By CKG Nair, The writer is a former member of the Securities Appellate Tribunal and former director of National Institute of Securities Markets, and is a public policy commentator
Financial sector regulators have been quite proactive in rule making for improving and improvising governance of their regulated entities (REs). Rightly so, given their lofty mandate of investor protection, system integrity, financial stability, and so on. Regulators could succeed greatly in their mission if they get that magical governance code right and make REs govern/behave well. On the contrary, they become sleepless after each episode of governance failure under their watch. And the search for new, more potent weapons resumes, often without throwing away the rusted ones. Recent episodes of alleged corporate missteps (IndusInd Bank, Gensol Engineering, Religare) and (continued) mis-selling in insurance services etc. are fresh eye-openers. That too, before such episodes relating to Yes Bank, IL&FS, DHFL, BharatPe, Fortis, and so on were forgotten.
The Reserve Bank of India (RBI) is planning to intensify its monitoring of bank board proceedings through its system of senior supervisory managers (SSMs). Designated officers of the regulator will closely look at the board proceedings of their REs in terms of quality of discussions, contributions of board committees, mismatch between recorded discussions and minutes, and so on. Though post-facto, it is like the regulator moving closer to the boardroom—despite the fact that directors on those boards are appointed with the RBI’s approval and many of the independent directors are former senior regulatory officials, former bank heads and former senior civil servants.
The Securities and Exchange Board of India (Sebi) issued a consultation paper on Strengthening Governance of Market Infrastructure Institutions (MIIs)—stock exchanges, clearing corporations, and depositories—taking note of the “rapid increase in investor base and volumes; a growing network of intermediaries associated with them; significant growth in revenue and profitability”, etc. Irrespective of whether they are listed or not, Sebi’s hold on governance of MIIs has been very tight for several years. The Mahalingam Committee’s (November 2022) recommendations on MIIs’ governance enhancement were implemented just two years ago.
The new proposals aim to enhance the governance standards of two out of three key verticals of MIIs—“critical operations” and “regulatory, compliance, risk management, and investor grievances, etc.”—by putting each of these verticals under a dedicated executive director/key managerial person (KMP) who will be on the MII’s board of directors. These proposals are furthering the steps taken based on the Mahalingam Committee’s recommendations. Unlike the RBI-proposed SSM monitoring system, Sebi is not stepping nearer to the MII board. Rather, it is enhancing the accountability of the officers of the MII itself, by raising their status as board directors. Still, it is an indirect recognition that a public interest director-based system is falling short of expectations.
Over the last 25 years, the regulators have spent quite a lot of their time and energy in developing a “robust” system of governance of their REs. While the main load on corporate governance is lifted by SEBI, prudential regulators (RBI, Insurance Regulatory and Development Authority of India, Pension Fund Regulatory and Development Authority) supplement their own themes over and above Sebi regulations for listed entities and supplant for their unlisted REs.
No one can accuse Sebi of framing governance related regulations or guidelines unilaterally or with routine public consultations. The model edifice built for listed companies over two decades has been the distilled recommendations of various committees headed by eminent professional entrepreneurs (KM Birla, 2000; Narayana Murthy, 2003; Uday Kotak, 2017).
Elaborate regulations relating to the composition of board, number of board committees, enhanced role of independent directors, improving disclosures came from these committees. For MIIs, the Pherwani Committee’s (1994) recommendations and the government’s bold policy in setting up a demutualised National Stock Exchange and appropriate fit and proper criteria got supplemented through some of the recommendations of the Bimal Jalan Committee (2010) on ownership and governance norms. These, after periodic fine-tuning by Sebi, got reinforced with the Mahalingam Committee’s recommendations in 2022.
The RBI has had the benefit of several expert committees on banking/non-banking financial company (NBFC) reforms over decades. Specific attention to the governance of bank boards, particularly of public sector banks, was the mandate of the PJ Nayak Committee (2014).
Elevated norms on corporate governance also came from eminent, philosopher directors on boards of companies of repute, through their writings. They glorified the ideal governance edifice using the high-principles of dharma, eloquently picking exemplary anecdotes from the epics.
Despite 25 years of setting progressive standards for corporate governance, by a proactive Sebi with other regulators on a par, why is it that governance at times becomes a casualty? What ails governance of MIIs even with Sebi’s micro-scrutiny? Or financial sector listed banking companies or NBFCs with Sebi and the RBI supervising them as conduct and prudential regulators respectively? Why is reputation risk not making REs govern themselves well, even when their boards are full of eminent directors? What happened to the much-hailed governance principle of “giving voice to values”, by independent directors?
There are no easy answers to these questions. Basically, there are limits to behaviour modification, even with the best of intention. A big edifice of laws and regulations cannot substitute norms and principles, as stated by institutional thinkers. Regulators got carried away with an exalted version of governance and started to romanticise their rule-book. When asked, a former regulatory chief, who later joined as independent director in a few boards, said “the regulator is in an utopia; reality is a joke”! Dharma in the modern corporate-financial-tech world is a mirage. Not only promoter/shareholder directors but even the independent directors/public interest directors, with their limitations of information and skill gaps, love giving their voice to value rather than to values.
Acknowledging the complexity of governance, which is the outcome of many non-linear functions, regulators should temper their expectations from a principal-agent model. Come down from utopia to eutopia, the practical world. Differentiate between financial crimes and lesser civil violations and punish the former swiftly. Follow a core responsibility approach rather than a catch-all one in investigations and adjudications. Clearly demarcate the regulatory role and accountability of MIIs as under the relevant parent Acts. And allow them to run their business.
Also, why only punish violations; why not start rewarding well-governed entities? Like the IPL fair play awards, REs would cherish a governance award from their regulators.