Class Lecture

Corporate Finance, ESG, and Financial Controls in the Indian Context for Lawyers

1. Overview of Corporate Finance & E.S.G. in the Indian Context

Overview:

Corporate Finance: At its core, corporate finance deals with the financial decisions corporations
make and the tools and analysis used to make these decisions. It revolves around three fundamental
principles:

 Investment decisions (capital budgeting)

 Financing decisions (capital structure)
 Working capital management.
 Environmental, Social, and Governance (E.S.G.):

Environmental: Relates to a company’s impact on the environment. Includes energy consumption,

waste management, pollution, and conservation efforts.

Social: Addresses how a company manages its relationships with employees, customers, suppliers,
and communities. This includes diversity, human rights, consumer protection, and animal welfare.

Governance: Pertains to a company's leadership, executive pay, audits, internal controls, and
shareholder rights. Crucial for lawyers due to associated legal implications.

Intersection: Today, investors and stakeholders emphasize ESG criteria for investments. A
corporation's ESG practices can impact its financial performance and its access to capital.

Details:

a. Companies Act, 2013: This Act contains provisions related to financial statements, audit, and
internal controls which directly impact corporate finance decisions.

i. Financial Statements and Audit: The Act has provisions that mandate the format and
content of financial statements. It ensures that companies maintain transparency and
accountability in financial reporting for example, Schedule III of the Companies Act, 2013
provides the details of the general instructions for preparation of the balance sheet and
the statement of profit and loss of a company.

ii. E.S.G and CSR: Section 135 of the Companies Act mandates that companies with a net
worth of ₹500 crores or more, or a turnover of ₹1,000 crores or more, or a net profit of ₹5
crores or more during the immediately preceding financial year, should spend at least 2%
of their average net profits on corporate social responsibility (CSR) activities.
 b. SEBI's Listing Obligations and Disclosure Requirements (“LODR”): Mandates listed
companies to disclose their ESG metrics, pushing the corporate sector to adopt better ESG
practices.

i. Mandatory ESG Disclosures: In 2021, SEBI introduced specific ESG reporting requirements
for the top 1000 listed companies by market capitalization, signalling a more sustainable
path for India Inc.

ii. Regulation 34: SEBI introduced the Business Responsibility and Sustainability Report
(BRSR), which replaces the Business Responsibility Report (BRR). BRSR is a more
comprehensive tool for reporting ESG parameters by listed entities.

Example:

The Tata Group, one of India's largest conglomerates, showcases their commitment to ESG via
initiatives like sustainable steel production and community developmental activities.

Mahindra & Mahindra, a key player in India's automobile sector, emphasizes its commitment to ESG
through green and sustainable initiatives, such as producing electric vehicles and ensuring
sustainable supply chains.

ITC Limited, a conglomerate with businesses spanning FMCG, hotels, paper, and agribusiness, has
made sustainability a core tenet of their corporate strategy. They've championed afforestation,
sustainable agriculture, and water conservation in their ESG endeavours.

2. Financial Controls and their Significance in Corporate Governance

Overview:

Financial controls are the systems, policies, and procedures put in place by organizations to manage
and monitor financial resources, ensuring they are used efficiently and effectively.

Significance:

 Transparency and Accountability: Enhances trust among stakeholders.

 Risk Management: Reduces errors, fraud, and financial mismanagement.
 Optimal Utilization: Ensures resources are utilized for the intended purposes, increasing ROI.
 Compliance: With financial regulations, legal requirements, and auditing standards.

Details:

a. Companies Act, 2013:

 i. Section 134: Mandates the inclusion of a statement by the Board on the existence and
effectiveness of internal financial controls. This section emphasizes that the Directors'
Responsibility Statement should confirm that the directors had devised proper systems to
ensure compliance with the provisions of all applicable laws.

ii. Section 177(4): The audit committee should scrutinize inter-corporate loans and
investments, ensuring compliance and financial prudency.

b. SEBI's Corporate Governance Code, LODR:

Emphasizes financial transparency and accountability, requiring listed firms to establish

certain committees to oversee financial matters. The SEBI’s Corporate Governance Code
under the LODR Regulations encompasses a wide range of provisions aimed at improving
transparency, accountability, and the protection of shareholders' rights such as:

i. Board Composition: The code outlines the composition of the Board of Directors,
emphasizing a balance between executive and non-executive directors, and mandating a
minimum number of independent directors.

ii. Committees of the Board: The regulations prescribe the constitution of various
committees like the Audit Committee, Nomination and Remuneration Committee,
Stakeholders Relationship Committee, and Risk Management Committee, each having
specified roles and responsibilities. For example, Regulation 18 stipulates the composition
of the audit committee, ensuring that the majority are independent directors. This is
pivotal for unbiased oversight of financial disclosures.

iii. Disclosure Requirements: The code mandates regular disclosures, including quarterly and
annual financial statements, related party transactions, shareholding patterns, and
corporate governance compliance reports, among others, to keep the shareholders
informed.

iv. Shareholders’ Rights: The regulations emphasize the protection of shareholders' rights and
ensuring equitable treatment of all shareholders, including minority and foreign
shareholders.

v. Independent Directors: The code lays down specific duties, roles, and responsibilities of
independent directors to maintain the independence of the board’s functioning.

vi. Risk Management: Listed entities, depending on their size and type, are required to form a
Risk Management Committee to assess and mitigate business risks.

vii. Corporate Social Responsibility (CSR): Provisions regarding CSR activities are included,
aligning with the requirements of the Companies Act, 2013.

viii. Whistleblower Policy: The code mandates the establishment of a vigil mechanism or
whistleblower policy for directors and employees to report concerns about unethical
behaviour, actual or suspected fraud, or violation of the company’s code of conduct.
Example:

a. The IL&FS crisis of 2018 highlighted the repercussions of inadequate financial controls and
oversight. Inadequate risk assessment and unchecked debt accumulation led to a liquidity
crisis, having ripple effects on the Indian financial market.

b. The Satyam scandal in 2009 showcased a lack of proper financial controls. Post the scandal,
the regulatory environment in India underwent major changes to strengthen corporate
governance.

3. Internal Financial Controls and their Implementation

Overview:

Internal financial controls refer to the mechanisms designed to ensure:

 Transactions are executed with proper authorization.

 Transactions are recorded in a way that permits the preparation of accurate financial statements.
 Assets are safeguarded against unauthorized access or use.
 Recorded assets are periodically verified with existing assets.

Implementation:

 Risk Assessment: Identify vulnerabilities in financial reporting.

 Control Environment: Create a culture that emphasizes the importance of internal control.
 Control Activities: Deploy policies and procedures that enforce management directives.
 Information & Communication: Effective channels for relaying pertinent information.
 Monitoring: Ongoing or periodic evaluations of the IFC system.

Details:

a. Companies Act, 2013:

i. Section 143: Provides guidelines on Internal Financial Controls (IFC). Section 143(3)(i)
requires auditors to state whether the company has adequate internal financial controls in
place and the effectiveness of such controls.

ii. Section 177: The audit committee should evaluate internal financial controls and the
whistleblowing mechanism.
iii. Section 149(8) and Schedule IV: It stipulates the code for independent directors, which
includes aspects of safeguarding the interests of all stakeholders and ensuring the
credibility of financial statements.

b. ICAI’s Guidance Note

 i. The guidance note provides detailed guidance on the audit of internal financial controls
over financial reporting. Offers a more comprehensive understanding of evaluating the
adequacy and effectiveness of controls in various areas like operational processes, IT
systems, and regulatory compliance.

ii. The Institute of Chartered Accountants of India (ICAI) has published a Guidance Note on
Audit of Internal Financial Controls Over Financial Reporting, which serves as an invaluable
resource for auditors and companies aiming to implement and assess Internal Financial
Controls (IFC). This Guidance Note is especially crucial in the context of Sections 143(3)(i)
and 134(5)(e) of the Companies Act, 2013. Section 143(3)(i) mandates the auditors of a
company to include in their report a statement on whether the company has adequate
internal financial controls system in place and the operating effectiveness of such controls.
Correspondingly, Section 134(5)(e) requires the Board of Directors of a company to confirm
in their Directors’ Responsibility Statement that they have laid down internal financial
controls to be followed by the company and such internal financial controls are adequate
and operating effectively. The ICAI Guidance Note elucidates various aspects of IFC,
providing detailed procedures and criteria for the audit of internal financial controls,
leveraging frameworks like COSO (Committee of Sponsoring Organizations of the Treadway
Commission) for enhancing organizational performance and governance. The guidance
serves as a comprehensive manual for ensuring that companies not only comply with the
statutory requirements but also build robust financial controls that safeguard assets and
enhance the reliability of financial statements.

Example:

a. Infosys, a leading IT company in India, has consistently been lauded for its robust internal
financial controls, which are often viewed as benchmark practices in the Indian corporate
world.

b. HDFC Bank, one of India's premier banks, employs advanced financial technologies and
stringent internal controls to manage risks, ensuring the accuracy of financial reporting and
safeguarding assets.

c. Tata Consultancy Services (TCS), a leading IT giant in India, employs a robust IFC framework.
Through periodic assessments and third-party audits, TCS ensures the credibility of its
financial disclosures, safeguarding stakeholder interests.

4. Role of CFO (Chief Financial Officer) in Corporate Governance

Overview:

Key Responsibilities:
 Overseeing the financial operations and strategy.
 Risk management.
 Ensuring compliance with financial regulations and standards.
 Representing the company to financial stakeholders.

In Corporate Governance:

 Stewardship Role: Protecting company assets and ensuring effective resource use.
 Transparency: Providing accurate financial information to stakeholders.
 Strategy Alignment: Aligning financial strategy with corporate goals.
 Compliance and Ethical Leadership: Ensuring the organization stays compliant and adheres to
ethical standards.

Details:

a. Companies Act, 2013:

i. Section 203: Designates the CFO as a key managerial personnel (KMP), highlighting their
importance in corporate governance. As a KMP, CFOs are obligated to disclose their
remuneration, changes in holding of shares, and other relevant details.

ii. Section 138: Emphasizes the appointment and role of internal auditors who report to the
CFO. This further buttress the CFO's role in maintaining internal checks and balances.

iii. Section 134(5)(e): This section requires the Directors' Responsibility Statement to include a
confirmation by the directors that they have laid down internal financial controls to be
followed by the company and that such controls are adequate and were operating
effectively, highlighting the role of the CFO in implementing and monitoring these controls.

iv. Section 179: Grants the Board of Directors the power to carry various activities, including
borrowing and investing funds, where the CFO plays a crucial role in advising and
implementing the board’s decisions regarding financial matters.

b. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:

i. Regulation 17(6)(ca): This regulation stipulates that the CFO shall provide a certification to
the board of directors regarding the financial statements and the cash flow statements for
each financial year, asserting the authenticity and correctness of the financial disclosures.

ii. Regulation 18: Specifies the formation of the Audit Committee, where the CFO interacts
frequently with the committee to ensure the accuracy and transparency of financial
disclosures.
 iii. Regulation 21: Mandates the constitution of the Risk Management Committee for a certain
class of companies, signifying the CFO’s role in assessing, managing, and mitigating
financial and operational risks.

iv. Regulation 33: Requires the CFO to sign the financial results, underscoring their
responsibility for accurate financial reporting and disclosures.

Conclusion

Navigating the intricate landscape of corporate finance, ESG, and financial controls in India requires a
nuanced understanding of the Companies Act, SEBI regulations, and more. The corporate finance
and governance landscape has been shaped meticulously with the evolving regulations and norms,
primarily set by the Companies Act and SEBI. Understanding these in depth is paramount for lawyers
advising corporations or engaged in litigation. Notable events, like the IL&FS crisis, serve as
significant pointers to the criticality of financial controls. In this ecosystem, the CFO emerges not just
as a financial strategist but also as a guardian of corporate ethics and governance.