Newsletter Category: 2023

The announcement that the 15% residual shareholding of the Government of India in IDBI Bank, post the disinvestment, would be classified as public shareholding has evoked mixed feelings. On the positive side, every measure intended to make the proposal more attractive for potential investors, and thereby, to increase the earnings of the Government, needs to be supported. At the same time, concern ought to be expressed at the manner in which regulatory exemptions and carve-outs are being thought of from time to time for public sector undertakings (PSUs), making the playing field less level on a continuing basis.

The special treatment given to PSUs, in the matter of overcoming regulatory constraints, has been in evidence for a long time. The examples are too many to be detailed in a newsletter. The LIC-IDBI merger tells its own story, and sheds adequate light on how regulations have been given the go-by. Traditionally, and in accordance with legal provisions, the Insurance Regulatory and Development Authority of India (IRDA) had not permitted LIC to invest in more than 15% of the shareholding of any company. This hurdle was overcome by the Government advising the IRDAI that the 15% investment cap will not apply in the case of LIC’s acquisition of shares in IDBI Bank, as this was to be an exceptional acquisition. Complying with the Government’s stated wishes, the IRDAI on 29^th June 2018 allowed LIC to buy up to 51% in IDBI Bank. On 21^st January 2019, IDBI Bank became a subsidiary of LIC.  On 19^th December, 2020, it was reclassified as an Associate company, since it reduced its shareholding to 49.24%, consequent on the issue of additional equity shares under Qualified Institutional Placement (QIP). It is relevant to mention that while allowing LIC to buy up to 51%, the IRDAI had imposed a condition that the stake should be reduced to 15% over a period of 5-7 years. Reading all these developments together, it becomes abundantly clear that LIC was merely to hold the baby till a suitable private investor came calling.

SEBI Regulations stipulate that a mandatory open offer shall be made when the shareholding reaches a prescribed limit. This condition was not insisted upon. Stated briefly, regulations and legal provisions, which were found inconvenient, were merely swatted away to pave the way for a smooth transaction at every stage.

There was a time when regulatory organisations did not exist. The regulatory and supervisory functions resided in the administrative Ministries and Departments of the Government. Thereafter, with several sectors being opened up for public participation, it was felt that the responsibility for regulation must be shifted from the Government to an entity tasked to discharge these functions in an objective and transparent manner, without factoring in the nature of ownership. It was recognised that so long as the Government chose to be a direct participant in some sectors of economic activity, there would be co-existence of, and resultant competition between, the PSUs and private sector units. This mixed economy approach (sometimes referred to as a mixed up economy approach) has served the needs of a heterogenous population over the decades.

As regulatory organisations began to get established, there was the legitimate expectation that acting in a functionally autonomous fashion, such organisations would lay down the common framework applicable to PSUs and private sector units. This did not happen overnight. Ministries and Departments, long used to exercising these powers, were reluctant to cede ground, and there was often a standoff between the concerned administrative Ministry and the regulatory organisation, when it came to even-handed implementation of regulations. It was almost as if the fear of letting go was premised on the fear of becoming irrelevant, forgetting that the domain of policy continued to remain with the concerned Ministry. At the same time, there were critics and commentators that spoke of “independent” regulatory organisations, giving the impression that these organisations existed independent of everyone else, even though they had no territory of their own, and did not fly a flag of their own. The legitimate expectation that these were to be functionally autonomous regulators, and not much more, was lost sight of, with the focus on the imaginary independence of such regulators.

One of the first task of regulators is to put in place a set of prescriptions, to ensure that the regulated entities, public or private, functioned in the manner that was expected of them. One of the expectations was that all stakeholders would be treated equally, and that there would be checks and balances, and structural arrangements put in place, to ensure that there was no disproportionate benefit to any segment of stakeholders.

Notwithstanding these intentions, the Government, through various measures, ensured that PSUs were required to comply with a lesser set of prescriptive arrangements, which were less rigorous. To cite one example, public sector banks (PSBs) were exempted from some of the requirements that as listed entities they would have had to comply with, in the absence of such exemptions. There were occasional carve outs from regulations to provide a different, and an easier, playfield for PSUs.

In the matter of reducing Government shareholding in PSUs, and also in cases of divestment, a number of exemptions were sought from the regulators, and were given with admirable alacrity. There was not even the pretence of digging in, to establish that regulations should apply equally to all entities in a regulated universe, notwithstanding the pattern of ownership. When it came to offers for sale, special dispensations were made available easily. In the context of minimum public shareholding in listed entities, Government undertakings benefitted by the existence of differential treatment. There were very rare cases in which ownership was not allowed to be made the basis for special treatment. In one such instance, when Clause 49 of the Listing Agreement was given effect to, it was noticed that PSUs did not bring on board, the prescribed number of Independent Directors (IDs). They sought extension of time for complying with this requirement. Failing that, they wanted exemption, on the basis that they were majority owned by the Government of India. When both these requests were turned down, they continued to cock a snook at the regulator. Only a later change of mind in the regulatory organisation led to their getting away with non-compliance. Later when the Companies Act, 2013 and SEBI LODR Regulations, 2015 provided that there should be at least 1 woman Director on the Board, the PSUs were found to be non-compliant for long periods, with no action being taken against them for such regulatory non-compliance. This continued when the stipulation was that every listed entity should have at least 1 woman ID. What is worse was that after the Coal India imbroglio, the IDs, for fear of being proceeded against by an institutional investor, opposed the management’s decision on pricing. They were then collectively shown the door, and similar treatment was extended to IDs on the Boards of several other PSUs. This resulted in completely non-compliant Boards, with only management representatives on the Board, thereby negating even the basic requirement of Corporate Governance.

There is no doubt that going forward there will be instances in which with the maximisation of revenue as a major objective, and for making the offering more attractive to investors, some regulatory requirements would be ignored. It is not necessary to produce evidence that such an approach would undermine the concept of functionally autonomous regulators creating a level playing field for all participants. Since these are undertakings that compete among themselves, it is inconceivable why the same set of rules cannot apply equally to all the participants. You should not have a game in which a PSU competes against a private sector unit, with different rules applicable to them in the playfield.

There are some who believe that the Government has no business to be in business. In this situation, there would be no need for carve outs, and the concept of a level playing field would come into being without much effort. However, there are those that believe that in an economy with multiple challenges, and with segments of the population being on opposite sides of different divides, there would be a need for a strong healthy vibrant public sector to continue to exist. The latest statement emanating from the highest level of the Government of India is very encouraging, since it urges the public sector and the private sector to work together in furtherance of national goals and objectives. What would have further strengthened this view would have been the expression of a hope that regulators will function autonomously in an even-handed manner, dispensing no favours based on ownership.

Tailpiece –

After the Government had reduced its shareholding in some banks, an Executive Director of a PSB was asked why the number plate on his car had the words “a Government of India Undertaking”. He replied that it made access to parking easier in crowded areas. What he did not foresee was that with PSBs reducing in number, he too could be “parked” in due course.

 

At the outset, we at Excellence Enablers wish you and your loved ones a very happy, healthy, peaceful and enriching New Year.

Omar Khayyam in his Rubaiyat propounded the philosophy “Unborn tomorrow, dead yesterday, why fret when today be sweet”. Many modern Gurus have also counselled their followers that one must “live in the moment”, and not spend too much time on what has already transpired, and what is likely to happen, going forward. While this view might receive approbation from those unwilling to take note of the past and the future, this is an approach that ignores, at its peril, knowledge from the past.

2022, the year of the World Cup, witnessed, in the corporate arena, a number of fouls, penalties and goals (scored by the Regulator). The lessons therefrom are extremely useful in looking at what lies ahead in the corporate universe. In a calendar year crowded with controversies, some clearly stood out.

In quick succession, Independent Directors (IDs) of the finance subsidiary of a public sector undertaking resigned from their Board positions. Shortly thereafter, one witnessed resignations from the Board of the parent company. The attitude of the management was dismissive, to the say the least. Unlike in the case of many other companies, the departing Directors chose to record, in considerable detail, the reasons why they were leaving. Briefly stated, the management made it difficult for them to continue to stay on the Board with self-respect, and the feeling that they could contribute to the performance and growth of the company, while respecting governance norms and practices.

The standoff between the management and the Board was a fairly common phenomenon in the year gone by. In one case, the Founder and his wife were accused of cheating and embezzlement. Their response has been to blame themselves for induction of the “wrong” (inconvenient?) person as Director, and then as Chairman. Needless to state, the days ahead will witness even more dirty linen being washed in public.

One company which had a very successful public issue, decided to issue bonus shares, at a time when the share prices had tanked. Questions have been raised as to whether the IDs failed in looking at governance matters relating to the bonus issue.

While these were instances of the existence of Directors not being tolerated, one company appointed at least 15 employees as Directors, and made them shareholders of shell companies. Interestingly, some former employees were inducted as Directors by using their digital signatures, after they had left their jobs. Whose graves will these digital signatures dig?

CEOs were also in the spotlight for the wrong reasons. The shareholders of one private bank filed a requisition to conduct an Extraordinary General Meeting to curb the spending powers of the CEO. Yet another company fired its Co-founder, following an independent forensic audit into allegations of serious financial irregularities. There was of course the celebrated case of one MD and CEO being guided by an alleged Yogi, with the Himalayan ranges as his last known address.

Auditors were also in the news for the wrong reasons. The most recent instances are the sanctions being imposed on two of the Big 4 by the USA’s Public Company Accounting Oversight Board (PCAOB) and UK’s Financial Reporting Council (FRC) respectively, with the Indian media largely ignoring this finding by overseas Regulators. Nearer home, the National Financial Reporting Authority (NFRA) has questioned the professionalism and the independence of audit partners in large firms, and levied penalties, including, but not limited to, their not being allowed to practice for specified periods.

What do these instances portend? As long as greed influences human conduct and decision-making, there will be transgressions, and even very obvious violations of laws and regulations. It is of utmost importance that in such cases, the delinquents should be quickly identified, and given exemplary punishment. This would in turn require the strengthening of regulatory capacity, both in terms of numbers, as well as in terms of skillsets of contemporary relevance. Is this something that can be looked forward to in 2023? There is always the hope, but expectations, based on experience, do not measure up.

2022 also saw many changes and additions to regulations, initiated by the Regulators, especially the securities markets Regulators. Consultation papers flew thick and fast, leaving it to market participants and others involved to quickly respond to proposed changes in regulations that might, going forward, adversely impact them. While in most cases, a consultative process was followed, there is no clarity as to how many suggestions were received, and how many of them were considered, and either accepted or not agreed to. An empty consultative process is, to put it bluntly, a waste of time for all concerned. Twists and turns are also not unknown in the regulated space. For example, with great fanfare, SEBI put out a two-stage approval process for the appointment of IDs. There was expectedly some pushback, with corporates contending that the new process would add to expenditure, without any significant benefits being gained therefrom. The two-stage process was abandoned during the consultation process, but following the maxim “what you lose on the swings, you gain on the roundabout”, SEBI came up with a single stage approval process, however, involving approval by 75% of the shareholders. This revised approval structure has been in place for only a few months. Meanwhile, SEBI has proposed to go back to a modified two-stage approval process on the lines initially suggested. Was this a case of “regulate in haste, and revise at leisure?”

Consistent with the philosophy of “Vasudhaiva Kutumbakam”, SEBI expanded the universe of related parties. Resultantly, a new category of Related Party Transactions (RPTs) have come into being. There is more that needs to be taken to the shareholders for approval. Will Boards and Audit Committees become passthrough agents over a period of time?

Not surprisingly, much of the focus of regulations and Regulators remained on IDs. In a recent prescription, SEBI has mandated that when a company is seeking to access the public market, the IDs should pronounce on the appropriateness of the issue price. Pricing of an IPO is a complex issue, and persons without expertise should not be tasked with deciding on such matters. Would it be reasonable to assume that better sense will prevail, and the remit of the IDs would be reduced to what they can, and should, handle? The revolution of rising expectations, consequent on such prescriptions, could deal a death blow to the institution of IDs.

Yet another gem from the Regulator’s treasure chest has been the suggestion that corporates should comment on every matter that appears in the print media, and in the social media. It is not unknown that the media, to increase readership, or to gain more eyeballs, sometimes put out sensational news items, which are without any basis. Would it not be preferable to leave it to the corporate to decide what reports to comment on in some detail, and what to brush aside or ignore as baseless? The proposed regulation could lead to a Department of Media Responses being created in the larger companies.

Market Infrastructure Intermediaries (MIIs) also received some attention. As against 50% of the Board comprising IDs, as at present, it has now been suggested that 75% on the Board should be IDs. What additional value this would add is a matter that needs to be clarified. By now, it is recognised that a majority in the Board is often not the best way to determine what is relevant and productive.

Happily, 2022 also witnessed a fair measure of stakeholder activism. Proposals for enhancement of executive compensation did not sail through unchallenged, as they did in the past. With a few resolutions for enhancement of executive compensation being turned down by the shareholders, at least in the first instance, it became abundantly clear to the corporates that unless there is justification spelt out in adequate detail in the resolutions, they should not expect the passing of these resolutions to be a cakewalk.

The year gone by also saw significantly increased attention being paid to the identification of risks, and the management of such risks. Covid-19 has, in some quarters, been given credit for risk becoming centre stage, forcing Boards and managements to look at employee heath and welfare, and the ensuring of business continuity, as important tasks. There has been considerable discussion and debate on the issue of cyber security, and the steps required to identify the systemic weaknesses, and to shore up the defences against any such attacks. As the year wound to a close, India’s premier hospital had a massive cyber security attack on its systems. This reportedly affected the smooth functioning of the hospital for at least 2 weeks, and considerable patient information was reportedly compromised. It would be useful to reflect on the possible consequences of such an attack on a large entity in the financial sector, and the damage it could do to the health of the sector.

Adverse commodity prices and supply side shocks were also witnessed by many companies. Consequent on the Russian invasion of Ukraine, companies had to scramble to address these issues. The non-availability of chips was a major setback to the manufacturing sector. The fact that these concerns were addressed, and the ship was kept on even keel, redounds to the credit of managements and Boards.

Sustainability became a part of the active vocabulary of most corporates and stakeholders. Recognition that India needs an ESG approach, that is consistent with its ground realities, is increasingly gaining currency. This too is expected to play out significantly in 2023 and the subsequent years.

A lot of what has transpired, in the year gone by, should lead us to reflect on whether we need to travel down the path of increased prescriptions and micromanagement by Regulators. Would it not be far more value-adding if Boards were appropriately composed, and left to determine what should be done to promote Corporate Governance, while seeking to increase business, and add to the profitability? There are obviously no easy answers. What is clear is that more regulations, which would usher in more processes and disproportionate time invested by senior managements on compliance matters, is not a worthwhile option. At the end of the day, regulations that are clear, written in simple language, and have continuity as a major element, will alone deliver what stakeholders expect from corporate entities. Winter is going. Spring is round the corner.