Remunerating in a lean year: Statutory amendments for minimum remuneration to independent directors now effective

Payal Agarwal | Executive (payal@vinodkothari.com)

 

Highlights

 

Introduction

Independent directors (IDs) are a crucial part of corporate governance structure; however, their remuneration is currently solely by way of sitting fees and a “profit-linked” commission[1]. Profit is something which is completely dependent on business models, a whole matrix of internal and external factors, and something like a Covid-crisis will evidently leave a whole lot of companies in India and elsewhere into the red. In these circumstances, how do companies remunerate independent directors, to reward them for the time they spend and the responsibilities they shoulder.

To resolve this difficulty, amendments were made vide the Companies (Amendment) Act, 2020.While most of the sections of the Amendment Act were made effective on 28th September 2020, the sections relating to remuneration of NEDs and IDs were not been made applicable since the same was required to be adequately supplemented by corresponding amendments in Schedule V of the Act as well. However, just before the Covid-ravished FY 2021 was to end, MCA has put into effect the amended sections 149(9) and Section 197(3) and simultaneously brought amendments in Schedule V of the Act.

Effects of the amendments

These amendments will enable companies to adequately remunerate their NEDs and IDs for their efforts. Contrary to the rigidity in the erstwhile provisions, which had a complete bar on payment of remuneration to NEDs and IDs in absence of profits, these amendments enable companies to pay minimum remuneration to NEDs and IDs even at times of losses/ inadequate profits. Note that there always was a provision for minimum remuneration in case of EDs.

Applicability

  • Private companies are not covered by the ceilings of managerial remuneration. Hence, private companies are completely outside the purview of the restriction.
  • Public companies, both listed and unlisted, will be covered by the amendment.
  • The amendment is of enabling nature. It does not mandate companies to remunerate their NEDs and IDs. So, companies may, if they so desire, remunerate their IDs and NEDs in the year of inadequate profits, or losses.
  • The amendment applies to all NEDs and IDs.
  • The amendment pertains to the “profit-linked” commission. That does not mean the commission as originally proposed had to be profit-linked. Even if the commission was a fixed amount, it will still be covered by the ceiling given in second proviso to sec. 197 (1). Hence, any commission is necessarily profit-linked.
  • The amendment is effective immediately. That means companies may make use of the amended provisions for FY 2020-21.
  • The amendment does not lead to an automatic variation in the remuneration policy or shareholders’ resolution. In essence, the amendments are of enabling nature: within the ambit of the amended provisions, companies may take corporate action to remunerate their NEDs and IDs. The actions have to be taken by the companies in question, which may include remuneration policy, appropriate shareholder resolutions, etc.

Amendments to Schedule V – maximum limits on remuneration of “other directors” specified

Part II of Schedule V of the Act deals with the remuneration of “managerial personnel”. In this connection, please note that “managerial personnel” refers to managing director, manager and whole-time director of the company. Now, with the present amendment to the Schedule, part II has become applicable on the “other directors” as well. The term “other directors” has been clarified in the amendment notification itself by way of an explanation which states,

For the purposes of Section I, II and III (relevant parts that have been amended) the term “or other director” shall mean a non-executive director or an independent director.”

Section II of Part II of the Schedule specifies maximum remuneration that can be paid to a director, be it a managerial personnel or otherwise. For directors other than the managerial personnel, the remuneration has been specified at an amount almost 1/5th of that permissible to the managerial personnel.

The result of bringing IDs within the scope of Schedule V is that whereas the IDs would have been receiving very low remuneration in comparison to their roles and responsibilities in an organisation due to inadequacy of profits, the IDs will have a chance of getting a fair remuneration.

Questions relevant to the amendments

Various questions arise out of the amendments, such as –

  1. Will the amendments require modification in existing remuneration policy?
  2. Can the NEDs and IDs be paid remuneration in excess of those specified in Schedule V?
  3. Whether a single approval can suffice for the remuneration of all NEDs and IDs or such resolutions will have to be approved separately for the individual directors?
  4. Whether NRC will be eligible to recommend remuneration payable to IDs?
  5. Whether a prior approval of shareholders will be required or whether post facto approval may be obtained?

Answers to these and other relevant questions revolving around the aforesaid amendments has been dealt with in our detailed FAQs and can be accessed here.

Conclusion

The role of non-executive and IDs is very crucial to a company. The professional expertise of NEDs in their specific fields brings requisite value to a company. Considering the role played by IDs in effectively balancing the conflicting interest of the company and its stakeholders and bringing independent judgement to the Board’s decisions, it would be unfair if they are not paid adequately for the efforts put by them in the effective conduct of business.

Further, in the present scenario, amidst the economic breakdown worldwide, many companies may not be able to earn the profits as expected, or might be facing losses as well. In such circumstances, the aforesaid amendments were a necessity.

However, the erstwhile provisions had no scope of payment of remuneration to them in case of loss. With the aforesaid amendments coming into force, the companies will be able to compensate their non-executive and IDs well, even in case of no/inadequate profits.

Our other articles on the related topics can be read here –

[1] http://vinodkothari.com/wp-content/uploads/2018/09/Defaulter-companies-to-seek-lenders-nod-to-pay-managerial-remuneration-1-1.pdf

[2] http://vinodkothari.com/wp-content/uploads/2018/10/Appointment-and-Remuneration-of-Managerial-Personnel.pdf

[3] http://vinodkothari.com/wp-content/uploads/2018/09/Managerial-Remuneration-five-decades-control-cedes.pdf

[4] http://vinodkothari.com/2020/03/remunerating-neds-ids-in-low-profit-yrs/

[5] http://vinodkothari.com/wp-content/uploads/2019/09/Manangerial-Remuneration_IMTB-_26.08.pdf

[1]  SEBI has recently in its consultation paper on review of regulatory framework applicable to IDs suggested that profit-linked commissions should be barred and shall be substituted by higher sitting fees or issue of stock options. Please refer to our article for broader understanding of the same.

Conflicting provisions on CSR applicability under CA, 2013 & CSR Rules

CSR Rules require further tailoring to fit

CS Ajay Kumar K V | Vinod Kothari and Company

Corporate Social Responsibility (‘CSR’) framework in India has always been adaptive to changing times and has witnessed quite an evolution. The basic idea behind the CSR provisions was to promote responsible and sustainable business philosophy at a broad level and to encourage companies to come up with innovative ideas and robust management systems to address social and environmental concerns of the local area and other needy areas in the country.

Despite the evolution and series of amendments, certain provisions in the Companies (Corporate Social Responsibility Policy) Rules, 2014 (‘CSR Rules’) continue to conflict with the requirements under section 135 of the Companies Act, 2013 (‘CA, 2013‘). This article discusses two of such conflicting provisions relating to CSR applicability.

As per Section 135 (1) of Companies Act, 2013, CSR provisions were originally applicable to companies meeting the thresholds of INR 500 crore net worth or INR 1000 crore turnover or INR 5 crore net profit during any financial year. The meaning of the term ‘any financial year’ was clarified by MCA to imply any of the three preceding financial years. This was amended vide the Companies (Amendment) Act, 2017 (‘CAA, 2017’) thereby shifting the applicability on companies meeting any of the aforesaid criteria during the immediately preceding financial year, on the basis of recommendation made by High-Level Committee on Corporate Social Responsibility (‘HLC-CSR’)1. Further, in terms of Section 384 (2) of CA, 2013 CSR provisions are applicable to foreign companies as well.

Conflicting provision under CSR Rules

  • On Applicability [Rule 3 (1)]

Rule 3 (1) of CSR Rules provides that a company including its holding or subsidiary, and a foreign company defined in Section 2 (42) of CA, 2013 fulfilling the criteria specified under Section 135 (1) of CA, 2013 are required to comply with CSR related provisions.

Section 135 (1) is absolutely clear on the applicability par. Therefore, the intent to include holding and subsidiary company of a company that meets the criteria is unclear. If the holding or subsidiary company independently meets the criteria specified under Section 135 (1), only then it will be required to comply with CSR related provisions.  The applicability cannot be linked with applicability of the Section 135 (1) to the holding or subsidiary company.

  • Cessation of Applicability [Rule 3 (2)]

In terms of Section 135 (1) read with Section 135 (5), companies meeting the aforesaid criteria during the immediately preceding financial year are required to constitute CSR Committee and spend in every financial year, at least 2% of the average net profits of the company made during the three immediately preceding financial years. Consequently, companies not meeting any of the aforesaid criteria during the immediately preceding financial year are not required to ensure CSR related compliances[1].

However, Rule 3 (2) continues to provide a time frame of 3 consecutive financial years as an eligibility to discontinue ensuring compliance under Section 135. The said provisions have become redundant after enforcement of CAA, 2017. Relevant extract of HLC-CSR is as under:

 “The Companies (Amendment) Act, 2017 has amended the eligibility criteria as being based on financial parameters of the ‘immediately preceding’ financial year instead of three immediately preceding financial years prevalent until then. Rule 3(2) of the Companies (CSR Policy) Rules, 2014 specifies that companies which cease to be eligible under Section 135(1) of the Act for three consecutive financial years shall not be required to comply with provisions of Section 135.

 In view of the 2017 amendment, Rule 3(2) is redundant. “

Power of Central Government to revise thresholds

The Report of the Company Law Committee in 2019[2] based on the experience gained from the industry recommended the revision of the net worth/ turnover/ net profit thresholds specified in Section 135(1) from time to time to suit the changing requirements of the economy. The extracts of the committee note were;

“The Committee noted the merit in ensuring that static financial thresholds do not come in the way of corporate-driven socio-economic development and environmental conservation. In order to keep such revision process timely, the Committee recommended insertion of suitable provisions in the Section 135(1), which would enable the Central Government to enhance such limits by way of rules.”

However, the provisions of the Companies Act, 2013 do not provide for enabling power to the Central Government to revise the statutory thresholds framed 8 years back.

Conclusion

Prior to enforcement of CAA, 2017, the applicability was required to be ascertained based on the net-worth, turnover and net profits during any of the three preceding financial years. Therefore, Rule 3(2) of CSR Rules also provided a similar timeline for determining inapplicability of the CSR related provisions.

However, pursuant to amendment in Section 135 (1) by way of CAA, 2017 the Company is required to ascertain applicability by referring to the net-worth, turnover and net profits during the immediately preceding financial year. Accordingly, the inapplicability provided in Rule 3 (2) also was required to be aligned with amended Section 135 (1). Despite the deletion recommended by HLC-CSR, the provisions reflect under CSR Rules. Accordingly, companies need not wait till deletion of Rule 3 (2) as the same is anyways redundant post enforcement of amendment made in Section 135 (1).

Further, Rule 3 (1) of CSR Rules does not provide any additional clarity on the applicability and should be suitably amended. Lastly, enabling power to review static thresholds may also be inserted in Section 135 (1) of CA, 2013.

 

[1] https://www.mca.gov.in/Ministry/pdf/CSRHLC_13092019.pdf

[2] https://www.mca.gov.in/Ministry/pdf/CLCReport_18112019.pdf

Our other material on CSR can be accessed through the below link:

MCA notifies abridged annual return for small companies after 4 years

Carries out corrective changes in MGT Rules

By CS Aisha Begum Ansari, Assistant Manager, Vinod Kothari & Company

aisha@vinodkothari.com

Introduction

Four years after proposing amendment in Section 92 (1) of Companies Act, 2013 (‘Act’), Ministry of Corporate Affairs (MCA) notified the amendment in Companies (Amendment) Act, 2017[1] with effect from March 5, 2021.

The aforesaid amendment provided for following under Section 92 (1) & (3):

  1. Empowering Central Government to prescribe an abridged form of annual return for One Person Company (OPC) and Small Companies[2];
  2. Deletion of requirement to furnish details of indebtedness in the annual return;
  3. Deletion of requirement to furnish details indicating names, addresses, countries of incorporation, registration and percentage of shareholding of Foreign Institutional Investors;
  4. Doing away with the requirement of annexing extract of annual return to the Board’s report and mandating companies to place a copy of annual return on their website and provide the link of the same in the Board’ report.

While the amendment in relation to point 4. above was already notified with effect from August 28, 2020; MCA notified amendment in Companies (Management and Administration) Rules, 2014[3] (‘MGT Rules’) giving companies the option to annex extract of annual return in case of inability to place a copy of annual return on the website. Section 92 (3) of the Act post amendment did not provide any specific power to prescribe rules, however, MCA had amended Rule 12 of MGT Rules.

Further, in 2016 while amending MGT rules[4] in relation to voting by electronic means, MCA inadvertently deleted the explanations provided in sub-2 of Rule 20 that defined terms viz, agency, cut-off date, remote e-voting etc.

Corrective amendments in MGT Rules

MCA, on 5th March, 2021[5] notified amendments in MGT Rules to carry out corrective changes and to insert format of abridged annual return subsequent to notification of amendment in Section 92 (1) of the Act.  The synopsis of the amendments are as mentioned below:

Insertion of abridged annual return in Form MGT-7A and revision of Form MGT-7

Rule 11(1) of MGT Rules have been substituted prescribing separate format of annual return for OPC and small companies which shall be filed in Form No. MGT-7A from the financial year 2020-21 onwards. Other companies to continue to file annual return in Form MGT-7.

MCA has also revised the format of Form MGT-7 for filing the annual return by companies other than OPC and small companies.

Form MGT-7 v/s Revised Form MGT-7

Sr. No. Para & Field No. Information required in revised Form MGT-7 which was not required under erstwhile Form MGT-7

 (For Companies other than OPC & Small Companies)

1. Para IV Field (i) (d) 1.       Bifurcation of shares held in demat and physical form.

2.       Requirement of mentioning ISIN of equity shares of the Company;

2. Para IV Field (iv) Following rows are deleted:

1. Secured Loans (including interest outstanding/accrued but not due for payment) excluding deposits;

2. Unsecured Loans (including interest outstanding/accrued but not due for payment) excluding deposits;

3. Deposit.

3. Certification part Following new certification are required to be confirmed, (seems relevant only for private companies).

1.       The company has not, since the date of the closure of the last financial year with reference to which the last return was submitted or in the case of a first return since the date of incorporation of the company, issued any invitation to the public to subscribe for any securities of the company.

2.       Where the annual return discloses the fact that the number of members, (except in case of one person company), of the company exceeds two hundred, the excess consists wholly of persons who under second proviso to clause (ii) of sub-section (68) of section 2 of the Act are not to be included in reckoning the number of two hundred.

 

Revised Form MGT-7 and Form MGT-7A

Sr. No Para & Field No. Information required to be provided in Form MGT-7A which was not required under Form MGT-7

(For OPC & Small Companies)

1.         Para I Field vi Whether Form is filed for OPC or Small Co. [New Insertion]

 

2.         Para III Particulars of associate companies including joint ventures. (not applicable for OPC) [Substituted by deleting holding and subsidiary Companies]
3.         Para IV (ii) Details of shares/Debentures Transfer since closure date of last financial year (or in the case of the first return at any time since the incorporation of the Company) (not applicable for OPC-Newly Inserted)
4.         Para IV (iv) Securities (other than  shares and debentures) (not applicable to OPC-Newly Inserted)
5.         Para VIII Field A Members/Class/Requisitioned/CLB/NCLT/Court Convened Meetings (not applicable to OPC-Newly Inserted)
6.         Para VIII Field B Board Meetings (not applicable for OPC-Newly Inserted)
7.         Para VIII Field C Attendance of Directors (not applicable for OPC-Newly Inserted)
8.         New attachment List of Directors [Newly Inserted]
9.         Certification part Following new certification are required to be confirmed.

1.       The company has not, since the date of the closure of the last financial year with reference to which the last return was submitted or in the case of a first return since the date of incorporation of the company, issued any invitation to the public to subscribe for any securities of the company.

2.       Where the annual return discloses the fact that the number of members, (except in case of one person company), of the company exceeds two hundred, the excess consists wholly of persons who under second proviso to clause (ii) of sub-section (68) of section 2 of the Act are not to be included in reckoning the number of two hundred (seems relevant only for small companies).

10.      Information not required to be provided in Form MGT-7A which was required in Form MGT-7 1.       Whether shares listed on recognized Stock Exchange(s);

2.       CIN of the Registrar and Transfer Agent;

3.       Details of stock split/consolidation during the year (for each class of shares);

4.       Secured Loans (including interest outstanding/accrued but not due for payment) excluding deposits;

5.       Unsecured Loans (including interest outstanding/accrued but not due for payment) excluding deposits;

6.       Deposit;

7.       Details of directors and key managerial personnel;

8.       Committee Meetings;

9.       Number of CEO, CFO and Company secretary whose remuneration details to be entered

 

Deletion of extract of annual return

Realizing that amended Section 92(3) of the Act did not provide any prescriptive power to MCA, Rule 12 has been substituted to provide that Annual Return is required to be filed with the Registrar upon payment of specified fees.  While, the requirement to file Annual Return with the Registrar along with timelines has been provided in Section 92 (4), Rule 12 still provides a generic statement.

So, the positions stands clarified that companies will be required to upload the annual return on the website, if any, and provide the link thereof in the Board’s report.

Explanations relating to e-voting restored

Rule 20 of MGT Rules deals with voting through electronic means wherein it mandates the companies whose equity shares are listed on recognized stock exchange and who have not less than 1000 members to provide the facility of e-voting to the members in the general meeting. It exempted Nidhi companies from the requirement of providing e-voting facility to its members.

The original text of Rule 20 explained the following terms:

  1. Agency
  2. Cut-off date
  3. Cyber security
  4. Electronic voting system
  5. Remote e-voting
  6. Secured system
  7. Voting by electronic means

The above terms were omitted vide Companies (Management and Administration) Amendment Rules, 2016[6]. MCA has restored the same with the present amendment. Accordingly, the cut-off date will be not earlier than seven days before the date of general meeting, which was previously specified in the Rules.

Conclusion

The present amendment brings clarity and settles all questions relating to annual return and e-voting. Annexing extract of annual return is past. Whole of the annual return in Form MGT-7 or Form MGT – 7A as applicable, is required to be uploaded on the website of the company and web-link of the same to be provided in the Board’s Report.

 

[1]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=TTbtgoimZaEriqvC1uq63cVI1aUKrmySF7pn3LWSIhRnwlDT+xFtqSRh8eE9YDYmTZpXWl/g6A+Dx/OT8agtKUclWEhfgK03TlnWLOuiGw6K1VTDhD8p3mpQTiLgy2ewBHNyAHD0wK1NTYvNTxvKE72myo++ycxQaipOFSzBIY4coKGinwHEcAFWj2Fn6hr6

[2] “small company” means a company, other than a public company whose paid-up share capital does not exceed two crore rupees and turnover as per profit and loss account for the immediately preceding financial year does not exceed twenty crore rupees

[3]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3z9mihm9CxHHzu82fmWlMKzy8jPS04vbR

[4]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3DZ3eKuS27Ryli2KQpdUJBX7LNlkBrkXwnB0Mo6W4iI/tFsp4nH5DYuXMxD09O4auZIWA0g9jbZU=

[5] https://www.mca.gov.in/Ministry/pdf/CompaniesMgmtAdminAmndtRules_05032021.pdf

[6]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3DZ3eKuS27Ryli2KQpdUJBX7LNlkBrkXwnB0Mo6W4iI/tFsp4nH5DYuXMxD09O4auZIWA0g9jbZU=

 

Our other videos and write-ups may be accessed below:

Relating to above topics:

http://vinodkothari.com/2020/08/extract-or-the-annual-return-itself-anomaly-under-section-92-through-the-companies-amendment-act-2017/

YouTube:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Other write-up relating to corporate laws:

http://vinodkothari.com/category/corporate-laws/

 

MCA updates brings changes to the Annual Return

MCA eases some requirements for OPCs and small companies

Companies (Management and Administration) Amendment Rules, 2021 notified

Companies (Incorporation) Third Amendment Rules, 2021 notified

Presentation on Corporate Bonds and Debentures

Our other videos and write-ups may be accessed below:

YouTube:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Other write-up relating to corporate laws:

http://vinodkothari.com/category/corporate-laws/

Our  our Book on Law and Practice Relating to Corporate Bonds and Debentures, authored by Ms. Vinita Nair Dedhia, Senior Partner and Mr. Abhirup Ghosh, Partner can be ordered though the below link:

https://www.taxmann.com/bookstore/product/6330-law-and-practice-relating-to-debentures-and-corporate-bonds

ESG concerns in corporate governance in India

Sikha Bansal, Partner (sikha@vinodkothari.com) and Payal Agarwal, Executive (payal@vinodkothari.com)

Introduction

ESG (where, E stands for Environment, S for Society, and G for Governance) is a term that has earned a lot of attention in the recent years. Related terms used are ESG investing, ESG reporting, ESG rating, etc. – all focussing on and circumscribing same factors.

The ESG analysis is sought as a measure of responsible investing, and goes beyond the traditional method of using only financial factors for evaluation of an investment or potential investment.  ESG, in essence, recognises financial relevance of various non-financial elements which impact business in several ways. With sustainable development being the desirable result of whatever we do, efforts have been made to incorporate ESG issues in the analysis of the business performance as a whole.

In context of the same, we have tried identifying ESC concerns in India, in relation to corporate businesses. While in India, we have already something called ‘business responsibility reporting’, we need to see if this sufficiently captures the spirit of ESG and where it stands vis-à-vis global practices.

What is ESG?

Before we go on to the question why we need ESG, we need to understand what ESG, and also, why and how it has assumed so much of importance.

The emergence of ESG dates back to earlier years of 2000s. A report titled Who Cares Wins: Connecting Financial Markets to a Changing World[1], highlighted the emerging ESG issues and made several recommendations, including – (i) financial institutions should commit to integrating environmental, social, and governance factors in a more systematic way in research and investment processes, (ii) the companies a leadership role by implementing environmental, social and corporate governance principles and polices and to provide information and reports on related performance in a more consistent and standardised format, and (iii) investors shall explicitly request and reward research that includes environmental, social and governance aspects and to reward well-managed companies. Further, the report recommended that the financial analysts shall not only focus on ESG risks and risk management, but also consider ESG issues as a potential source of competitive advantage. The report also identified the following drivers through which good management of ESG issues can contribute to shareholder value creation[2].

Later, UNEP FI, in its 2005 Report[3], highlighted the distinction between ‘value-driven’ vs. ‘values-driven’ investment, and observes, “ESG considerations are capable of affecting investment decision-making in two distinct ways: they may affect the financial value to be ascribed to an investment as part of the decision-making process and they may be relevant to the objectives that investment decision-makers pursue.” This report noted that, the movement towards mainstream consideration of ESG issues in investment decision-making is a response of variety of factors, including, increasing evidence of the nexus between performance on ESG issues and financial performance, reputational concerns, consumer pressure, public opinion, introduction of corporate environmental reporting obligations, etc.[4]

Some institutional investors believed that environmental, social and governance (ESG) issues were not relevant to portfolio value, and were therefore not consistent with their fiduciary duties. However, in report titled “Fiduciary Duty in the 21st Century[5], issued by UN agencies and PRI[6], it was clarified that the assumption is no longer supported, and that, failing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty. The said report identifies critical importance of incorporating ESG standards into regulatory conceptions of fiduciary duty, for mainly three reasons – firstly, ESG incorporation is an investment norm; second, ESG issues are financially material; and thirdly, policy and regulatory frameworks are changing to require ESG incorporation.

Presently, there are several organisations, projects and reports focussing on ESG issues. These organisations may be governmental as well as independent. For instance, Global Reporting Initiative (GRI)[7] has formulated several standards[8] for sustainability reporting. See also, OECD (2017), Investment governance and the integration of environmental, social and governance factors.

Pillars of ESG

ESG, as stated above, has 3 pillars – Environmental, Social and Governance Each of these pillars comprises of several factors which would be a ‘parameter’ in ESG analysis.

  • “environmental” pillar focusses on creating a sustainable environment, where parameters such as impact of a company’s activities on the climate, company’s liability towards the environment, creating eco-friendly products, etc are checked and measured;
  • “social” aspect focusses on creating value for the society, by laying emphasis on the human rights issues, workplace health and safety, labour training and management, interaction with communities, customer relationship etc;
  • “governance” aspect covers issues on the corporate governance of a company and has two main elements: corporate structures, and corporate behaviour.

We have compiled a list of such factors[9] as below –

ESG Reporting

EU law requires large companies to disclose certain information on the way they operate and manage social and environmental challenges. EU’s directive, 2014/95/EU also called the non-financial reporting directive (NFRD), acknowledges that disclosure of non-financial information is vital for managing change towards a sustainable global economy by combining long-term profitability with social justice and environmental protection and lays down the rules on disclosure of non-financial and diversity information by large companies[10]. The Directive amends the accounting directive 2013/34/EU (by inserting Article 19a) so as to mandate inclusion of non-financial statement containing information to the extent necessary for an understanding of the undertaking’s development, performance, position and impact of its activity, relating to, as a minimum, environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters, etc.

It further provides, “Where the undertaking does not pursue policies in relation to one or more of those matters, the non-financial statement shall provide a clear and reasoned explanation for not doing so.”

The EU has issued its guidelines to help companies disclose environmental and social information, and published guidelines on reporting climate-related information. Also, EU has also launched a public consultation on the review of the NFRD[11].

The OECD Report of 2017[12] compiles ESG reporting requirements (voluntary as well as mandatory) across the world by institutional investors, and by way of corporate disclosures. The report observes that the reporting requirements are usually voluntary (“comply or explain”) and are not prescriptive on the methods or metrics to be used.

The Financial Reporting Council (FRC) of UK released a discussion paper – “A Matter of Principles: The Future of Corporate Reporting” (2020). The discussion paper proposes a network of interconnected reports based on objectives rather than a single comprehensive annual report. The proposals include 3 reports – Business report, the full Financial Statements and a new Public Interest Report. It also focuses on widening the definition of materiality so that it does not remain limited to accounting standards only, but covers other wider range of activities that affect a company significantly. Section 6 of the this Report deals extensively with non-financial reporting, stated to include information relating to employees, suppliers, customers, the community, the environment and human rights.

In a study, “The consequences of mandatory corporate sustainability reporting: evidence from four countries (2015)”, it has been observed that even though the regulations often allowed companies, via comply or explain clauses, to choose not to make greater disclosure, there was a 30%-50% average increase in ESG disclosure as a result of the regulations being introduced (albeit from a low starting base). The greatest increase came in the first year of the regulations coming into force. All three types of disclosure – environmental, social and governance – increased.  The findings, therefore, suggest that, contrary to popular belief that an increase in disclosure regulation imposes significant costs on companies and, therefore, has a negative impact on shareholders, the reality is that improved disclosure creates value for companies, not destroys it.

ESG Rating

Investors, institutional institutions, etc. would generally make use of ESG information for investment decisions through ESG ratings provided by ESG rating agencies[13]. This assessment and measurement often forms the basis of informal and shareholder proposal-related investor engagement with companies on ESG matters[14]. ESG factors can provide valuable insights into possible current and future environmental and social risks and opportunities for corporate entities, given the impact and dependence entities have on the environment and society. These ESG issues in turn have the potential to lead to a direct or indirect financial impact on the entity’s profits and investment returns[15].

See Boffo, R., and R. Patalano (2020), “ESG Investing: Practices, Progress and Challenges”, OECD Paris, for an elaborate discussion on ESG rating and indices and the methodologies adopted for the same. The paper also compiles ESG Criteria as used by major index providers as follows[16]

Even though there are countries where ESG Reporting has been initiated as a voluntary or mandatory measure, the requirement of ESG rating has not been found to be mandated in any country by way of explicit regulations on the same.  However, institutional investors, proxy advisor firms etc., are largely using these ratings while making investment decisions as part of making socially responsible investment.

ESG in Indian Context

The Indian legislation has been trying to cover the various aspects of ESG in a fragmented manner.

For instance, the board’s report shall disclose the conservation of energy, technology absorption, etc.[17] The aspects have to be dealt with in detail – the company shall disclose steps taken or impact on conservation of energy, steps taken to utilise alternate sources of energy, capital investment in energy conservation equipments, efforts towards technology absorption, etc. Besides, a director owes a fiduciary duty towards the community as well as for the protection of the environment[18]. Also, CSR activities include various socio-economic activities, required to be disclosed separately in the annual report[19]. However, the closest requirement is that of Business responsibility Reports (BRR) which has been mandated from ESG perspective only, as discussed below.

What is Business Responsibility Report (BRR)?

BRR or Business Responsibility Report can be said to be the foremost step in India in promoting non-financial reporting in India, on a mandatory basis. The initiative was one of the responses to India’s commitment towards the United Nations Guiding Principles on Business & Human Rights (UNGPs) and Sustainable Development Goals.

The BRR is based on the 9 principles in line with the ‘National   Voluntary   Guidelines   on   Social, Environmental and Economic Responsibilities of Business’ (NVG)[20] issued by MCA. The guidelines state that the companies should not be just responsible but also socially, economically and environmentally responsible. Through such reporting, the guidelines expect that businesses will also develop a better understanding of the process of transformation that makes their operations more responsible. The NVG were further revised and the MCA formulated the ‘National Guidelines on Responsible Business Conduct’ (NGRBC)[21]. The said guidelines stipulated that the businesses should –

  • conduct and govern themselves with integrity in a manner that is Ethical, Transparent and Accountable,
  • provide goods and services in a manner that is sustainable and safe,
  • respect and promote the well-being of all employees, including those in their value chains,
  • respect the interests of and be responsive to all their stakeholders,
  • respect and promote human rights,
  • respect and make efforts to protect and restore the environment,
  • when engaging in influencing public and regulatory policy, should do so in a manner that is responsible and transparent,
  • promote inclusive growth and equitable development, and
  • engage with and provide value to their consumers in a responsible manner.

The Securities and Exchange Board of India (SEBI), in 2012[22], through its listing conditions mandated the top 100 listed entities by market capitalisation to file BRR from ESG perspective. This was extended to top 500 companies in FY 2015-16[23]. The coverage has been extended to 1000 companies now[24]. In the year 2020, MCA issued Report of the Committee on the Business Responsibility Reporting, and SEBI issued a Consultation Paper on the format for Business Responsibility and Sustainability Reporting (BRSR, suggesting that BRR shall be renamed as BRSR). See our detailed analysis of the recommendations made in these reports.

See also, our earlier article on BRR. The eventual development in BRR framework is shown below –

BRR – Identifying ways to improve

ESG has no statutory definition, per se. We have tried identifying possible factors, based on various reports, indices, etc. which would reflect a holistic ESG perspective of an entity.

How effective is the present framework of BRR can be understood by way of the following table:

BRR vs ESG – Hits and Misses

Hits Misses
Climate change Carbon emissions
Resource use , sustainable sourcing Green building
Environmental protection and restoration Biodiversity and land use
Renewable energy Discharge of effluents
Water use ————-
Energy efficiency —————
Clean tech —————-
Safety of employees, customers Privacy and data security
Skill upgradation training Financial product liability
Labour management ————
Practice against child labour, sexual harassment, forced labour ————
Protection of human rights ————-
Satisfactory redressal of customer complaints ————
Stakeholder engagement ————
Ethics and bribery Board structure
Anti competitive behaviour Executive pay
Unfair trade practices Codes and values
—————– Tax transparency

 

Most of these gaps in the present BRR format are covered under the proposed BRSR. The BRSR has provisions for reporting on the carbon emissions of a company, discharge of other effluents by the company, and reporting relating to the privacy and data security of the customers etc. Also, the BRSR defines the scope of reporting for every item very precisely.

However, matters such as financial product liability and various aspects of governance still needs a dedicated space.

NSE Study of BRR Reporting in India

A study of NSE, while conducting the ESG analysis of Indian companies, has checked the disclosures provided under the BRR framework by the companies as part of its ESG analysis.

Some significant findings of the study has been pointed below:

  • Among the nine principles, the least number of sample companies responded positively for disclosures on principle 7 (i.e., public advocacy). It had the lowest score on all four measures.
  • One of the recurring reasons for not framing a policy on the principle 7 is that there is no specific/ formal policy on public advocacy. However, companies have stated that they indirectly covered aspects of principle 7 under other policies. This may be attributed to the fact that in India, advocacy, if at all done, is done in a non-transparent manner.
  • The second worst response was with respect to the principles relating to ‘respect and promoting human rights’ and ‘engagement and providing value to customers and consumers’. Once again, probably, these concepts are yet to be assimilated in our system.
  • Higher positive responses were found across principle 1 (ethics), principle 3 (employees), principle 4 (stakeholder), principle 6 (environment), and principle 8 (growth and equitable development – social responsibility). This can be attributed to the fact that some of these policies flow from various legal mandates in India. Hence, most companies have formal policies to comply with the law on these principles.

The study highlights that companies have largely scored better on policy disclosures followed by governance factor, compared to environment and social factors. This can be attributed to the fact that governance reforms have transformed into laws by various regulatory agencies within India, in the last two decades. Similarly, many policies have been mandated to be prepared by regulatory authorities. Hence, companies have scored higher on policy disclosure parameters.

Closing Thoughts

The BRR Reporting in India, in terms of key areas, goes a long way in presenting a holistic ESG scenario. Some structural changes in the extant format may facilitate better reporting.

Further, the Indian companies are found to perform well in the governance related matters, in comparison to the environmental and social factors, admittedly for the presence of various statutory requirements and regulatory supervision on the governance requirements of a company. However, the companies need to improve their environmental and social scores as well.

[1] December, 2004. The Report was a joint initiative of financial institutions which were invited by United Nations Secretary-General Kofi Annan to develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions. See also, “Who Cares Wins” : One Year On” – A Review of the Integration of Environmental, Social and Governance Value Drivers in Asset Management, Financial Research and Investment Processes, published by the International Finance Corporation.

[2] Refer, page 12 exhibit 9 of the said Report

[3] A legal framework for the integration of environmental, social and governance issues into institutional investment”

[4] Refer, page 24 of the said Report.

[5] The website is https://www.fiduciaryduty21.org/ . The report has been last updated in the year 2019.

[6] Principles of Responsible Investing (PRI) is a United Nations-supported initiative, launched in 2006 by UNEP Finance Initiative and the UN Global Compact.It  is a network of international investors working together to put the six Principles for Responsible Investment into practice. The PRI were devised by the investment community and reflect the view that environmental, social and governance (ESG) issues can affect the performance of investment portfolios and therefore must be given appropriate consideration by investors if they are to fulfill their fiduciary (or equivalent) duty. In implementing the Principles, signatories contribute to the development of a more sustainable global financial system.

[7] GRI was founded in Boston in 1997 following public outcry over the environmental damage of the Exxon Valdez oil spill.  The aim was to create the first accountability mechanism to ensure companies adhere to responsible environmental conduct principles, which was then broadened to include social, economic and governance issues. The first version of what was then the GRI Guidelines (G1) published in 2000 – providing the first global framework for sustainability reporting. The following year, GRI was established as an independent, non-profit institution. In 2016, GRI transitioned from providing guidelines to setting the first global standards for sustainability reporting – the GRI Standards.

[8] The GRI standards can be accessed here https://www.globalreporting.org/standards/

[9] The list is a compilation of the various factors identified by various organisations and reports such as, PRI, MSCI Research, NSE-SES report on ESG analysis of 50 Indian companies, etc.

[10] EU rules on non-financial reporting only apply to large public-interest companies with more than 500 employees. This covers approximately 6,000 large companies and groups across the EU.

[11] See here.

[12] OECD (2017) Investment governance and integration of environmental, social and governance factors

[13] Some well- known ESG rating providers include: (a) Dow-Jones Sustainability Index, (b) S & P Global Ratings, (c) MSCI ESG Research etc.

[14] https://corpgov.law.harvard.edu/2017/07/27/

[15] S&P Global Ratings: Exploring Links To Corporate Financial Performance

[16] Source: Boffo, R., and R. Patalano (2020), “ESG Investing: Practices, Progress and Challenges”, OECD Paris

[17]Companies Act, 2013, section 134(3)(m), read with rule 8 of the Companies (Accounts) Rules, 2014

[18] Ibid, section 166.

[19] Ibid, section 135 read with Companies (Corporate Social Responsibility Policy) Rules, 2014.

[20] 2011. A refinement of earlier Corporate Social Responsibility Voluntary Guidelines 2009, released by the Ministry of Corporate Affairs in December 2009.

[21] 2019. See Press Release.

[22] CIR/CFD/DIL/8/2012 dated 13th August, 2012

[23] See update, and notification.

[24] See notification.