India Inc.’s Corporate Governance Agenda Starting 2019

The corporate governance road ahead for India Inc., their auditors and independent directors 

Mumbai Skyline (Photographer: Kuni Takahashi/Bloomberg)
Mumbai Skyline (Photographer: Kuni Takahashi/Bloomberg)

Starting April 2019, the criteria to determine independence of independent directors will get stricter, the job of auditors will become tougher, approval threshold for related party transactions will become higher and disclosures in financial statements will become more granular.

That’s thanks to SEBI’s recent amendments to its Listing Regulations that have been amended along the lines of the Kotak Committee recommendations. The committee was set up in in June last year to recommend changes to improve the corporate governance standards at listed companies.

Key Changes

Changes To The ID World

Currently, any person who is or was a promoter of the listed entity or its holding, subsidiary or associate company cannot be an independent director. Starting next year, the restriction will also extend to members of the promoter group of the listed entity.

Besides, as the Kotak Committee suggested, board interlocks won’t be permitted. As the committee put it, board interlocks arise due to common non-independent directors on boards of listed entities.

According to the amendment, independent director means:

“who is not a non-independent director of another company on the board of which any non-independent director of the listed entity is an independent director.”

The committee’s report explains this well. For instance, if Mr. A is an executive director on listed company ‘A’ and is also an independent director on company ‘B’, then no non-independent director of company ‘B’ can be an independent director on the board of company ‘A’.

Independent directors will also need to keep a closer watch over overseas material unlisted subsidiaries.

In their current form, the Listing Regulations mandate that at least one independent director on the listed entity’s board should be a director on board of an unlisted material subsidiary, incorporated in India. This will now apply to all material subsidiaries irrespective of where they are incorporated.

Financials To Get More Granular

To ensure, greater transparency at the group level, the Kotak Committee had suggested that listed companies must disclose consolidated financial statements on a quarterly basis. SEBI has accepted this recommendation.

“If you look at the BSE 100 companies, until last year, close to 50 percent of them declared only standalone results on a quarterly basis,” Sai Venkateshwaran, partner and head of Accounting Advisory Services at KPMG India told BloombergQuint. Companies will need to gear up their processes to report consolidated results on a quarterly basis, he said

In a lot of cases, there would be global subsidiaries. Their auditors will have to complete the limited review within definite timelines for the parent to make the submission. The whole ecosystem will need to step up. 
Sai Venkateshwaran, Partner & Head-Accounting Advisory Services, KPMG India

Also, every quarter financial information of the group, accounting for at least 80 percent of each of the consolidated revenue, assets and profits, respectively, must undergo audit or a limited review. There are situations where only the parent company’s financials have been subjected to a review and the information relating to several of the subsidiaries is based on management information, Venkateshwaran explained.

“This raises a question on the reliability of the consolidated information if large parts of if haven’t been subjected to a review. This will help minimise the likelihood of any misreporting,” he pointed out.

Additionally, companies will also need to submit – as part of their standalone and consolidated financial results – a statement of cash flows. Companies may be reporting profits but whether it is resulting in cash is not known until the annual disclosure is made, Venkateshwaran said. This amendment will give visibility on that front, he added.

Further, material adjustments made in the results of last quarter that pertain to previous quarters will also need to be disclosed.

Auditors’ Job To Get Tougher

SEBI has now introduced the concept of group audits. The statutory auditor of the listed companies will need to undertake a limited review of all the entities whose accounts are to be consolidated with that of the parent.

The parent company auditor will have to carry out certain processes on the subsidiaries irrespective of whether he’s their auditor or not. With this change, the parent company’s auditor may not be able to totally disclaim responsibility for the audits of subsidiaries. This is also moving towards international practices, where the group auditor takes full responsibility for the consolidated financial statements”.
Sai Venkateshwaran, Partner & Head- Accounting Advisory Services, KPMG India

The amendments also address the vexed issue of auditor qualifications.

The requirement to quantify auditor qualifications, currently, is not a mandatory one. It will become starting next year. The management will have to mandatorily quantify the qualification and the auditor will need to review it.

Related Party Transactions Approval

Currently, the Listed Regulations require companies to frame a policy on materiality of related party transactions. Next year onwards, clear threshold limits, approved by the board, will need to be laid down to determine which related party transactions will qualify as material. The policy and thresholds will need to be reviewed by the board once every three years.

Also, payments to a related party for brand use or royalty that exceed 2 percent of the annual consolidated turnover will qualify as material. Once qualified so, a material related party transaction will need shareholder approval. There’s an additional change here. So far, a related party could not vote on such a proposal. Now, related parties will be allowed to cast a negative vote.

Separation Of Board And Management

Starting April 2020, the top 500 listed companies by market capitalisation will have to keep the roles of chairperson and management separate. The chairperson will have to be a non-executive director and not be a relative of the managing director or the chief executive officer.

Here, SEBI has taken the recommendation of the committee a step further. The committee had suggested this role separation for companies with more than 40 percent of public shareholding. SEBI hasn’t incorporated any threshold for this amendment.