Sebi’s new LODR amendments empower independent directors, but allowing for a lead independent director is crucial

July 05, 2021 5:45 AM

Despite all the changes, the question remains—have these actually enhanced the independence of an independent director and can regulatory changes alone help in strengthening the latter.

The impact on governance in Indian companies still remains to be seen; independence is after all, a state of mind, and cannot be imposed through regulation alone.The impact on governance in Indian companies still remains to be seen; independence is after all, a state of mind, and cannot be imposed through regulation alone.

By Sai Venkateshwaran

Sebi recently approved amendments to the Listing Obligations and Disclosure Requirements (LODR), to bolster the framework governing independent directors for listed companies in India. These amendments follow from a Sebi consultation paper earlier this year, which discussed several proposed changes to the rules governing the appointment and removal of independent directors as well as their role and remuneration. While many of the proposals discussed in that paper have been tweaked or diluted, the approved amendments will certainly help strengthen India’s corporate governance framework. The impact on governance in Indian companies still remains to be seen; independence is after all, a state of mind, and cannot be imposed through regulation alone. The key changes cut across five broad themes.

First, it mandates a structured process for selection linked to needs of the board. When the Kotak Committee on Corporate Governance recommended that companies perform a mapping of skills and competencies required by the board in the context of its business/sector and those available with the board, it wasn’t only meant to be a disclosure exercise, but rather to nudge companies to perform a critical assessment of skillsets and ensure that the board composition is optimal, bringing the right set of complementary skills and competencies. With these amendments, Sebi has essentially mandated a structured process to be run by the Nomination and Remuneration Committee (NRC) and enhanced its role and transparency to ensure that the right person is appointed as independent director (rather than someone merely recommended by the promoter).

Second, the appointments/re-appointments and removal of independent directors will be backed by the voice of the institutional and other public shareholders with adequate safeguards. While the proposal of dual approval and vote of ‘majority of minority’ hasn’t gone through, the amendments mandate special resolutions for these appointments and removals. With the trend of promoter shareholding slowly coming down in Indian companies, a sizeable proportion of public shareholders, including institutional shareholders, will need to vote in favour of these resolutions for them to pass for many companies. This is accompanied by the need to seek quicker shareholder approval, with the approval window being reduced to three months from the date of appointment on the board or next general meeting, whichever is earlier. Further, it also requires greater disclosure, including entire resignation letter, along with a list of her/his continuing membership of other boards and committees.

Third, the amendments provide greater voice to independent directors in the NRC and Audit Committee, mandating two-thirds of these committees to comprise independent directors. While the proposal to have only those directors not related to the promoters to be on the AC hasn’t been approved, increasing the strength of independent directors from simple majority to two-thirds is welcome.

Fourth, mandating approval of all related party transactions only by independent directors on the Audit Committee. While the proposal was to not have any directors related to the promoters on the AC, the amendments have essentially made the approval of these transactions the prerogative of the independent directors. The real test however remains on how the independent directors review both the qualitative and quantitative aspects of each of the related party transactions and focus on ones that really impact the interests of minority shareholders and other stakeholders.

Last, it mandates the directors’ and officers’ insurance cover applicable to the top 1,000 companies, while also making a reference to the ministry of corporate affairs to allow flexible compensation structures, including stock options, profit linked commissions, etc, within the overall limits of Companies Act, 2013. The provision of stock options will require an amendment to the Companies Act, which currently has a specific prohibition on granting options.

Despite all these changes, the question remains—have these actually enhanced the independence of an independent director and can regulatory changes alone help in strengthening the latter. It is in this context that one of the recommendations made previously by the Kotak Committee relating to the appointment of a lead independent director is relevant. The implementation of that proposal was deferred by Sebi when it considered those recommendations. However, that remains one of the proposals that can make a difference in the Indian context, where boards have dominant promoters, often in the role of chairperson, and the lone voice of an independent director may not be forceful enough. A lead independent director can help organise independent directors and amplify the impact of that collective voice in driving change in governance standards in board rooms.

Therefore, in balance, when one looks at these changes to the framework, it certainly will nudge boards and independent directors, and shareholders, where required to take actions that further enhance governance standards. However, the real change will be seen when there is independence in spirit rather than just in form.

The author is Partner, KPMG in India
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