Insulation from Scandals

Recent corporate scandals, such as Enron and World.com have rocked the global financial markets and shaken the confidence of investors. The authorities and the regulators all over the World are burning midnight’s oil to prevent recurrence of such scandals. Fortunately, we in India are having peaceful sleep as we are to a large extent insulated from corporate scandals. No major scandal involving corporate governance has taken place in India so far. It did not contract any contagion effect of the overseas, in particular across the Atlantic, corporate governance scandals, even though the Indian economy is substantially integrated with the global order; a number of trans-national corporations are operating in India and quite a few large Indian firms are listed on various overseas stock exchanges, including New York Stock Exchange, National Association of Securities Dealers Automated Quotes and London Stock Exchange. This is largely due to the robust corporate governance standards put in place by the regulators to prevent corporate scandals. However these global, wellpublicized corporate debacles have provoked an engaging debate across the Indian jurisdiction on strengthening corporate governance standards further.

The securities market reflects and regulates corporate governance standards. Many jurisdictions use securities market as a tool to improve corporate governance. In India the securities market is undergoing a cleansing over the last decade or so and building resilience to corporate scandals?. With the objectives of improving market efficiency, enhancing transparency, preventing unfair trade practices and bringing the Indian market up to international standards, a package of reforms consisting of measures to liberalise, regulate and develop the securities market was introduced in the 1990s. The practice of allocation of resources among different competing entities as well as its terms by a central authority was discontinued. The issuers complying with the eligibility criteria now have freedom to issue the securities at market determined rates. The secondarymarket overcame the geographical barriers by moving to screen based trading, which made trading system accessible to every body anywhere in the Indian sub-continent. Trades enjoy counter-party guarantee. The trading cycle shortened to a day and trades are settled within 2 working days, while all deferral products are banned. Physical security certificates have almost disappeared. A variety of derivatives are available. In fact, some reforms such as straight through processing in securities, T+2 rolling settlement, clearing corporation being the central counterparty to all the trades on the exchanges, real time monitoring of brokers’ positions and margins, and automatic disabling of brokers’ terminals are singular to the Indian securities market. Indian disclosure and accounting standards are as modern, updated, potent and versatile as those of any other market. Today, the Indian securities market stands shoulder to shoulder with most developed markets in North America, Western Europe and Far East.

As the regulator for the securities market, the Securities and Exchange Board of India (SEBI) has been focussing on the following areas to improve corporate governance:

1. Ensuring timely disclosure of relevant information,

2. Providing an efficient and effective market system,

3. Demonstrating reliable and effective enforcement, and

4. Enabling the highest standards of governance.

Disclosure standards in the Indian Regulatory jurisdiction are at par with the best in the world - a feedback from several global organisations, both regulatory and market participants. Similar views have been expressed by various academicians and researchers. Research by Prof. Florencio Lopez-de-Silanes, the findings of which have been circulated as background paper for this forum, grants India 100% marks on disclosures.

A company is required to make specified disclosures at the time of issue and make continuous disclosures as long as its securities are listed on exchanges. The standards for these disclosures, including the content, medium and time of disclosure, have been specified in the Companies Act, Disclosure and Investor Protection Guidelines, Listing Agreement, Regulations relating to insider trading and takeovers etc. These disclosures are made through various documents such as prospectus, quarterly statements, annual reports etc. and are disseminated through media, web sites of the company and the exchanges, and through EDIFAR (Electronic Data Information Filing and Retrieval) System maintained by the regulator. These disclosures relate to Financial Performance, Shareholding Pattern, Trading by Insiders, Substantial Acquisitions, Related Party Disclosures, Audit Qualifications, Buyback Details, Corporate Governance, Actions taken against Company, Risk Management, Utilization of Issue Proceeds, Remuneration of Directors etc. All listed companies and organisations associated with securities markets including the intermediaries, asset management companies, Trustees of mutual funds, SROs, stock exchanges, clearing house / corporations, public financial institutions, professional firms such as auditors, accountancy firms, law firms, analysts, consultants, etc. assisting or advising listed companies are required to abide by the Code of Corporate Disclosure Practices specified in SEBI (Insider Trading) Regulations.

Indian securities market has a large infrastructure to meet the demands of a sub continental market. There are 23 stock exchanges, and about 10,000 brokers, 15,000 sub-brokers, 10,000 listed companies, 500 foreign institutional investors, 400 depository participants, 150 merchant bankers, 40 mutual funds offering over 450 schemes, and 20 million investors. Yes, there is only one regulator. Not only the numbers are gigantic, but also the systems and infrastructure are equally atlantean and sophisticated. All stock exchanges in India offer online, fully automated, nation wide, anonymous, order-driven screen based trading system. The clearing corporation performs full novation and settles the transactions on T +2 rolling settlement. (Never ever has the exposure to the networth of the clearing corporations in the last two years has been more than 5%). It has a comprehensive risk management system, including Value at Risk (VaR) based margining system, which is monitored on real time basis with built in mechanism of automatic disablement of terminals of the trading/clearing members. The depositories legislation ensures free transferability of securities with speed, accuracy and security. The securities are transferred electronically in demat form. Further, Indian accounting standards follow International Accounting Standards (principle based) and are by and large aligned. In addition to creating an efficient trading platform and clearing and settlement mechanism, our focus is substantially directed towards:

1. Provision of timely availability of high quality price sensitive information to the market participants to enable them to take informed decision and ensure efficient price discovery,

2. Maintenance of high quality of services and fair conduct for market participants. The regulations specify high standards to become market intermediaries and require them to abide by a code of conduct.

3. Ensuring that the market is fair, transparent and safe so that issuers and investors are at ease to carry out transactions.

The regulator aims to ensure that no misconduct goes unnoticed or unpunished. It keeps an eagle eye on the happenings in the market and identifies anything unusual or undesirable, which may adversely affect the efficacy of the market. Every market participant, irrespective of his size and influence in the market or in the polity, is held accountable for his misdeeds very expeditiously. The proactive and aggressive approach of the regulator in enforcement can be gauged from the fact that during the financial year 2002-2003, SEBI passed 561 orders, out of which over 350 were punitive

If Indian securities market is a model for others, it is natural that it leads in the area of corporate governance also. The Kumar Mangalam Birla Committee of the Indian jurisdiction outlined a code of good Corporate Governance, which compared very well with the recommendations of the Cadbury Committee and the OECD codes. The code was operationalised by inserting a new clause (Clause 49) to the Listing Agreement, and have been made applicable to all the listed companies in India in a phased manner. Following the implementation of the Birla Committee recommendations, substantial developments took place in corporate world and securities market which required revisit of the issue. The Narayan Murthy Committee has refined the corporate governance norms which are proposed to be implemented through modification in the listing agreement. Government also appointed a few committees. Based on their recommendations, Government is trying to provide statutory back up to corporate governance standards.

The initiatives for improvement in corporate governance are coming mainly from three sources namely,

• Market,

• Regulator and

• Legislature.

While the legislative initiative is directed towards bringing about amendments to the basic law – India’s Companies Act - to include certain fundamental provisions related to corporate governance, dynamic aspects of corporate governance such as disclosures, accounting standards, etc. are being pursued through the regulatory initiatives by bringing about amendments to the Listing Agreement. Such an approach is aimed at because a comparatively more complicated and protracted process is involved in the amendments to legislation in a truly democratic society like India’s. The most important initiative comes from market forces and mechanisms which encourage and insist on the management’s improving the quality of corporate governance. Indian market has formalised such forces in the form of a rating called ‘Corporate Governance and Value Creation Rating’, which is quite unique in the World and is sought after voluntarily by the companies. Let me discuss these three initiatives in the reverse order.