SEBI prepares guidelines for proxy advisers

Rabindra Jhunjhunwala, Khaitan & Co,Saranya Mishra, Proxy advisers

The concept of a “proxy adviser” is of Western import, and, despite its nascency, has slowly and steadily gained importance in the Indian market as a critical intermediary and a rather persuasive influencer of a company’s decision making and policies through the shareholders.

Proxy advisers mainly cater to institutional shareholders’ needs by providing them with independent and fact-based research input and insight to enable them to make informed decisions.

Accordingly, proxy advisers tend to gain a certain vantage owing to the trust placed in them by institutional shareholders, which in turn, by virtue of the exercise of the voting power by such shareholders, has ramifications on the governance and corporate decision making of the company, impacting shareholder value, the markets and the economy as a whole.

To regulate proxy advisers, given their unique position in the market structure, the Securities and Exchange Board of India (SEBI) had rolled out the SEBI (Research Analysts) Regulations, 2014 (RA regulations), which require mandatory registration of the proxy adviser as a research analyst with the SEBI.

The regulations provide an elementary regulatory framework in terms of management of conflict of interest and disclosure requirements, and an eight-point code of conduct. Such regulation was, and continues to be, a rarity from a global perspective, since in most countries proxy advisers are not regulated.

Recently, the SEBI issued two circulars, one dated 3 August 2020 providing “procedural guidelines for proxy advisers”, and the other dated 4 August 2020 providing “grievance resolution between listed entities and proxy advisers” (collectively the SEBI circulars), which are the first of their kind for the Indian market to have stipulated categorical disclosure requirements for proxy advisers.

The SEBI circulars reflect some of the key recommendations in respect of conflict of interest, voting, fiduciary duty, and information sharing and grievance redressal system, which were suggested by the SEBI Working Group on Proxy Advisers in its Report on Issues Concerning Proxy Advisers, dated 24 May 2019.

While the SEBI circulars seem to have codified the prevalent business practice of the major proxy advisory firms, as a necessary next step, proxy advisory firms shall be required to do the following for ensuring compliance with the SEBI circulars, which are effective from 1 January 2021.

Formulate and adopt

  • Voting recommendation policy, which includes circumstances of when such recommendation shall not be provided (to be reviewed annually);
  • Communication policy, which is the stated process to communicate with clients and company, and timeline to receive comments from the company;
  • Sharing policy, to ensure sharing of the report with clients and company at the same time; and
  • Conflict of interest policy, to provide for procedures to disclose, manage/mitigate any potential conflict of interest, including from conflict arising from other business activities undertaken by the proxy adviser.

Disclosure requirements

  • Disclosure of the voting recommendation policy to clients;
  • Publication of the sharing policy on the website;
  • Explicit mention of the following in the advisory documents, including recommendations issued to the client:
    • Methodologies and processes followed by the proxy adviser in the development of the research and corresponding recommendations in respect of a company;
    • The legal requirements or higher standard (which is beyond the basic legal requirement) applied for arriving at the recommendations, along with rationale for adoption of a higher standard, instead of application of the requirement by law; and
    • Statement on conflict of interest, specifically mentioning areas of potential conflict of interest and the mitigation plan instituted as a safeguard for ensuring there is no conflict
  • Material revisions or factual errors in the recommendations, already shared with the client, to be disclosed to the client within 24 hours of the receipt of information;
  • Ensure accuracy of information relied on for the recommendations made by the proxy adviser in respect of a given company by receiving comments/clarifications from the company and disclosing the same in an addendum to the report, as well as revising the recommendations initially made to clients.

The SEBI circulars prove to be a benchmark for the transparency, reliability and independence required from the proxy advisers in discharging their function, which in a sense is fiduciary.

This update was prepared by Rabindra Jhunjhunwala, a partner at Khaitan & Co, along with associate Saranya Mishra.