SEBI’s Stewardship Code for Institutional Investors

[Pammy Jaiswal is a Partner at Vinod Kothari and Company]

The activism of institutional investors was experienced for the very first time in Life Insurance Corporation v. Escorts Ltd., 1986 AIR 1370. While the Bombay High Court initially held that the role of the Life Insurance Corporation (LIC) is unconstitutional and mala fide, the Supreme Court allowed the LIC’s appeal and specifically stated that allegation of mala fides against the LIC was baseless. The Supreme Court stated that, being a shareholder, the LIC can exercise all shareholder rights including requisitioning an extra-ordinary general meeting, and that it is not wrong in its part to reject the issuance of equity linked debentures which can dilute its shareholding.           

Institutional investors include entities such as alternative investment funds (AIFs), mutual funds (MFs), pension funds, government treasury and insurance companies, to name a few. They invest large amount of funds in companies, and their investment is mostly financial in nature. While their individual investment is huge, the funds that they invest belong to a large pool of diversified investors with small, medium and large contributions. Since the institutional investors play an important role in protecting the interest of their diversified investors, they are expected to act as stewards for their clients. 

Globally too, institutional investors are required to follow appropriate stewardship codes. Bodies in countries such as the United Kingdom, Japan, Australia and United States, to name a few, have laid down principles under their respective codes, which tend to be similar in nature and intent.

In India too, a stewardship code for insurance companies (IRDAI Code) issued by the Insurance Regulatory and Development Authority of India (IRDAI) is already in place since 2017. Further, a stewardship code for pension funds (PFRDA Code) issued by the Pension Fund Regulatory and Development Authority (PFRDA) has been in existence since 2018. On very similar lines as that of the global practices and the Indian insurance and pension fund regulators, the Securities and Exchange Board of India (SEBI) has, pursuant to the approval of the sub-committee of the Financial Stability and Development Council (FSDC-SC), brought into being a circular detailing the Stewardship Code to be adopted by MFs and all categories of AIFs from the financial year commencing April 1, 2020. The only line of distinction between the global practice and that of the Indian legislation with respect to this code is that in other countries as mentioned above, the same is applied on a “comply or explain” or “apply and explain” principles, whereas the Indian regulators have made it mandatory to implement the respective codes.

This post provides an overview of the Code to be framed and adopted by institutional investors. Further, beside the other aforesaid reasons, the idea behind bringing up the Code for institutional investors may also have been guided by the growing equity share of the institutional investors in Indian capital markets. The data with respect to the increasing market share of MFs in Indian capital markets is also included.

Role of institutional investors in the corporate governance of companies

Institutional investors play a significant role in holding high standards of corporate governance. Further, the OECD Principles of Corporate Governance contain explicit provisions on the significant role of institutional investors with respect to good corporate governance. OECD states the following:

Institutional investors differ widely, including with respect to their ability and interest to engage in corporate governance. For some institutions, engagement in corporate governance is a natural part of their business model, while others may offer their clients a business model and investment strategy that does not include or motivate spending resources on active ownership engagement. Others may engage on a more selective basis, depending on the issue at stake (Isaksson and Çelik, 2013a). The Principles annotations note that if shareholder engagement is not part of the institutional investor’s business model and investment strategy, that mandatory requirements to engage, for example, through voting, may be ineffective and lead to a box-ticking approach.

Further, according to various research papers and legal articles (for example, an SSRN Paper) and various other sources, it is abundantly clear that institutional investors acting in fiduciary capacity are expected to disclose various aspects, some of which relate to managing conflict of interest, voting policies, and the like. Institutional investors view corporate governance differently than individual investors, since they have larger block holdings than individual investors. Hence, institutions play a more active role.

Principles under the Code

Principle 1 – Formulate policy to discharge its stewardship responsibilities

Institutions are to formulate a comprehensive policy on discharge of stewardship responsibilities and at the same time disclose it on its website. Such policy shall contain a framework for monitoring and engaging with the investee company on matters such as performance, strategy, risk structure, governance and capital structure, etc. A training policy for personnel involved on implementation of the principles is crucial and may form a part of the policy. Further, the policy is also required to be reviewed periodically and, in case any activity is outsourced, the policy should provide the mechanism to ensure compliance with stewardship responsibilities.

Principle 2 – Have a clear and detailed policy to manage ‘conflict of interest’

The institutional investors should identify areas where conflicts of interest may arise, and they should lay down a clear cut policy to identify and manage such conflicts. Institutional investors should always give preference to the interest of its clients or investors before the interest of investee company.  Also, they are to provide periodic updates of the same publicly. The said principle provides for certain actions for mitigating conflicts of interest as mentioned below:

  • Blanket ban on certain investments;
  • Setting up of a conflict of interest committee;
  • Clear segregation of voting function and client relations;
  • Abstain from decision making if any person has conflict of interest in any transaction; and
  • Maintenance of records and minutes of decision taken to address confliction.

Principle 3 – Monitor the business of the investee company

An institutional investor should monitor the investee companies according to their size, i.e., different level of monitoring for different investee companies, and it should also keep in mind the regulations related to insider trading while seeking information from investee company. Areas that may be monitored are as follows:

  • Company’s operational and financial performance;
  • Quality of the board and management of the company;
  • Corporate governance of the board and related part transactions;
  • Risk including Environmental, Social and Governance (ESG) risk;
  • Shareholders’ rights and their grievances.

Principle 4 – Have a clear policy on identifying intervention in the investee company as well as collaborate with other institutional investors for interest of its investors

Institutional investors are to frame a clear policy on identifying intervention areas in the investee company. Intervention areas may include poor financial performance of the company,   corporate governance related practices, remuneration strategy, ESG risks, leadership issues and litigation. Hence, institutional investors must have a clear policy to identify such intervention and they must meet or discuss with the board to solve such intervention. Further, the policy should also contain the provision for collaboration with other institutional investors for meeting or fulfilling the interest of ultimate investors.

Principle 5 – Clear policy on voting right and disclosure of same

It is necessary to have a clear policy on voting rights and to disclose same. Instead of blind faith in the investee company’s management, institutional investors should exercise their voting right after in-depth analysis. All the voting policies should be publicly disclosed.

Principle 6 – Periodically report on these stewardship activities

Institutional investors shall report regarding every principles to its client or investors about their stewardship responsibilities, and same shall be placed on their website.

Introduction of the Code guided by growing trend of MFs in Indian capital markets

As mentioned earlier, it is also most likely that the growing market share by the institutional investors may have been one of the reasons for introducing as well as mandating the implementation of this Code unlike the other countries where the same is voluntary.

According to a research paper published by AMFI, the mutual fund industry’s stellar growth has come on the back of a surge in equity-oriented funds, which saw their assets under management (AUM) log a whopping 38.6% compound annual growth rate (CAGR) between March 2014 and June 2019. The surge took the equity-oriented mutual funds’ share of industry assets to 45% as of June 2019, up sharply from 24% as of March 2014. Further, a factbook issued by CRISIL also refers to figures which makes it evident that the Indian capital markets have seen a huge leap in the share of MFs.


While the Code has been framed rightly to improve investor protection as well as good corporate governance, the question that remains is the way forward for AIFs and MFs to kick-start the implementation of SEBI’s circular. Considering that the applicability is from the financial year 2020-2021, AIFs and MFs have a lot to accomplish currently in terms of framing of the policy with a holistic approach of covering all the principles and be ready with the same before 1 April 2020.

Institutional investors have great potential to influence the investee company to set and maintain high standards of corporate governance. Going by the Escorts case discussed at the beginning, it is quite evident that institutional investors have the power of destabilizing the management by exercising their shareholder rights. Further, since they continue to owe a fiduciary obligation towards their investors, documenting and following this Code becomes all the more relevant.

Pammy Jaiswal

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