Rebuilding investors’ confidence through effective governance · inevitable in increasingly integrated global economies, where the ... risks around data security, cyber, business

August 2018

Rebuilding investors’ confidence through effective governance

Section Page

Foreword 03

Overview 04

Theboardofdirectors:Businesscore 05

Corporategovernancegonebad 08

Achangedparadigm 11

Howtoboostinvestors’confidence 17

Ourview 23

Contents

02 Rebuilding investors’ confidence through effective governance

Rebuilding investors’ confidence through effective governance 03

Foreword

ThecountrywitnessedincreasedM&Aactivityin2017,growingat53.3%to$77.6billionin2017.CompaniesinIndiaraisedINR1.6trillion($24.96bn)throughtheprimarymarketin2017.Asaresult,investorconfidencehasimproved,reflectedinIndia’sentryinthetop100intheWorldBank’s‘EaseofDoingBusiness’rankings.Indiaalsomaintainedahealthygrowthrateofabout7%in2017andthefiscaldeficitdecreasedto3.2%oftheGDP.Ontheregulatoryfront,SEBIKotakCommitteeandCompaniesAct2013(theAct)introducedfar-reachingchangestoenhancetransparencyinfinancialreporting.Section138(1)oftheActhasgivenstatutoryrecognitiontothefunctionofinternalaudit.

Anincreasinglycomplexbusinessenvironment,characterisedbygrowingexpectationsanddemandsfromtheboard,auditcommitteeandallrelevantstakeholdersnecessitatesamorebalancedmixofauditprofessionalsandbusinessexecutives.Forinternalauditleaders,thenewnormalistoassumenothingisnormal.Transformation,especiallyasaresultoftechnology,isinevitableinincreasinglyintegratedglobaleconomies,wherethefutureofinternalauditlooksbothpromisingandchallengingascompaniescometogripswithdigitalisation.

The internal audit function needs to change the status quo andintegrateplanning,executionandreportingwithnewmethodsandskills.Regardlessoftheapproach,therewillberisksarounddatasecurity,cyber,businessresilience,third-partymanagement,datasharing,governanceandbudgeting.ThisiswhereRoboticProcessAutomation(RPA)andCognitiveIntelligence(CI)canenableautomationofrepetitivetasksandaccelerate reporting with integrated set of analytical capabilities toauditwithadvancedtechnologies.

These developments present an opportunity for the internal audit function to act as an independent adviser to the management andsupportthemanagement’sgoals,monitorenterpriseriskandenhanceregulatorycomplianceefforts.Thefunctionneedstobeagileintheadoptionofnewmethods.Transformedoperations on the part of internal auditors is a requisite to remainrelevanttostakeholdersandimprovetheirresponsestoconstantlyevolvingbusinessdisruption.Thisparadigmshiftwouldfurthersatisfystakeholders,whodependoninternalauditor’s objectivity and independent advice to address advancedchallenges.

Inthisreport,wedissectsomeofthecriticalaspectsimpactinginvestors’ confidence in company formations and cover the regulatorydirectivestowardsenhancementoflong-termshareholdervalue.Itincludesexperiencesofcompaniesandaddresses common questions around why good corporate governanceandinternalcontrolsarenecessary,notonlyinordertogaincredibilityandtrust,butalsoasapartofstrategicmanagementforsurvival,growthandconsolidation.

Ihopeyoufindthereportinformativeandlookforwardtohearingfromyou.

Vishesh C ChandiokChief Executive OfficerGrant Thornton India LLP

Forinternalauditleaders,thenewnormalistoassumenothingisnormal.Anewdoor for internal auditors has now opened to change the status quo and transform operations–thedigitalway.


Overview

IndiaInc.hasgrownbyleapsandboundsinrecentyears.Asaresult,corporateIndia’sattentionhasevolvedfromsimple‘management’to‘governance’andnow‘effectivegovernance’.ManyscandalshaverockedIndia’scorporatelandscape,seriouslyshakingtheconfidenceofinvestors.Thissurgeinthe instances of failure of corporate governance structure has raised serious questions about the role oftheboardsandcomplianceirregularities.InJune2017,theSecuritiesandExchangeBoardofIndia(SEBI)formedahighpoweredcommitteeundertheleadershipofUdayKotak(KotakCommittee)toelicit recommendations to improve the standards of corporate governance of listed companies in the country.On28March2018,SEBI’sboardaccepted69%oftherecommendations.

The final assent to corporate governance practices in the effective management of a company came through new significant provisions introduced in theCompaniesAct,2013(theact)intheformofIndependentDirectors(IDs),womendirectorsontheboard,CorporateSocialResponsibility(CSR)andmandatorycomplianceofSecretarialStandardsissuedbyInstituteofCompanySecretariesofIndiaasperSection118ofCompaniesAct,2013.The provisions were further strengthened in the Companies(Amendment)Act2017.Theprovisionsobligatecompaniestoensurethatallstakeholdersget their fair share of the firm’s earnings and assets and involve a commitment to run businesses inalegal,ethicalandtransparentmanner.Thisdedication must come from the very top and permeatethroughouttheorganisation.

The Act also strongly emphasises on internal controls and casts a responsibility on the board foroverseeingit.Underclause(e),sub-section(5),Section134,oftheAct,InternalFinancialControls(IFC)aredefinedinthewidestpossiblemanner to encompass anything and everything thatacompanydoes.TheInstituteofCharteredAccountantsofIndia(ICAI)issuedanupdated‘GuidanceNoteonAuditofInternalFinancialControlsoverFinancialReportingorICFR’in

September2015.Boardsoflistedcompaniesandmany specified unlisted companies are required to affirmintheDirectors’ResponsibilityStatementsinAnnualReportsthatIFCsystemsinthecompaniesareadequateandoperationallyeffective.StatutoryauditorstooarerequiredinSection143toreportontheadequacyandoperationaleffectivenessofIFC.

TransitiontoIndianAccountingStandards(IndAS)inIndiancompaniestostandardisefinancialreportinginlinewithglobalInternationalFinancialReportingStandards(IFRS)hasaddedanotherflagtotheeffectivecorporategovernancemechanisms.On17May2016,ICAIalsoissuedanewStandardonAuditing(SA)701,CommunicatingKeyAuditMattersintheIndependentAuditor’sReport.Thishighlighted that the scope of good corporate governancesolutionshasfurtherwidened.Thisisdue to increasing conflict between ownership and managementdisciplinesandthenon-complianceoffinancialreportingbyauditors.Asaresult,investorssuffer heavy losses and loose trust in the financial viabilityofthecompanyanditsethicalstandards.

AsregulatoryandlegalrecourseinIndiaisstillatthedevelopmentalstage,itputstheburdenofduediligencereviewoncompaniesandmakesthe implementation of corporate governance and internalcontrolsatoppriority.

The board of directors: Business core


Corporategovernanceisanintegralpartofaneffectiveriskmanagement activity of any organisation and should be stringently adopted.Itwillleadtoincreaseinshareholder’swealth,increaseininvestors’confidenceandreducedcostofcapital,alongwithotherbenefitsofbrandequity,greateremployeemoraleandgreaterconfidenceoflendersandcreditors.

The board of directors is one of the most crucial aspects of any organisation’s corporate governance framework.TheinstitutionofindependentdirectorsontheboardofIndiancompaniesandthatofthe CFO/company secretary in the executive managementisdesignedtocreatechecksand balances and uphold transparency with accountabilityindecision-making.Bothhavelegal,fiduciary and professional responsibilities apart fromethicalconsiderationstogoverntheirdecision-making.Butdoesitreallyworkthatway?

Itis,thus,importanttounderstandtheconceptof directorship to the board of directors followed inIndia.Formany,raisingavalidconcerntantamountstonoeffectivetask,and,hence,theychoosenottosayanything.Theindependentdirectors,too,areusuallychosenonboardonthebasisoffamiliarity,andnotnecessarilymerit.Forcomplying with the regulation on having a woman directoronboard,companieswerewitnessedtoappointtheirfemalerelativesasdirectors,whichclearly symbolises the dilution of the effectiveness oftheregulationperse.

Thereneedstobeclarityontheroleofdirectors,and they should have the autonomy to fulfill their responsibilities.Lackofincentivesfordirectorstodosomakescompanieslessattractivetoindependentdirectorandalsolesscompetitive.

Thisseverelyerodesinvestortrust,despitethebesteffortsofgovernments,regulatorsandotherbodies

tofurtherstrengthenregulatoryframeworksandensure to design them explicitly to instil investor confidenceincapitalmarkets.

Morethanhalfofthe2,500executivesfrom35economieswhichtookpartintheGrant Thornton International Business Report (IBR) survey conductedbetweenFebruaryandMarch2018are experiencing growing pressure to collect and respondtotheviewsofwiderstakeholders(suchasemployees,customers,suppliersandinvestors).In some markets, including the US, UK, India and South Africa, more than 70% of executives feel that the pressure to increase stakeholder engagement has increased over the past two years.

Asaresult,businessesneedtodeterminetherightboardcomposition,governanceandriskmanagementstructure.Itisalsoimportantto develop effective mechanisms for inviting stakeholderfeedbackandactonthisinformation–a narrow focus on financials is no longer enough for long-termcorporatesuccess.Asaboardmember,itisimportanttoknowwhetherthereisenoughinformation to manage and direct business and whetheritissubjecttosufficientvalidation.

Addressingthesechallengesislikelytorequireabroader-basedandmoreproactiveapproachtogovernanceanddecision-making.Thus,investorsatall levels demand greater corporate transparency


in order to assess a company’s current position andtobetterunderstanditslong-termvisionandinvestmentvalueproposition.Withtherecentchangesinthestatutes,corporationsanddirectorsareundergreaterinvestorscrutinythaneverbefore,intermsofnotjusttheirfinancialscorecard,butalso records around setting and practicing strong environmental,socialandcorporategovernancepolicies.Boardsareunderincreasingpressurefromregulatorsandcustomersaliketoengagemorebroadlywithstakeholdersandbuildtheirviewsandexpectations into the strategy and management of thebusiness.

IBR surveyOverthelasttwoyears,thereisgreaterpressureon boards/companies to collect and respond to the viewsofwiderstakeholders(suchasemployees,suppliers,community,customersandinvestors).

Note:GrantThorntonInternational’sIBRisasurveyofbothlistedandprivatelyheldbusinesses.Thedataforthisreportwasdrawnfrominterviewswithmorethan2,300chiefexecutiveofficers,managingdirectors,chairmenandotherseniorexecutivesconductedbetweenFebruaryandMarch2018.

There is a risk of proxy agencies at times acting like dominant shareholders and unduly influencing the corporate governance landscape

Country Strongly agree

Disagree/ Strongly disagree

Global 55.5% 12.6%Africa 78.1% 14.8%APAC 43.4% 11.7%EU 52.6% 19.3%NorthAmerica 71.8% 8.2%LatinAmerica 54.8% 8.9%Australia 61.8% 2.6%Canada 60.4% 9.8%India 79% 2%NewZealand 58% 0%SouthAfrica 79% 10%Spain 55% 14%UK 80.8% 7.2%USA 73% 8%


Corporate governance gone bad


Theneedforadialogueisheightenedbythespeedatwhichmarketsarebeingdisrupted,customerexpectationsarechangingandcorporateempiresarerisingandfalling.Ifthebusinessisinthedark,whatdostakeholdersthinkorarerelyingon?Inrecenttimes,severalinstancesofdownrightfailureofcorporategovernancehavegrabbedtheheadlines.Letustakealookatsomeofthemoreprominentcasesthathavebeeninthespotlight:

Entity and facts Impact on investors’ confidence

A large airline – Exposé of fraudulent transactionsCentralBureauofInvestigation(CBI)investigatedallegedviolationofnormsinobtaininginternationalflyinglicencesbythegroupCEO.Theyallegedlylobbiedforfasterclearances,andtheremovalandrelaxationofruleswithgovernmentservants.

Thesharesslumpedasmuchas6.3%(lowestinsixmonths)aftertheCBIprobe.

A leading integrated healthcare delivery service provider – A rather dramatic unfoldFour directors on the board appealed to the shareholders to not vote themout.Threeofthemresignedbeforethemeetingwherethematterwastobevotedupon,andthefourthwasvotedofftheboard.Atthe core of the controversy was the preference of bids made by the directorsregardingthesaleofthemedicalchain.

Thestockshitamulti-yearlowinintradaytradeaftertheresignationofthepromoters.Thecompany’smarketvaluemorethanhalved.

An Indian multinational bank – A systematic failure of vigilance AnINR11,000crorescandalwentuncheckedforyears,raisingquestionsonhowpublicbanksundertaketheirroles.Thefactthatemployeescolludedagainsttheinterestsofthebankandmanagedtostayundertheradarpointstoalackofchecksandbalances.Fundsweredivertedwithoutbeingred-flaggedbyinvestigativeagencies/thetaxdepartment.

Sharescrashed10%intraday,erodingclosetoINR4,000croreinvestormoney.Equity-orientedmutualfundswereseverelyhit.

A German automaker – Emissions scandalThecompanyriggeditsautomobilestopassqualitytests,causingdamagetohumanhealthandtheenvironment.Duetothisroughly$25billionscandal,thecompany’ssalesandstockplummetedtounprecedentedlows.

Stockpricedippedby28.6%overfivetradingdays.Largeshareholderssoughtcompensationfortheplunge.

An American multinational financial services company – Fraudulent transactions by employees on behalf of clientsThemisstepsbecamepublicinSeptember2016where5,300employeeswerefiredandthebankwaspenalised$185million.Evenbeforetheimpactofthishadbeenfullyrealised,newallegationsregardingfraudsinautoinsurancesurfacedinJune2017.Alongsideapenalty,theFederalReservedisallowedtheentitytogrowitsassetsuntilthebankmadesomechangesinitswayoffunctioning.

Thestockssanktoatwo-andahalfyearlow.Thescandalcausedreputationalandfinancialharm

Such scandals will not occur if there is complete transparency within companies. It is therefore important to evaluate integrated reporting as a safeguard against corporate governance failures.


There is a need to change the negative perceptions around decisions to ‘explain’ratherto‘complywith’certainregulatoryprovisions.

Thefollowingarethebasiccorporategovernanceguidelineswhichoverseeriskmanagement:

Reporting: Thereportsfrommanagementtotheboardshould,inrelationtotheareascoveredbythem,provideabalancedassessmentofthesignificantrisksandtheeffectivenessofthesystemofinternalcontrolinmanagingthoserisks.Anysignificantcontrolfailingsorweaknessesidentifiedshouldbediscussedinthereports,includingtheimpactthattheyhavehad,ormayhave,onthecompanyandtheactionsbeingtakentorectifythem.

Roles and responsibilities: All employees have some responsibility for internal control as part of theiraccountabilityforachievingobjectives.They,collectively,shouldhavethenecessaryknowledge,skills,informationandauthoritytoestablish,operateandmonitorthesystemofinternalcontrol.

Implications and value

Changes have been brought about in the principles of governance to prevent defalcations and create balancestoadheretothenotifiedregulations.Inadditiontotheex-postmeasures,thereisaneedtoinstitutionalisemoreefficientex-antechecksto detect the wrong being commmitted and even more to ensure mechanisms are in place to prevent suchwrongsfrombeingcommitted,asisthemanifestationsoftherecentenactmentsinstatutes.

Now,thespotlightisonanopaquebusinessculturedominatedbypowerfulfamilies,knownas‘promoters’,andtheabsenceofcontrolstoreinthemin.Theentrenchedpowerofmanybusinessfamiliescombineswithaweaklegalsystemandoffersfewprotectionstowhistle-blowers.Thishasled to a culture where no one wants to oppose a promoter.Thus,failuresofcorporategovernancehurt investor confidence and can impact the

shareholders’value.Goodgovernancehasseveralelements,andpositivelyinfluencesinvestorsinseveralways.Needlesstosay,theinvestorsentimentshouldbeapriorityforanycompany.

A good system of corporate governance has to include several elements of smart business practice:

• A fundamental focus on ethics• Clear alignment between corporate goals and

governance• Appropriate management strategy• The right organisational structure• EffectiveriskreportingTherightgovernancestructurereassuresregulators,employeesandinvestorsinmorethanoneway.Anorganisation can realise the benefits by structuring itsriskmanagementpracticeswell.


A changed paradigm


Constitution of audit committee in accordance with the board rules

New requirementInsteadoflistedcompanies,listedpubliccompanies should be required to constitute anauditcommittee.

Selection of IDs having no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters or directors, during the two immediately preceding financial years or during the current financial year

New requirementWiththe2017AmendmentAct,remunerationasdirectorortransactionnotexceeding10%ofaperson’stotalincome or such amount as may be prescribed will not impairindependence.

Disclosure of expertise of directors

New requirementAll listed companies will now be required to disclose in their annual report a matrix setting out the competenciesthatthey‘believe’theirdirectorsshouldpossessandtheskillsetthateachdirector‘actually’possessesandadditionally,fromMarch2020,disclosetheirnamesinthematrix.

More elaborateEnsureconstitutionofawholesomeboard

Board composition

New requirementMinimum6directorsonaboard

More elaborateWhilehavingmoredirectorswillenabletheboard to discharge its duties in a robust manner,boardswithevendirectorshipsmayfacefrequentdeadlocksituations.

1

6

5

2

Kotak Committee recommendations

Companies (Amended) Act

2017

Companies (Amended) Act

2017



Effect on Related Party Transactions (RPTs)

New requirementEnhanceddisclosureofRPTsandrelatedpartiestobepermittedtovoteagainstRPTs

More elaborateRelated parties will now be allowed to cast a negative vote on RPTsrequiringshareholders’approvalassuchavotecannotamount to a conflict of interest

7




SEBI accepts the key recommendations of the Kotak Committee

New requirementThe maximum number of listed entity directorships held by a single individual will be reduced from10to8by01April2019andto7by01April2020.Further,anypersonwhoisaManagingDirector(MD)orawhole-timedirectorinalistedentitycannolongerserveasanindependentdirectorinmorethan3listedentities.

More elaborateWitheffectfrom01April2020,thetop500listedcompaniescannolongerhavethesameindividualasthechairpersonaswellastheMD/ChiefExecutiveOfficer(CEO).

Thereisastipulationthatonlyanon-executivedirectorwouldbeappointedasachairperson.

Revised eligibility criteria; exclusion of board inter-locks

New requirementPersonswhoconstitutethe‘promotergroup’ofalistedcompanycannotbeappointedasindependentdirectors.

More elaborateUntilnow,itwascommonpracticeforpromoterstobeindependent directors in each other’s companies or to appoint relativesasindependentdirectors.Thisamendmenthaswidenedthenetofexclusionssoastoimplementasystemof‘trueindependence’.

3

4


Summary of changes in Companies (Amended) Act 2017

The2017AmendmentActhasincludedrelaxations,whichwereearlieravailableinrules,aspartoftheactitself.Thiswilladdressconcernsaroundtherulesoverridingthe2013Act.

Particulars Then Now Observation

Restrictions on power of the boardSec180

Subsection(1)clause(c)ofthe2013Act requires that if money proposed to be borrowed and money already borrowed by the company exceeds theaggregateofitspaid-upsharecapitalandfreereserves,aspecialresolutionisrequired.Thesecuritiespremium amount is not included in thiscomputation.

The2017AmendmentActamendssection180(1)(c)sothatitincludessecuritiespremiumalongwithpaid-upshare capital and free reserves for the calculation of maximum limits on the borrowingpowersoftheboard.

Maximum limits on the borrowing powersoftheboardareenhanced.

CSRSec135

The2013ActrequiresthateverycompanywithanetworthofINR500croreormore,turnoverofINR1,000croreormoreornetprofitofINR5croreormoreduringanyfinancialyearwillconstituteaCSRcommittee.

Suchcompaniesshouldspend,ineveryfinancialyear,atleast2%oftheiraveragenetprofitsmadeduringthe three immediately preceding financialyearsinpursuanceofitsCSRpolicy.

Further,thesaidcommitteewillconsistofthreeormoredirectors,outof which at least one director should beanID.

The2017AmendmentActreplacesthewords‘duringanyfinancialyear’withthewords‘duringtheimmediatelyprecedingfinancialyear’.Further,whereacompanyisnotrequiredtoappointanIDundersection149(4),itwillconstituteaCSRcommitteewithtwoormoredirectors.

The2017AmendmentActaddressesvarious practical issues that were arisingintheapplicationofCSR-relatedrequirements.Further,theCentralGovernmentmay prescribe sums which will not be includedforcalculatingnetprofitofacompanyundersection135.

LoanstodirectorsSection185

Thesectionofthe2013Actprovidesthatacompanycannotprovideloan,guarantee or security to any of its directors or to any other person in whomthedirectorhasaninterest.

The2017AmendmentActreplacesthecurrent requirement of the section withacompletelynewsection185.

This is a welcome step to address severalpracticalaspectsinthisregard.

IDsSec149

Inthe2013Act,evenminorpecuniaryrelationships may render a person ineligibleforappointmentasanID.

The materiality concept has been introduced for determining whether pecuniary relationships impact independence.

The changes will ease the burden of ensuring independence for companies aswellastheirIDs.

Auditcommitteepre-approvalofRPTSec177

Undersection177ofthe2013Act,the audit committee is required to pre-approveallRPTsandsubsequentmodificationsthereto.Incontrast,section188requirestheboardand/orshareholderstopre-approveonlyspecificRPTs.

IftransactionsofRPTsbetweenaholding company and its wholly owned subsidiaries require board approvalundersection188,thentheywill also require approval of the audit committee.

The2017Actclarifiesthatiftheaudit committee does not approve transactions not covered under section 188,itwillmakeitsrecommendationstotheboard.


Particulars Then Now Observation

ICFRSec134

The director’s responsibility statement should,amongothermatters,statethat the directors of a listed company hadlaiddowntheinternalfinancialcontrols to be followed by the company and that such controls were adequateandoperatingeffectively.

Nochange There is no requirement to exempt IDsincertifyingthatthedirectorshavelaiddowntheinternalfinancialcontrols to be followed by the company.

Appointment of auditorsSec139

Auditor appointed by the shareholdersattheAGMforaconsecutiveperiodoffiveyearsneedtoberatifiedeachyearattheAGM.

There will be no requirement for annualratificationofauditor’sappointmentattheAGM.

The change is supportive of the auditor’sindependence.

Disqualificationfor appointment of directorSec164

Directorsmaybedisqualifiedfromre-appointmentinthecompanyorappointment in any other company foraperiodoffiveyearsfromthedateofdisqualificationongroundsmentionedinthesection.

The2017AmendmentActclarifiesthatifapersonincursdisqualificationundersection164(2),theofficeofthe director will become vacant in all the companies except the company which is in default under section 164(2).

Whenapersonisappointedasadirector of a company which has already defaulted under one or both of theaboveclauses,thensuchdirectorwillnotincurdisqualificationforaperiod of six months from the date of appointment.

PenaltyonauditorsSec147

The2013Acthasnotdefinedtheterm‘anyotherperson.’Thus,itwasnotedthattheterm‘anyotherperson’insub-section(3)mayresultinanunintended inclusion of a number of parties

The2017AmendmentActhasdeletedthewords‘anyotherperson’insection147(3)(ii).Inplaceofthesewords,thewords‘membersorcreditors of the company’ have been insertedinsub-section(3)

Incaseofanywilfulcontraventionby the auditor with an intention to deceive the company/shareholders/creditors/taxauthorities,thepenaltyissignificantlyenhanced.

Auditor reportingSec143

Companies(Auditor’sReport)Order,2015requiresthatanauditorshouldreport on whether managerial remuneration has been paid or provided in accordance with the requisite approvals mandated by the provisionsofsection197readwithScheduleVtotheCompaniesAct.

The2017AmendmentActrequiresthat the auditor of a company will makeastatementastowhethertheremuneration paid by the company to its directors is in accordance with the provisionsofsection197.

Itmightleadtoduplicationofreporting.


Extent of agreement towards risk management (Global overview)

Do shareholders seem to have a strong focus on corporate governance?

For those that do manage their risk, to what extent do you agree or disagree with the following statements (global response)?

3.8

4.9

14.9

10.5

11.5

8.0

12.4

12.4

16.5

18.1

13.4

13.9

51.6

54.1

48.0

48.8

51.3

54.3

30.7

26.7

18.1

16.4

22.2

22.1

We have assessed the risks affecting our business

We align our risk management culture to our business strategy

All employees are trained to monitor and mitigate risk

Our supply chain is aware of and adheres to our risk management culture

We have fully embedded risk management policies and procedures into our business

We have the risk management processes and infrastructure in place to react quickly to an unforeseen event

0.8

0.8

0.8

2.2

2.0

1.1

Strongly agree

Agree Neither agree or disagree

Disagree Strongly disagree

Changes to a company’s corporate governance code are usually due to changes in legislation or the referencecorporategovernanceframework.Suchchanges can also result from requests from the boardandshareholders.

The topics of discussion with investors on corporate governance seem to centre around remuneration andthenominationofdirectors,withissuesbeingraisedatvariouspointsatadhocmeetings.Itcouldbearguedthatifcorporategovernancelinkstosustainablebusinessperformance,itwouldbelikelyto improve investors’ confidence as investors would takeagreaterinterestinabroaderrangeofissuesincludingpurpose,corporateculture,strategy,riskmanagementandsuccession-planning.

Itisinterestingtonotethateffectivecorporategovernance is directly related to factors such as theskills,personalitiesandexperienceoftheboardmembers.Thesefactorsare,inturn,influencedbyboardroomculture.

Many major governance failures turn out to be linkedtotheexistenceofadominantindividualwhosebehaviourwentunchecked,leadingtopoorcorporate governance and erosion in reputations andshareholdervalue.Forthisreason,astrongerlinkbetweenethicsandgovernanceisessentialtohelpthecompany’sstakeholderstobehave,intheirdecisionsandactions,inawaywhichisacceptable,reasonable and in conformity with the given values ofreference.

Source:GrantThorntonIBR


How to boost investors’ confidence?


TCWGaretheperson(s)ororganisation(s)withresponsibilityforoverseeing the strategic direction of the entity and obligations related totheaccountabilityoftheentity.Forsomeentities,managementincludessomeorallofTCWG.Insomecases,someorallofthosechargedwithgovernanceareinvolvedinmanagingtheentity.Inothers,TCWGandmanagementcomprisedifferentpersons.Whileinsomecases,TCWGareresponsibleforapprovingtheentity’sfinancialstatements,inothercasesthemanagementhasthisresponsibility.

There is a need for the auditor to determine the appropriateperson(s)withintheentity’sgovernancestructurewithwhomtocommunicate.TCWGmayassist the auditor in understanding the entity and its environment,inidentifyingappropriatesourcesofauditevidence,andinprovidinginformationaboutspecifictransactionsorevents.However,theauditorshall nonetheless be satisfied that communication withperson(s)withmanagementresponsibilitiesadequately informs all of those with whom the auditor would otherwise communicate in their governancecapacity.

Standards on Auditing (SA) 260 recognises the importanceofeffectivetwo-waycommunicationinanauditoffinancialstatements,providesanoverarchingframeworkfortheauditor’scommunicationwithTCWG,andidentifiessomespecificmatterstobecommunicatedwiththem.Further,SA265establishesspecificrequirementsregarding the communication of significant deficiencies in internal control the auditor has identifiedduringtheaudittoTCWG.

TCWGareresponsibletooverseethefinancialreportingprocess,therebyreducingtherisksofmaterialmisstatementofthefinancialstatements.Thus,theobjectivesoftheauditoraretoprovideTCWGwithtimelyobservationsarisingfromthe

audit that are significant and relevant to their responsibility to oversee the financial reporting processandtopromoteeffectivetwo-waycommunicationbetweenthem.

Of importance to note as an auditor here in this context is that when deciding whether there is alsoaneedtocommunicateinformation,infullorinsummaryform,withthegoverningbody,the auditor may be influenced by the auditor’s assessment of how effectively and appropriately the subgroup communicates relevant information with thegoverningbody.Theauditormaymakeexplicitinagreeingthetermsofengagementthat,unlessprohibitedbylaworregulation,theauditorretainsthe right to communicate directly with the governing body.

Those Charged With Governance (TCWG)


Inclusion of Key Audit Matters (matters of significance)

KeyAuditMatters(KAMs),asdefinedbyauditingstandardSA701,arethosemattersthat,intheauditor’sprofessionaljudgement,wereofmostsignificance in the audit of the financial report of the currentperiod.KAMsshouldbeidentifiedfromthematterscommunicatedwithTCWG.Thesematterscould,interalia,includetheauditor’sresponsibilitiesin relation to the financial statements audit and significantfindingsfromtheaudit.

FromthematterscommunicatedtoTCWG,mattersthat require significant auditor attention are identified which primarily relate to matters that pose challenges to the auditor in forming an opinion or obtaining evidence that in his/her judgement was sufficientandappropriateunderthecircumstances.

Risk identified

Has the risk been raised with the management and TCWG

YES YES

NO NO NO

NO

YES

YES

Does the matter require significant auditor action?

Is this a KAM?

No further action Explain why not Explain why not

Explain why not

No further action

No further action

Explain why

Do we want to include the KAM in the opinion of the independent auditor’s report?

How have we addressed the KAM in the independent auditor’s report?


New accounting standards are likely to bring more trust among Indian investorsTheIndianAccountingStandards(IndAS)areharmonisedwithInternationalFinancialReportingStandards(IFRS)tomakereportingbyIndiancompaniesmoregloballyaccessible.WithIndiancompanieshavingafarwiderglobalreach,the reporting standards were converged with internationalstandards,resultinginIndAS.Aphase-wise convergence is laid down by the Ministry of CorporateAffairs(MCA).TheprescribedlistedcompaniesinIndiahavestartedreportingunderthenewIndASfromfinancialyear2016-17.

IndASarecloserdomesticequivalentofIFRSandareconsideredbetterthanGAAPintermsof disclosures and accounting issues coverage suchasderivatives,embeddedderivatives,hedgeaccounting,businesscombinationandcontrolparameters.

WhileIndiaisconvergingwithIFRSandnotadoptingIFRS,severalcarve-outshavebeencreatedfromIFRStorepresentthefinancialsofthecompaniesinthemostaptmanner.ThefactthatfinancialstatementsunderIndASareclosertoIFRSthan previous accounting standards will give foreign investorsadditionalconfidence.However,thisconfidencewillbelimitedbythenumberofcarve-outsfrom,andamendmentsto,IFRS.

The new accounting standards are based on theprinciplesof(a)substanceoverform,(b)fairvaluationand(c)increaseddisclosuresinfinancialstatements.However,theyprovidealotofdiscretionontheformofthemanagement’sestimates.

Formostcompanies,adoptingIndASisbetteraccounting.Itwillleadtoincreasedtransparency,better investor relations across the world and reducedcosts,especiallyformultinationalcompanies,asaresultofoneaccountinglanguage.The quality of reporting will be much more superior forIndiancompaniesandtherewillbeinternationalcomparability.TheIndianstockmarketsalreadyhave a high percentage of foreign owners; that might further increase and the ratios may get better.ReportingunderIndASorIFRSwillelevatethe overall confidence in the quality of financial reporting,andtheriskpremiumotherwisegettingattached or even the discount getting attached to thereportedearningsofthecompanieswillgooff,resultinginlowercostofcapital.

Thus,theregulatorsandallstakeholdersneedtoput together a robust system to monitor the quality of financial reporting and at the same time come out with new standards to align with the ongoing accountingchange.

Ind AS are based on the principles of a substance over form b fair valuation c increased disclosures

India’s transition to Ind AS


Even though there may not be immediate implications of identification of SBOs, the jurisprudence at some stage is expected to hold the SBOs responsible for the deeds of companies.

The regulations require the corporate veil to be pierced to identify natural persons owning companies in order to close the loop on combating money laundering and terror financing to induce investors’ confidence.TheMCAvideitsNotificationdated13June2018has enforced the provisions of amended section 90oftheCompaniesAct,2013andalsoissuedtheCompanies(BeneficialInterestandSignificantBeneficialInterest)Rules,2018.Section90hasbeen enforced to identify such individuals who directly or indirectly hold beneficial interest in the company and whose names do not reflect in the registerofmembersasholderofsuchshares.Thereis a need to ensure compliance under the provided sectioninalogicalway.ItisacollaborativeexercisebetweenthecompanyandtheSignificantBeneficialOwner(SBO).

OncetheSBOsareidentified,thecompanyisonly required to maintain a record of it and file itwiththeregistrar.Wherenonaturalpersonisidentified in case of shareholders being other than naturalpersons,theseniormanagingofficialofthecompanywillberegardedastheSBO.Theintent is to have the natural person identified who may be held responsible or accountable in case of suspicious and mala fide activities of the company alongwiththeofficersofthecompany.

Asamatteroffact,SBOasaconceptisimplemented for the avoidance of misuse of ‘corporatevehicles’,likecompanies,trusts,foundations,partnershipsandothertypesoflegalpersonsandarrangements,whichplayavitalroleineconomyroundtheglobe.Thesecorporatevehicles,insomewaysortheother,aremisusedforunlawfulpurposessuchastaxevasion,moneylaundering,corruption,insiderdealingandotherillegal/benamitransactions.

Thus,section90hasbeenframedmorefromaPreventionofMoneyLaundering(PML)perspective.ItishighlylikelythatthenaturalpersondeclaringasSBOcontinuestobeabenamidar.Therealand

legitimate owner may not step forward considering theconsequenceundertheProhibitionofBenamiPropertyTransactionsAct,1988.Asamatterofcompliancewithsection90,eitherthebenamidaror in his absence the senior managing official of the companywillberegardedastheSBO.

Moreover,SBOexercisingsignificantinfluence(asdefinedinIndAS28)overthecompanywillbe a related party for the purpose of Accounting Standards.AndtheentityoverwhichtheSBOhassignificant influence shall also be regarded as a relatedpartyforthereportingentity.

Overall,themeasureensuresthattheonewhohas control or significant influence cannot plead unawareness.Consideringthepracticaldifficulty,itmay be clarified that each of the upstream/investor companies shall also ensure that disclosure is given bythenaturalpersontotheapplicableentities.However,itwillbedifficultfortheSBOtodeclarereasons for not registering shares in their name or directandindirectpercentageofvotingrights.

Themandateoftherulesistolookthroughtheentire maze of intermediate entities and identify theultimateindividualownersofacompany.TheramificationsofthesedisclosuresforIndiaIncissignificant and the potency of these regulations cannotbeundermined.

The new significant beneficial ownership rules


Balanceofpower-sharingamongstshareholders,directorsandmanagement is paramount to enhance the value of the shareholders andprotecttheirinterests.Thisistheprimarygoalofcorporategovernance.Thereisaneedofacorporatestrategythatisfinancially,legallyandethicallysound.Beyondthat,investorsliketoseeresponsibleandsustainablestrategiesforattractinginvestors,aboardthathastheappropriatebackgroundformanaginginvestments,andexecutives who clearly understand the fundamentals of corporate governance.

Four key gatekeepers

Theroleofacorporategovernancegatekeeperisto align the management’s interests with those of long-termshareholdersandtoprotectinvestorsfrom misleading financial information published in publicfilings.Misleadingfinancialinformationcouldleadtofailureofthesecorporations.Thefourkeygatekeepersofcorporategovernanceare:1 Independentandcompetentboardofdirectors2 Independentandcompetentexternalauditor3 Objective and competent legal counsel4 Objective and competent financial advisors and

investmentbankers

Members of an organisation must encourage all to complywiththeapplicablepoliciesandprocedures.The values and norms encompassed in the organisation’s corporate culture must be consistent withitsstandardoperatingprocedures.Thiswouldbuildinvestors’confidenceinthesecorporations.Consideringcomplianceasatickinthechecklist’isnotgoingtosufficeanypurposeforthatmatter.

Management and board of directors

Regulators

Investors and analysts

Auditors

• Increasedcommunicationbetween auditors and TCWG

• Increasedattentiontodisclosures in the financial statements

• Greatertransparency• Better and clear information

regarding significant areas

• Meaningful information leading to better data for decision-making

• Tailor-madeandrelevantinformation as against templatised reporting

• Renewed focus on matters to be reported

• Increasedprofessionalscepticism

• Nochangeinunderlyingauditprocedures

Role of corporate governance gatekeepers


Our view


Corporategovernanceisnotatrend;itisheretostay.Successivefinancial crises have heightened political interest to intervene and mandate responses to public concerns considering both corporate governanceandfinancialreportingtobeanessentialbuildingblockforfinancialintermediation,foreigninvestmentandsustainableeconomicdevelopment.

Indianboardsareevolvinginaway,andthisisalearningcurve.TheintroductionofTCWGwithKAM,theICAIguidancenoteoninternalfinancialcontrolsframework,periodicamendmentsintheCompaniesAct,andconvergenceofIndASwithIFRSalongwiththe governance principles and recommendations of theKotakCommitteearethestartofmorefocusonmeasurement of satisfactory governance to repose investors’confidence.Despitethemanycasesofbadcorporategovernanceinrecenttimes,progressisunderway.

There is a need to go from one extreme to another havingaskedtoughquestionsfromtheboard;however,theaccountabilitywouldrestwiththemanagement.Ifgenuineentrepreneursandindependentdirectorskeeplookingovertheirshouldersallthetime,itwoulddiscouragegoodindependent directors from joining boards and will maketheIndianindustrylesscompetitiveglobally.Thus,thebestwaytogoabouttheappointmentofIDsisbygettingminorityshareholderstoelectoneor even all independent directors so as to protect theinterestsoftheshareholders,especiallyminorityshareholders.Amongotherthings,therehastobea structural shift in the power equation between majority and minority shareholders in areas related to corporate governance as investors may question the ability of directors to fulfil their fiduciary responsibilitieswhentheyserveonmanyboards.

Organisations have started to reflect the importance of shareholders’ input into governance practices highlightingthatproperregulatoryframeworkandenforcement mechanisms are crucial to promote goodcorporategovernancepractices.Foreveryinstance of someone getting away with misuse ofposition,theremustexistanexampleofstrictdisciplinaryaction.Therefore,instancesofaboardexercising its power to remove the top leadership shouldnotbeveryhardtofind.

Intheend,corporategovernanceisaboutwhatpeople in privileged or responsible positions actually doordonotdowithotherpeople’s(shareholders’andtaxpayers’)money.Overall,companiesworldwide recognise these changing trends and actonthem.Theyrecognisetheopportunitiesthatcomewithembracinggoodgovernance.Forone,thisallowsthemtoattractmoreinvestors.Butgood governance also enables companies to gain reputation,whichattractstalent,newcustomersandpublicrecognition.

Needlesstosay,thingshavetochangenow.


Sources

Bare acts

CompaniesAct,2013

Companies(Amendment)Act,2017

GrantThornton’sIBRSurvey

GrantThorntonreport:Engagementbeyondtheboardroom:Whatdoyourstakeholdersexpect?

www.accaglobal.com

www.economicsdiscussion.net

www.mca.gov.in

www.nfcg.in

www.livemint.com

www.sebi.gov.in


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