2014 is shaping up to be a year of dramatic governance changes for Indian companies, as boards will be tasked with adding new committees and diversifying board membership and the periodic rotation of a company’s external auditor will become mandatory.
In August, India signed the Companies Act, 2013 (“Companies Act”) into law, ushering in sweeping reforms to its corporate governance laws and practices. Although companies have one year to become compliant with the new provisions of the law, the Companies Act not only modernizes Indian corporate governance to meet standards of other large global markets, but it also takes India into uncharted corporate governance territory.
Prior to the implementation of the Companies Act, corporate governance in India was shaped by few rules governing issues such as board independence and the presence of audit and nomination committees. With the introduction of the Companies Act, however, companies this will change. Companies will now be required to have minimum board independence of 33%, as well as a remuneration committee and a nomination committee (or combined as one) with a minimum independence level of 50%.
The Companies Act also governs issues related to board membership. For example, nominee directors, who are commonplace on Indian boards of directors, will be prohibited from being considered as independent directors, which will impact many companies. In addition, directors will no longer be considered independent following ten consecutive years of board service. However, at that point of service, directors are able to undertake a three-year “cooling off period” before serving again as an independent director. Companies will also be required to have at least one female director, marking a significant and progressive step forward in promoting the role of women in Indian boardrooms.
One of the unique changes to Indian corporate governance will be the requirement for companies with a net worth of INR 5 billion, turnover of INR 10 billion, or a net profit of INR 50 million during any financial year to establish a corporate social responsibility (“CSR”) committee, composed of at least three directors (one of whom must be independent). Upon adoption of a CSR committee, companies will be required to spend 2% of their average net profits for the immediate three prior financial years on activities that advance social responsibility, with a preference for investment in local areas near company operations. This new requirement is one of the most significant steps in the advancement of corporate social responsibility taken by corporate regulators in any major global market.
Although previously a voluntary recommendation, the relationship between a company and its auditors will also be changing. Individual auditors will be limited to service of five consecutive years and audit firms will be limited to maximum service of ten consecutive years. Although other markets, such as Indonesia, require auditor rotation, India is now one of the first major global markets to institute such requirements. In addition, auditor services will be now be limited. The new regulations will prohibit an auditor from providing the following services, in addition to audit services: (i) accounting and book keeping services; (ii)internal audit; (iii) design and implementation of any financial information system; (iv) actuarial services; (v) investment advisory services; (vi) investment banking services; (vii) rendering of outsourced financial services; and (viii) management services. Such limitations will hopefully strengthen auditor independence.
Also new to India is the ability to “clawback” remuneration paid to executive directors. Although similar policies are commonplace in much of Europe and North America, the ability for companies to recoup remuneration awarded on false or illegal pretenses has yet to take hold in Asia; in fact, India is the first market in this region to adopt such a regulation.
These changes are all reflected in our recently-released 2014 Proxy Paper guidelines for India, which can be found on our public website (here). The combined influence of the Companies Act with the existing Clause 49 of the Listing Agreement should push India to the forefront of corporate governance in emerging global markets (especially among fellow “BRIC” nations: Brazil, Russia and China). While the ultimate success of these changes will be measured with the passage of time, shareholders should be greatly encouraged by the breadth and depth of these changes.