserve Bank of India (RBI)
allocated a substantial part of its National Industrial Credit (Long Term
Operations) funds to IDBI.
During the 1970s and 1980s, the availability of subsidized loans and tax incentives
gave rise to mushrooming of new projects with meagre capital inputs from promoters.
This created a moral hazard problem, and the resultant accumulation of nonperforming assets
in the DFI portfolios. For example, IFCI reported 32.3 percent of total assets to be non-
performing as of March 2004.
Since the early 1990s, there have been several changes in the Governments attitude towards
the DFIs when financial sector liberalization began. The DFIs no longer have access to
subsidized funds or budgetary support5. In addition, they faced competition
in the areas of term finance from banks offering lower rates. The change in operating
environment coupled with accumulation of nonperforming assets caused serious
financial stress to the term-lending institutions, particularly for IFCI. A restructuring
package has been put into effect by the GOI and endorsed by the IFCI Board which
has agreed in principle to a merger with Punjab National Bank. In 2002, ICICI
merged with ICICI Bank and is now a widely-held listed bank with foreign
institutional investors holding 43.64 percent of the equity as of March 31, 2005.
Similarly, in December 2003, the IDBI (Transfer of Undertaking and Repeal) Act
2003 was passed by Parliament to transform IDBI into a banking company. IDBI Ltd.
is now registered as a company under the Companies Act, 1956 to carry out banking
business in accordance with the provisions of the Banking Regulation Act, 1949.
Two other major groups of Government-owned financial institutions have had a major
impact on equity investment trends in India. The first group consists of state-owned
life and non-life insurance corporations; the second group is made up of the public
sector mutual funds.
State-owned insurance companies
The nationalization of insurance business in India resulted in the establishment of the
Life Insurance Corporation (LIC) in 1956 as a wholly-owned corporation of the
Government of India. The Government of India consolidated 240 private life insurers
and provident societies, and LIC came into being. LIC currently offers over 50 plans
to cover life at various stages through a network of 2,048 branches. Besides
conducting insurance business, LIC invests a major portion of its funds in Government
and other approved securities, extends assistance to infrastructure projects and
provides financial assistance to the corporate sector through term loans and
underwriting/direct subscription to corporate shares and debentures.
The nationalization of the non-life insurance sector resulted in the formation of the
General Insurance Corporation (GIC) in 1973. GIC was set up as a holding company
with four subsidiaries (de-linked since 2000), New India Assurance (NIA), National
Insurance Corporation (NIC), Oriental India Insurance (OIC), and United India
Insurance (UII). NIC, incorporated in 1906, was nationalized in 1973 following the
amalgamation of 22 foreign and 11 Indian insurance companies. NIA, incorporated in
1919 and nationalized in 1973, had a pioneering presence in the Indian insurance
sector. It insured Indias first domestic airlines and was responsible for the entire
satellite insurance program of the country. UII was formed in 1973 following the
merger of 22 private insurance companies. As of March 31, 2004, it had a market
share of 22 percent among PSU insurers. OIC was incorporated in 1947 and
nationalized in 1973. It offers special covers for large projects like power plants,
petrochemical, steel and chemical plants. GIC and its erstwhile subsidiaries also
provide financial assistance to the corporate sector through term loans and direct
subscription to corporate shares and debentures.
Private sector insurance companies
In 1993, the Malhotra Committee was set up to evaluate the insurance industry and
recommend future directions. The committee submitted its report in 1994. Its major
recommendations included (i) reduction of Government shareholding in the stateowned
insurance companies to 50 percent, and a break up of GIC; (ii) allowing private
companies with a minimum paid up capital of INR 1 billion to enter industry, as well
as foreign companies in collaboration with domestic companies; and (iii) setting up an
insurance regulatory body11. In 2000, GICs supervisory role over its subsidiaries was
extinguished and GIC was re-designated Indian Re-insurer to function exclusively
as life and non-life re-insurer. In March 2002, GIC ceased to be a holding company for
its subsidiaries and their ownership was vested with the Government of India.12 In
April 2002, the Insurance Regulatory and Development Authority (IRDA) came into
being. IRDA is responsible for registering private insurance companies and framing
regulations for the industry.
The Insurance Regulatory and Development Authority (IRDA) Act allows foreign
companies a 26 percent equity stake in Indian insurance companies. As on June 2005,
there were 14 life insurance companies, 14 non-life insurance companies, and one reinsurer
(GIC) registered with IRDA. The Life Insurance Corporation of India (LIC) is the
only life insurer in the public sector. Eleven of the 13 private companies have an FDI
owning 26 percent of their equity, one (HDFC) has an 18.60 percent foreign shareholder,
and Sahara India is wholly Indian owned. Seven of the eight private companies in the general
insurance sector have foreign equity holdings of 26 percent. The only one that
does not is Reliance General Insurance Co. Ltd. Of the 13 companies in the private life
insurance sector, only one, namely Sahara India, does not have a foreign promoter.
The public sector still holds the overwhelming market share of premiums underwritten.
Of the total premiums (first year premiums and renewal premiums) in 2002-03, the LIC
had 95.29 percent of the market share while the private sector had just 4.71 percent. In
the non-life segment, the new insurers held a market share of 13 percent.
Mutual funds and FIIs
The Indian mutual fund industry came into being in 1963 with the formation of Unit
Trust of India, at the initiative of the Government of India and RBI. The history of mutual
funds in India can be broadly divided into four distinct phases16. In the first phase from
1964 to 1987, UTI was the only mutual fund operating in India. In the second phase
between 1987 and 1993, public sector banks and insurance companies were permitted to
set up mutual funds. State Bank of India, Punjab National Bank, Canara Bank, Indian
Bank, Bank of Baroda, Bank of India, LIC and GIC all set up mutual funds. The third
phase between 1993 and 2003 saw the entry of private sector mutual funds. As of January
2003, there were 33 mutual funds with total assets of INR 1218.05 billion. The Unit Trust
of India with INR 445.41 billion of assets under management was the largest. The fourth
phase starting in 2003 saw the beleaguered UTI being split into two separate entities.
India opened its stock markets to foreign institutional investors (FII) in September 1992.
FII include, among others, pension funds, mutual funds, asset management companies,
investment trusts, institutional portfolio managers, banks and insurance companies,
proposing to invest in India as broad-based funds (with at least 20 investors, each of
them not holding no more than 10 percent of the FII fund). The total number of FII
registered with SEBI crossed 700 in May 2005.
The entry and dominance of private sector mutual funds and FIIs in the last decade
completes the transition from a highly leveraged Indian corporate sector heavily
dependent on the DFIs, to an increasingly market-based system.
III. Legal and regulatory framework for Institutional
Investors
Institutional Structure of Regulation
Banks and DFIs
Banks and DFIs fall under the oversight of the RBI, with an implicit regulatory role
played by the Ministry of Finance. The main legislation governing banks and DFIs is
the Reserve Bank Act, 1934 and the Banking Regulation Act (1949). As discussed in the
previous sections, the Acts of Parliament governing IDBI and UTI were repealed in 2002
and 2004 to facilitate conversion of IDBI into a banking entity and into market-linked
mutual fund respectively.
Insurance companies
In the insurance sector, the two largest government-owned insurance companies- LIC and
GIC were set up under Acts of Parliament. Both these institutions fall under the
regulation and supervision of both the Ministry of Finance and the insurance regulator,
the Insurance Regulatory and Development Authority (IRDA). Other public sector
insurers and private sector insurers fall under the purview of the Insurance Act and
regulations issued by the regulator IRDA in 1999.
Mutual Funds and Foreign Institutional Investors
The regulatory framework for domestic mutual funds and foreign institutional investors
consists of the Mutual Fund Regulations (1992) and the FII Regulations (1994), issued
and enforced by SEBI. The regulations lay down the minimum eligibility criteria for
entry, net worth standards, and disclosure norms. In addition mutual funds and foreign
institutional investors are expected to follow a code of conduct that conforms to
guidelines issued by SEBI. The code of conduct lays out the broad principles of proper
business conduct and functioning of the intermediaries .
In 1996, all mutual funds except UTI came within the purview of the SEBI (Mutual
Fund) Regulations, 1996. UTI which was set up under an Act of Parliament was not
under the regulatory purview of SEBI until 2002 when the UTI Act was repealed and the
fund was split into UTI-I and UTI-II. Thereafter, UTI I and II were brought under the
regulatory purview of SEBI.
The Association of Mutual Funds of India (AMFI) is the self-regulatory organization
(SRO) set up in 1997. It is involved in a) recommending and promoting best business
practices and code of conduct to be followed by mutual funds; and b) interacting with SEBI
on all matters concerning the industry. In addition AMFI is addresses specific
technical issues faced by the mutual fund industry such as developing valuation norms
for illiquid securities. Amongst other activities conducted by the AMFI are administering
the certification examinations for persons involved in the mutual fund industry which
includes employees of the asset management companies and the various brokers,
distributors of mutual fund products. The AMFI is also involved in investor education
and awareness building.
SEBI issued the FII regulations in November 1995, based on guidelines issued by the
GOI in 1992. The regulations mandate the registration of foreign institutional investors
with SEBI. The FIIs were initially permitted access to primary and secondary markets for
securities and mutual fund products, with a stipulated minimum 70 percent investment in
equity. The initial ceilings on the ownership of any firm were 5 percent for a single FII
and 24 percent for all FIIs taken as a group. Individual ceiling on ownership has been
eased to 10 percent since February 2000, and the overall ceiling for all FIIs was removed
in September 2001 in favor of sectoral caps subject to shareholder resolution. FIIs have
also been permitted to invest in corporate and government bonds, and in derivative
securities. Further, foreign firms and individuals have been permitted access to the Indian
markets through FIIs as sub-accounts since February 2000. In the year 2003, earlier
limitations on FII hedging currency risk using currency forwards were removed, and FII
approval was streamlined and vested solely in SEBI, instead of SEBI and RBI as required
earlier.
Pension Funds Industry
A new Defined Contribution pension system has been introduced, which is applicable to
all Government employees recruited after January 1, 2004. This New Pension System
will be regulated by Pension Fund Regulatory and Development Authority (PFRDA)
promulgated through an ordinance on December 30, 2004. The PFRDAs role is to
license and supervise pension fund managers, lay down guidelines on the number of
market participants, prudential norms, investment criteria and capital requirements of
pension fund managers. PFRDA is also expected to issue FDI caps for the pension sector.
It is expected that initial investments in equity will be somewhat limited. All pre-January
2004 employees can also voluntarily join the new scheme to get an additional benefit.
Similarly, all those covered by the Employees Provident Fund (EPF) will continue in it,
but can voluntarily join the new scheme to. To a large extent, the new pension schemes
will resemble mutual funds, and subscribers will have a choice of parking their savings
(a) predominantly in equity,
(b) debt & equity mix, or
(c) entirely in debt instruments and
Government paper. Many of the major players in the mutual fund and the insurance
industry are set to enter the pension sector, expected to grow to INR 500 billion by 2010.


Board representation/Clause 49
The regulatory framework governing the boards of directors of Indian corporations is set
out in Chapter II (sections 252 to 269) of the Companies Act, 1956. In addition, Clause
49 of the Listing Rules issued by SEBI, which is implemented on a comply or explain
basis, also provides a framework for the board of directors of listed companies. Board
members have a fiduciary obligation to treat all shareholders fairly. At least two-thirds
of the board of directors should be rotational. One-third of the board consists of
permanent directors. These include promoters, executive directors and nominee directors.
Clause 49 applies to all listed companies with paid up share capital of at least INR 30
million36 (USD 660,000) or that have had a net worth of INR 250 million (USD 5.5
million). There are mandatory and non-mandatory requirements.
Independent Directors
One of the fundamental innovations of Clause 49 was to introduce the concept of
independent directors in the Indian corporate governance framework, further to the
recommendation of the Kumaramangalam Birla Committee Report on Corporate
Governance (The Kumaramangalam Committee) in 2000, and the additional
recommendations of The Narayana Murthy Committee in 2003. In this framework, the
members of the modern Indian board are jointly and severally accountable to all
shareholders without distinction, and hold the fiduciary position of a trustee for the
company. They ensure the strategic guidance of the company and monitor management.
Stakeholders, including creditors, are protected by contract law and specific legislation.
Section IA of Clause 49 requires issuers to have at least one-third independent directors
on their boards, if the functions of chairman of the board and CEO are decoupled, and 50
percent otherwise.37
The updated Clause 49 defines an independent director as a non-executive director who,
(a) apart from receiving directors remuneration, does not have any material pecuniary
relationships or transactions with the company, its promoters, its senior management or
its holding company, its subsidiaries and associated companies;
(b) is not related to
promoters or management at the board level or at one level below the board;
(c) has not
been an executive of the company in the immediately preceding three financial years; (d)
is not a partner or an executive of the statutory audit firm or the internal audit firm that is
associated with the company, and has not been a partner or an executive of any such firm
for the last three years. This will also apply to legal firm(s) and consulting firm(s) that
have a material association with the entity;
(e) is not a supplier, service provider or
customer of the company. This should include lessor-lessee type relationships also; and
(f) is not a substantial shareholder of the company, i.e. owning two percent or more of the
voting shares. It also caps to three terms of three years the mandates of independent
directors.
Nominee Directors
As discussed earlier, a series of DFIs were created by Acts of Parliament to support the
development of industrial companies, by extending loans to the latter or subscribing to
debentures issues. To protect the public institutions investments and equip it with
effective risk management tools, each founding Act of Parliament of the DFI stipulated
that the latter should insert two specific clauses in their loan agreements, systematically:
(1) a convertibility clause, which allowed the DFI to convert its loan/debenture into equity
(and hence allowed the DFI to take control of the corporation), if the company
defaulted on its debt obligation to the DFI; and
(2) a nominee director clause, which
gave the DFI the right to appoint one or more directors to the board of the borrowing
company.
In March 1984, the Banking Division of the Ministry of Finance, Department of
Company Affairs issued its Policy Guidelines relating to Stipulation of Convertibility
Clause and Appointment of Nominee Directors. The guidelines specified that IDBI,
IFCI, ICICI and IRCI should create a separate Cell the exclusive and whole-time function of
which would be to represent the institutions on the Boards of Companies. Outsiders should be
appointed as nominee directors only as additional directors were needed.
Nominee directors should be appointed on the Boards of all MRTP companies assisted by
the institutions. As regard non-MRTP companies, nominee directors should be appointed
on a selective basis, especially when one or more of the following conditions prevail: (a) the
unit is running into problems and is likely to become sick;
(b) institutional holding is more than 26 percent; and
(c) where the institutional stake by way of loans/investment
exceeds INR 50 million.
The Guidelines further stipulated that nominee directors should be given clearly
identified responsibilities in a few areas which are important for public policy. An
illustrative list of such responsibilities was provided, including
(a) financial performance
of the company;
(b) payments of dues to the institutions; (c) payment of government
dues, including excise and custom duties, and statutory dues; (d) inter-corporate
investment in and loans to or from associated concerns in which the promoter group has
significant interest; (e) all transaction in shares; (f) expenditure being incurred by the
company on management group; and (g) policies relating to the ward of contracts and
purchase and sale of raw materials, finished goods, machinery, etc. In addition the
Guidelines specified that the nominee directors should ensure that the tendencies of the
companies towards extravagance, lavish expenditure and diversion of funds are curbed.
With a view to achieve this object, the institutions should seek constitution of a small
Audit sub-committee of the board of directors for the purpose of periodic assessment of
expenditure incurred by the assisted company, in all cases where the paid-up capital of
the company is INR 50 million or more. The institutional nominee director will
invariably be a member of this Audit Sub-committee.
Considering that the practice of audit committees only became accepted internationally as
best practice in the late 1990s, the Ministry of Finance (MOF) Guidelines were in some
respect ahead of their time. However, Section 30.A of of the Industrial Development
Bank of India Act, (1964) stipulated that nominee directors would not (1) be subject to
the provisions of the Companies Act, or to provisions of the memorandum, articles of
associations or any other instrument relating to the industrial concern, nor any provisions
regarding share qualifications, age-limit, number of directorships, or removal from
office; and (2) incur any obligation or liability be reason only of his being a director or
for anything done or omitted to be in good faith in the discharge of his duties as a director
or anything in relation thereto. Hence, nominee directors were not jointly and severally
responsible to shareholders for the actions of the board.
In 1991, the Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) was
amended. Provisions relating to concentration of economic power and pre-entry
restrictions with regard to prior approval of the Central Government for establishing new
undertaking, expanding on existing undertaking, amalgamations, mergers and takeovers
of undertakings were all deleted from the statute through the amendments. The causal
thinking in support of the 1991 amendments is contained in the Statement of Objects and
Reasons appended to the 1991 Amendment Bill in the Parliament41.
Finally, in December 2003, the Industrial Development Bank (Transfer of Undertaking
and Repeal) Act, 2003 provided for the transfer and vesting of the undertaking of the
Industrial Development Bank of India to, and in IDBI Bank. However, Section 15 of Act
53 grandfathered the immunity extended to nominee directors. Specifically, section 15
stipulated that notwithstanding the repeal of the Industrial Development Act, 1964, the
provisions of Section 30A of the Act so repealed will continue to be applicable in respect
of the arrangement entered into by the Development Bank with an industrial concern up
to the appointed day and the Company [Industrial Development Bank of India] will be
entitled to act upon and enforce the same as fully and effectually as if this Act has nor
been repealed.
In 2003, The Kumara Mangalam Birla Committee recommended that institutions should
appoint nominees on the boards of companies only on a selective basis, where such
appointment is pursuant to a right under loan agreements or where such appointment is
considered necessary to protect the interest of the institution. It further recommended
that when a nominee of an institution is appointed as a director of the company, he should
have the same responsibility, be subject to the same discipline and be accountable to the
shareholders in the same manner as any other director of the company. In addition, if the
nominee director reports on the affairs of the company to a department of the institution
that nominated him on the board of the portfolio company, the institution should ensure
that there exist Chinese walls between such department and other departments which may
be dealing in the shares of the company in the stock market.
The Narayan Murthy Committee felt that the institution of nominee directors whether
from investment institutions or lending institutions creates a conflict of interest. The
Committee recommended that nominee directors should not be considered as independent
and stressed that it is necessary that all directors, whether representing institutions or
otherwise, should have the same responsibilities and liabilities as other directors.
However, as discussed in Section V, the final guidelines issued by SEBI in Clause 49
suggest that nominee directors whether from lending or investment institutions shall be
deemed to be independent directors.


Role of I nstitutional Investors
Corporate governance codes and guidelines have long recognised the important role that
institutional investors have to play in corporate governance. The effectiveness and
credibility of the entire corporate governance system and the company oversight to a large
extent depends on the institutional investors who are expected to make informed use of
their shareholders rights and effectively exercise their ownership functions in companies
in which they invest. Increased monitoring of Indian listed corporations by institutional
investors will drive the former to enhance their corporate governance practices, and
ultimately their ability to generate better financial results and growth for their investors. At
present, there are four main issues with role of institutional investor and corporate
governance:
Issues relating to disclosure by institutional investors of their corporate governance
and voting policies and voting records
Issues relating to the disclosure of material conflicts of interests which may affect the
exercise of key ownership rights
Focus on increasing the size of assets under management rather than on improving
the performance of portfolio companies.
Institutional investors are becoming increasingly short-term investors.
Several countries mandate their institutional investors acting in a fiduciary capacity to
disclose their corporate governance policies to the market in considerable details. Such
disclosure requirements include an explanation of the circumstances in which the
institution will intervene in a portfolio company; how they will intervene; and how they will
assess the effectiveness of the strategy. In most OECD countries, Collective Investment
Schemes (CIS) are either required to disclose their actual voting record, or it is regarded
as good practice and implemented on an comply or explain basis.
In addition, Principle 1G of the OECD Principles calls for institutional investors acting in
a fiduciary capacity to disclose their overall corporate governance and voting policies
with respect to their investments, including the procedures that they have in place for
deciding on the use of their voting rights.
SEBI has recently required listed companies to disclose the voting patterns to the stock
exchanges and Asset Management Companies of Mutual Funds to disclose their voting
policies and their exercise of voting rights on their web-sites and in Annual Reports.
Ministry of Corporate Affairs' (MCA) initiative on E-voting will also enable scattered
minority shareholders to exercise voting rights in General Meetings.
a) Institutional investors should have a clear policy on voting and disclosure of
voting activity
Institutional investors should seek to vote on all shares held. They should not
automatically support the board. If they have been unable to reach a satisfactory
outcome through active dialogue then they should register an abstention or vote
against the resolution. In both instances, it is good practice to inform the company in
advance of their intention and the reasons thereof. Institutional investors should
disclose publicly voting records and if they do not, the reasons thereof.
b) Institutional investors to have a robust policy on managing conflicts of interest
An institutional investor's duty is to act in the interests of all clients and/or
beneficiaries when considering matters such as engagement and voting. Conflicts of
interest will inevitably arise from time to time, which may include when voting on
matters affecting a parent company or client. Institutional investors should formulate
and regularly review a policy for managing conflicts of interest.
c) Institutional investors to monitor their investee companies
Investee companies should be monitored to determine when it is necessary to enter
into an active dialogue with their boards. This monitoring should be regular and the
process should be clearly communicable and checked periodically for its
effectiveness.
As part of these monitoring, institutional investors should:
Seek to satisfy themselves, to the extent possible, that the investee company's
board and committee structures are effective, and that independent directors
provide adequate oversight, including by meeting the chairman and, where
appropriate, other board members;
Maintain a clear audit trail, for example, records of private meetings held with
companies, of votes cast, and of reasons for voting against the investee
company's management, for abstaining, or for voting with management in a
contentious situation; and
Attend the General Meetings of companies in which they have a major holding,
where appropriate and practicable.
Institutional investors should consider carefully the explanations given for departure
from the Corporate Governance Code and make reasoned judgements in each
case. They should give a timely explanation to the company, in writing where
appropriate, and be prepared to enter a dialogue if they do not accept the
company's position.
Institutional investors should endeavor to identify problems at an early stage to
minimise any loss of shareholder value. If they have concerns they should seek to
ensure that the appropriate members of the investee company's board are made
aware of them.
Institutional investors may not wish to be made insiders. They will expect investee
companies and their advisers to ensure that information that could affect their ability
to deal in the shares of the company concerned is not conveyed to them without
their agreement.
d) Institutional investors to be willing to act collectively with other investors
where appropriate
At times collaboration with other investors may be the most effective manner to
engage. Collaborative engagement may be most appropriate during significant
corporate or wider economic stress, or when the risks posed threaten the ability of
the company to continue. Institutional investors should disclose their policy on
collective engagement. When participating in collective engagement, institutional
investors should have due regard to their policies on conflicts of interest and insider
information.
e) Institutional investors to establish clear guidelines on when and how they will
escalate their activities as a method of protecting and enhancing shareholder
value
Institutional investors should set out the circumstances when they will actively
intervene and regularly assess the outcomes of doing so. Intervention should be
considered regardless of whether an active or passive investment policy is followed.
Initial discussions should take place on a confidential basis. However, if boards do
not respond constructively when institutional investors intervene, then institutional
investors will consider whether to escalate their action, for example, by
holding additional meetings with management specifically to discuss concerns;
expressing concerns through the company's advisers;
meeting with the chairman, senior independent director, or with all independent
directors;
intervening jointly with other institutions on particular issues;
making a public statement in advance of the AGM;
submitting resolutions at shareholders' meetings; etc.
f) Institutional investors to report periodically on their responsibilities and voting
activities
Those who act as agents should regularly report to their clients details of how they
have discharged their responsibilities. Such reports may comprise of qualitative as
well as quantitative information. The particular information reported, including the
format in which details of how votes have been cast are presented, should be a
matter for agreement between agents and their principals.
Those that act as principals, or represent the interests of the end-investor, should
report at least annually to those to whom they are accountable on their policy and its
execution.
Like US funds, Indian asset management funds are now required to disclose their
general policies and procedures for exercising the voting rights in respect of the

shares held by them on their websites as well as in the annual report distributed to
the unit holders from the financial year 2010-11. However, there is only a marginal
increase in for/against votes and many funds fail to even attend meetings and have
abstention as a policy. Even among funds that voted, there is little alignment
between the votes and the voting policy.
In view of above, existing policy need to be examined. It may be deliberated on how
to create incentives for institutional investors that invest in equities to become more
active in the exercise of their ownership rights, without coercion, without imposing
illegitimate costs on them, and given Indias specific situation.
Fund houses should be mandated to adopt the global practice of quarterly vote
reporting and fund-wise vote reporting and to adopt detailed voting policies. Further,
vote reporting by fund houses should also be subject to audit.

V. Policy recommendations
The recommendations of the Kumaramangalam Birla Committee on the issue of
Institutional shareholders provide the framework for policy makers intervention in
India. The Committee highlighted that institutional shareholders, who own shares largely
on behalf of the retail investors, have acquired large stakes in the share capital of listed
Indian companies; they have or are in the process of becoming major shareholders in
many listed companies and own. The Committee called for institutional investors to play
a bigger role in the corporate governance of their portfolio companies, and stressed that
retail investors are relying on them for positive use of their voting rights. The Committee
highlighted practices elsewhere in the world where institutional shareholders influence
the corporate policies of their portfolio companies to maximize shareholder value, and
recommended that institutional investors follow suit. The Committee stressed that it is
important that institutional shareholders should put to good use their voting power.
The Committee recommends that the institutional shareholders should take an active
interest in the composition of the board of directors of their portfolio companies; be
vigilant; maintain regular and systematic contact at senior level for exchange of views on
management, strategy, performance and the quality of management; ensure that voting
intentions are translated into practice; and evaluate the corporate governance performance
of their portfolio companies. These were non-mandatory recommendations.
Incentives for institutional investors to play a more active role in the corporate
governance of their portfolio companies: It has long been recognized that institutional
investors, especially those acting in a fiduciary capacity, are better positioned than retail
investors to play a monitoring role in their portfolio companies because they do not face
the collective action (free rider) problem to the same extent (See Box-1 for a description
on free rider and collective action). The potential returns from their equity investment can
outweigh the monitoring costs. However, as discussed in Section IV, at present most
Indian institutional investors take a passive role in the corporate governance of their
portfolio companies. Even those institutions who exercise their ownership rights more
actively, to a large extent share the same view with regard to the monitoring of
management. Management is primarily screened ex-ante, at the time of deciding to take
an equity position in a company. Once an institution has taken the decision to invest in a
company, it supports its management. If and when it loses confidence in management, it
sells its shares.


From a cost/benefit standpoint, institutional investors consider that the potential benefits
of taking an active role in the corporate governance of their portfolio companies are not
commensurate with the costs associated with such monitoring role. This approach may be
legitimate, given the concentrated ownership structure of listed companies, the small
equity stakes of each individual institutional investor, and the lack of cooperation
between institutional investors.
However, the experience of OECD countries and the most dynamic emerging market
countries48 suggests that corporate governance practices of listed companies and their
voluntary compliance with Clause 49, and ultimately the protection of shareholders
rights, could be improved if institutional investors acting in a fiduciary capacity could be
induced to participate more actively in the corporate governance of their portfolio
companies.
From a policy standpoint, it is desirable that institutions acting in a fiduciary capacity,
such as pension funds, collective investment schemes and insurance companies should
consider the right to vote an intrinsic part of the value of the investment being undertaken
on behalf of their client. Failure to exercise the ownership rights could result in a loss to
their investors who should therefore be made aware of the policy followed by the
institutional investors.
In the United Sates, under the Employee Retirement Income Security Act (ERISA), a
pension plan fiduciary obligation includes the voting of proxies. In addition, the
Department of Labor considers that a pension plan sponsors fiduciary duty in managing
plan assets includes a duty to vote proxies in the interests of plan beneficiaries, and a
positive duty to actually vote on issues that may affect the value of the plans
investments. Pension plans are urged to develop written voting guidelines. The
Department of Labor also advocates that pension plan sponsors undertake activities designed
to monitor or influence corporate management where warranted, to enhance the
value of the plans investments.
The US requirement to vote is most appropriate for pension funds that have long term
assets and liabilities on their balance sheets, and must therefore follow long term
investment strategies. They have less of an incentive than mutual funds to maximize short
term returns. Voting with their feet is only one possible strategy if they are dissatisfied
with the management of a portfolio company. It can be more appropriate instead to
induce management to change its behavior. For example institutions might become
concerned about potential conflicts of interests on the board of their portfolio company.
Or they might wish to intervene to object to a proposed restructure of the board, or to a
particular transaction that the company proposes to enter into, or express concerns about
executive share option schemes or the level of benefits being given to non-executive
directors.
At present, there are no private pension funds in India, although the Pension Fund
Regulatory and Development Authority has been established and is currently developing
regulations for the private pension fund industry. The establishment of private pension
funds is expected in the near future. Currently, the main public pension fund is not
allowed to invest in equity. An obligation for Indian institutional investors to exercise
voting rights would therefore not be appropriate in India.
In the UK, the Myners Report of March 2001 recommended that the principles of the US
Department of Labor regarding the exercise of voting rights by pension funds be
embedded in the law of the land.To pre-empt government action, in 2004, the National
Association of Pension Funds issued its guidelines of voting which recommended that
pension funds exercise their voting rights. As a result, the government decided to wait
and see if a voluntary approach would work. This approach seems to have been
successful. In its Progress Report of March 2005, Mr. Paul Myners commented that of
the 34 [fund] managers that were asked about voting, 32 had a policy to vote all their UK
shares and, in the majority of instances, this policy was public. They also report quarterly
to their clients and explain their voting decisions, particularly when voting against the
recommendations of the board, or consciously withholding their vote.
The question for Indian policy makers is how to create incentives for those institutional
investors that invest in equities to become more active in the exercise of their ownership
rights, without coercion, without imposing illegitimate costs on them, and given Indias
specific situation?

The role of institutional investors in other countries:
Several countries mandate their institutional investors acting in a fiduciary capacity to
disclose their corporate governance policies to the market in considerable details. Such
disclosure requirements include an explanation of the circumstances in which the
institution will intervene in a portfolio company; how they will intervene; and how they
will assess the effectiveness of the strategy. In most OECD countries, Collective
Investment Schemes (CIS) are either required to disclose their actual voting record, or it
is regarded as good practice and implemented on an apply or explain basis. Table 2
below summarizes current practices in Australia, France, Italy, Portugal, Sweden,
Switzerland, the UK, and the US.








Country Current practice
Australia There is no obligation under applicable law for fund managers or
trustees to attend shareholders meetings or vote on resolutions.
However, the Investment and Financial Services Association (IFSA)
recommends that its members, as a matter of good practice, should []
vote on all material issues at all Australian company meetings where
they have the voting authority and responsibility to do so; and have a
written policy on the exercise of proxy voting.,
France The French association AFG-ASFFI considers it very
France The French association AFG-ASFFI considers it very important for asset
management portfolio companies to develop voting guidelines,
including voting criteria on resolutions. The AFG-ASFFI also strongly
encourages CIS operators to exercise voting rights and account for this
exercise in CIS annual reports.
Italy The Italian Asset management Association has issued guidelines
requiring asset management companies to formalize and keep
appropriate records showing the decision-making process followed in
exercising the voting and other rights attached to financial instruments
under management and the reasons for the decisions where the vote
concerns a company belonging to the same group as the SGR. The
position adopted in a shareholders meeting shall be reported, in relation
to their importance, to investors in the CIS annual report or in some
other appropriate manner previously established.
Portugal CIS must disclose to the CMVM, the regulatory agency, and the market,
how the CIS exercised its voting rights when the latter holds more than 2
percent of the voting rights of an issuer. In addition, its annual report,
the management company must identify and justify any deviation on the
voting policy, when it holds more than 1 percent of the voting rights of
an issuer. Disclosure is either to their clients (only with respect to the
securities of each client) or, in the case of investment advisor, to the
registered investment companies, or to the market, which is less costly.
Sweden The Swedish Association recommends that CIS operators [] establish
and publicize policies on corporate governance containing principles for
exercising voting rights and for electing board members. CIS operators
should also disclose to investors their standpoint in certain corporate
issues and the reason for their position.
Switzerland The Swiss Fund Association (SFA) emphasizes
Switzerland The Swiss Fund Association (SFA) emphasizes the obligation of CIS
operators to exercise shareholders rights pertaining to the investments of
the CIS independently and exclusively in the interest of investors. CIS
are required to be able to provide investors with information on their
exercise of their rights. Delegation is permitted to custodian banks or
other third parties, except where the exercise of the right could have
lasting impact on the interest of the investors. In such cases the CIS
operator is to exercise the rights itself or give explicit directions to its
delegates.
UK The UK Association of Unit Trusts and Investment Funds (AUTIF)
emphasizes in its Code of good Practice that fund managers should
become involved in governance matters and should report to their
investors on their policy on voting and other governance issues.
US The SEC recently issued a ruling mandating CIS to disclose their
US The SEC recently issued a ruling mandating CIS to disclose their proxy
voting policies and proxy voting records. The ruling requires registered
management investment companies to file with the SEC and to make
available to shareholders the specific proxy votes that they cast in
shareholder meetings of issuers of portfolio securities.
Source: IOSCO

Mandate for Conflicts of interests in OECD Countries:
Country Current Practices
Australia Yes, in the prospectuses, the annual report and Product Disclosure
Statements. In addition, when the operator of the CIS seeks to
confer a financial benefit on itself or a related party, it may only do
so with the prior approval of the scheme members.
Austria No.
Belgium Yes, in the annual reports.
Canada Yes, in the prospectus, the annual and semi-annual financial
statements. In certain circumstances, prior approval is required form
investors in advance of the transaction.
Czech Republic Yes, in the prospectus.
Denmark Yes, in the annual reports. The prospectus must disclose
information on contracts with related parties, including the
management company
Finland Yes, in semi-annual and annual reports.
France Yes, in the annual reports.
Germany Yes, in semi-annual and annual reports
Greece No.
Honk Kong
China
Yes, in the annual reports and offering documents.
Hungary No.
Italy Yes, the directors statements accompanying the CIS annual reports
must include a description of the dealings with other companies
belonging to the same group, and information on participation in
placements carried out by companies within the group.
Japan Yes, in the financial statements
Korea Yes, the Trust Property Management Report is provided to investors
every six months. The report includes the details of management of
trust property, details on investment in securities issued by an
affiliated company, and details on transactions made by a
management company or connected party with trust property.
Luxemburg No
Mexico Yes, in the prospectus.
Netherlands Yes, in the prospectus, semi-annual and annual reports
Norway Yes, in the prospectus, semi-annual and annual reports
Poland Yes, in the prospectus, semi-annual and annual reports
Portugal Yes.
Singapore Yes, in the prospectus, semi-annual and annual reports
Slovakia Yes, in the semi-annual and annual reports.