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Corporate Governance: SEBI Raises The Bar!

Published on Mon, Apr 21,2014 | 10:25, Updated at Mon, Apr 21 at 10:25Source : Moneycontrol.com 

By: Sai Venkateshwaran, Partner & Head of Accounting Advisory Services, KPMG India

SEBI’s recent amendments to clause 49 of the Listing Agreement make sweeping changes in the corporate governance environment in India. The new requirements rest on a principle based framework and is a quantum leap from more of a rule-based framework that existed earlier. This will enable corporate governance requirements being complied with not just in letter but also in spirit. These new requirements, which come into effect from October 1, 2014, serve three objectives – alignment with the Companies Act 2013, adoption of best practices on corporate governance and lastly, making the corporate governance framework more effective.  As a result, while in most areas the Clause 49 and Companies Act requirements are aligned, in certain areas, the SEBI requirements have been made more stringent.
 
One of the ways in which the new requirements seek to raise governance standards is by bringing in transparency. It requires, in several places, the company to disclose its policies on compliance on its website and in the annual report. This will help in making the stakeholders fully aware of the significant matters on corporate governance.
 
The key changes in the new corporate governance requirements are as under:
 
Framework

Instead of a more of a rule based approach to corporate governance, the new requirements have laid down principles in areas such as rights of shareholders, role of stakeholders, responsibilities of the Board and disclosure and transparency. Further, it states that where there is any ambiguity, the said provisions shall be interpreted and applied in alignment with the principles.
 
Composition of Board

1.  The requirement for basic composition of the Board have not been changed. The requirement for independent directors, through different from Companies Act, has been retained.

2.  The meaning of independent director has been aligned with the new Companies Act. The prohibition on having any material pecuniary interest as per the old corporate governance code has been replaced with a prohibition on any pecuniary interest in line with the Companies Act. The requirement that the independent director should not be a material supplier, service provider or customer or lessor or lessee of the company from the old corporate governance code has been retained. This requirement is not present in the Companies Act.

3.  the limits of number of directorship for independent directors is different from the Companies Act as well as old corporate governance code. The new requirement states that a person cannot serve as an independent director in more than 7 listed companies and if such person is a whole time director in any listed company, then the limit on independent directorships gets reduced to 3 listed companies.

4.  In terms of tenure for independent directors, it is aligned with the new Companies Act except in case of a person who has already served as an independent director for 5 years or more. Such directors would have only one term of five years to serve as an independent director.

5.  The new corporate governance code requires additional requirements with respect to independent directors on the following. These are aligned with the new Companies Act.

 

1.  formal letter of appointment

2.  performance evaluation

3.  separate meetings and

4.  training

 

1.  With respect to back-filling the position of an independent director who has been removed or has resigned, the time limit in the old corporate governance code as well as Companies Act was 180 days. This has now been truncated to either three months (90 days) or immediately next Board meeting (maximum 120 days). This might create hardship for companies especially given the fact that there is an overall shortage of availability of independent directors.  However, this doesn’t apply, if the Board already has the requisite number of independent directors.

2.  The new code additionally requires the Board to satisfy themselves on succession planning of Board and senior management.

3.  Independent directors are not entitled to receive any stock options; this requirement is also in line with the Companies Act.

4.  With a view to ensuring effective participation, the number of committees that a director can serve on has been limited to 10 committees, including a maximum of 5 committees where he can be the Chairman.  These apply only to committees of public companies, both listed and unlisted.

5.  The Board is also required to periodically review the company’s compliance with all applicable laws, and take steps to address non-compliances.  This is in line with the director’s responsibilities under the Companies Act, where they are require to ensure compliance with all laws and regulations.

 

Code of conduct
 
1.  The new corporate governance code requires incorporation of duties of independent directors in schedule IV of the Companies Act within the overall code of conduct for Board members and senior management.

2.  The new corporate governance code incorporates the responsibility statement for independent directors from the Companies Act. Thus the independent directors of listed companies will be held liable only for acts that occurred with his knowledge and through the Board process. It is important to note that the similar requirement under the Companies Act also extend to non-executive directors (NED). The corporate governance code does not extend this to NEDs.

 

Whistle Blower policy

1.  The new corporate governance code incorporates requirements for whistle blower policy from the Companies Act.  The new governance code also requires that the framework provide for direct access to the Chairman of the Audit Committee in exceptional cases.
 

Audit committee (AC)

1.  The new code retains the requirement for two-thirds of members of AC being independent. The Companies Act requires at least half of the AC members to be independent.

2.  Similarly it retains that the chairman of the AC is independent. There is no such requirement under the Companies Act.

3.  The role of Audit Committee under the new code also incorporates matters from the Companies Act such as reviewing and monitoring auditor independence etc, approval of transactions with related parties, scrutiny of inter corporate loans, valuations and evaluation of internal financial controls and risk management systems. It is important to note that the term used in this clause is internal financial controls which is straight out of section 177.
 

Nomination and remuneration committee (NRC)

1.  The new code requires listed companies to constitute a NRC. This is consistent with the requirements under the new Companies Act.

2.  The corporate governance guidance requires the chairman of the NRC to be independent.

3.  The remit of the NRC is wider than stated in the Companies Act.


Risk management

1.  The new code widens the requirements for risk management. The new code requires the Board to be responsible for framing, implementing and monitoring the risk management plan for the company.

2.  For top 100 companies by market capitalization as of the end of previous year – the new code requires formation of a risk management committee to execute the responsibilities of the Board.


Subsidiary companies

1.  The new governance code also requires the Board of the listed company to exercise significant oversight over the activities being undertaken by material subsidiaries (ie, a subsidiary whose income or net worth exceeds 20% of the consolidated income or net worth respectively, of the listed holding company).  In particular, it requires the following:

1.  At least one independent director of the holding company shall be a director on the Board of a material non-listed Indian subsidiary company.

2.  The Audit Committee of the listed holding company shall also review the financial statements, in particular, the investments made by the unlisted subsidiary company.

3.  The minutes of the Board meetings of the unlisted subsidiary company shall be placed at the Board meeting of the listed holding company. The management should periodically bring to the attention of the Board of Directors of the listed holding company, a statement of all significant transactions and arrangements (any individual transaction or arrangement that exceeds or is likely to exceed 10% of the total revenues or total expenses or total assets or total liabilities, as the case may be, of the material unlisted subsidiary) entered into by the unlisted subsidiary company.

4.  No company shall dispose of shares in its material subsidiary which would reduce its shareholding (either on its own or together with other subsidiaries) to less than 50% or cease the exercise of control over the subsidiary without passing a special resolution in its General Meeting.

5.  Selling, disposing and leasing of assets amounting to more than twenty percent of the assets of the material subsidiary shall require prior approval of shareholders by way of special resolution.


Related party transactions

1.  The needle on RPT has move sharply. From merely placing related party transactions before the Audit Committee under the old corporate governance code the requirement now is far more elaborate on all fronts. For starters, the definition of related party has been widened significantly. The definition under the corporate governance code is wider than the Companies Act especially in the following areas:

1.  Person that has a joint control or significant influence on the company. Under AS 18 and companies it alludes to person controlling the entity to qualify as a related party

2.  Fellow joint ventures and associates

1.  It seems that the requirements of related party that are expanded under the new corporate governance code with a view to achieve congruence of parties. To illustrate, if entity A has 20% interest in entity B, A will be a related party of B and B will be the related party of A.

2.  Further, the definition of related party transactions has been made wider to include even transactions free or charge; a related party transaction is a transfer of resources, services or obligations between a company and a related party, regardless of whether a price is charged.  Determination of whether a free of charge transaction is material still remains a challenge, as materiality is defined with respect to transaction values.

3.  In relation to approval of RPT, the new code specifies that all related RPTs require prior approval of Audit Committee and all material RPTs shall require approval of shareholders through special resolution with the interested party abstaining from voting. These requirements are in some ways different from the Companies Act.

4.  The code refers to guidance on what constitutes material. It states that higher of the transactions individually or taken together with previous transactions in a financial year exceeds 5% of annual turnover or 20% of net worth as per last audited financial statements.

5.  The approval of the Board on related party transactions seems conspicuously missing.

6.  Further all material RPTs have to be disclosed in the quarterly compliance report on corporate governance

7.  The policy relating to RPT have to be disclosed on the website and annual report of the company

8.  With respect to applicability, the new code states that RPT approval requirements have to be applied prospectively. With respect to existing material RPT that are likely to run beyond 31 March 2015 should be approved by the shareholders in the meeting after 1 October 2014. Early application of the shareholder approval requirements is permitted.

 
Disclosure of resignation of directors and appointment of independent directors

1.  Under the new code, the company is required to disclose the letter of resignation along with detailed reasons for resignation provided by the director of the company on its website within one day of the resignation. The copy of the resignation should also be forwarded to the stock exchanges and will be displayed on the website of the stock exchange.

2.  Similarly appointment letter of independent director has to be disclosed on the website of the company and stock exchanges.


Other points of note

1.  The new code continues with the CEO/CFO certification on internal controls for financial reporting and does not align with the requirements of section 177. However in the responsibility section of the new code it mandates Audit Committee to oversee internal financial controls. It seems a bit fuzzy on what the requirements of the Audit Committee are in this regard.

2.  In the non-mandatory requirements of the new code it states that the company may appoint separate persons to the post of chairman and MD/CEO. However under section 203 this seems to be an obligation unless the articles of the company suggest otherwise and a company that carries out multiple businesses.

3.  Section 138 requires the internal auditor to report directly to the Board. The new code in the non-mandatory requirements suggests that the internal auditor may report directly to the Audit Committee.

4.  Monitoring cell set up by SEBI last year, will also monitor compliance by companies with the requirements of clause 49 and report non-compliances to SEBI within 60 days of each quarter.  This is a welcome move, and shows the strong intent of SEBI to not only bring in regulations, but also put in place a monitoring mechanism.

5.  Where public funds raised have been used for purposes other than those stated in the prospectus, a statement certified by the statutory auditors is to be placed before the Audit Committee.  The Audit Committee shall make appropriate recommendations to the Board to take up steps in this matter.


Amendments to Clause 35B of the listing agreement

Amendments to clause 35B, enabling framework for e-Voting is now part of the listing requirements and is required for all resolutions to be passed at AGM or through postal ballot. This aligns with the rules in the new Companies Act.  This would encourage much more active participation by minority shareholders, including both institutional and retail shareholders.  These requirements are already effective pursuant to the Rules accompanying Companies Act 2013.

 
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