Sweeping changes have been introduced to the Corporate Governance Rules enshrined in the Listing Rules of the Colombo Stock Exchange. This is being done in a bid to qualitatively and quantitatively improve governance of listed companies in the interest of accountability and transparency.

Effective from 01 October 2024, requirements have been introduced for listed companies to establish and maintain policies on Environmental, Social, and Governance Sustainability (ESG). This is in addition to the policy requirements for matters relating to the Board of Directors, Board Committees, Remuneration, Risk Management, Control of Company Assets, Shareholder Investments, Internal Controls, Business Conduct and Ethics, Whistleblowing, and on Anti-Bribery and Corruption. The said policies are to be disclosed on the company websites.

In addition, the listed companies are now required to disclose in its Annual Report the policies that have been put in place as well as details relating to compliance by the listed companies with such policies. Further, details pertaining to any changes to these policies have to be disclosed in its Annual Report.

The Board of Directors

Moving forward, the Boards of the listed companies will be required to maintain a balance of representation between Executive and Non-Executive Directors, diversity in gender, skills, competencies, age, and industry requirements. The Boards will be expected to stipulate the maximum number of directors and rationalize the same, specify inter alia the maximum number of directorships held by directors in other listed companies, and provide details of compliance with these requirements in their Annual Report.

Board Composition

Requirement of Chairman and CEO Duality – in order to minimize conflicts of interest from arising, the Listing Rules contemplate the positions of Chairman and CEO of a listed company to be held by two different unconnected individuals.

Where such positions are held by the same individual or where the Chairman and CEO are close family members or related parties, a listed company must appoint an independent director as the “Senior Independent Director” (SID) and disclose the same to the market.

Senior Independent Director (SID)

The SID is expected to call a meeting of independent directors at least once a year or as often as deemed necessary under his /her chairmanship, without the presence of the other directors to discuss matters and concerns relating to the company and the operation of the Board. The SID shall report back the observations and outcome of such meetings to the Chairman and other board members.

The SID will be expected to call a meeting of the non-executive directors without the presence of the Chairman at least once every year to appraise the performance of the Chairman. The SID shall be entitled to a casting vote at such meetings and shall make a signed explanatory disclosure in the Annual Report of the Company.

Number of Directors on a Listed Company Board

The Board of Directors of a listed company shall at a minimum consist of five (05) Directors with at least two (02) independent directors or such number equivalent to one-third (1/3) of the total number of directors at any given time, whichever is higher. Any change to this ratio has to be rectified within ninety (90) days from the date of the change.

The Criteria for Determining ‘Independence’

An independent director who reaches the age of 70 years will no longer be deemed to be ‘independent’ in terms of the new rules and his status of being ‘independent’ will cease from thereon. However, he can function as a non-independent director.

A director shall be deemed not ‘independent’ under the following additional circumstances;

(i) If he has been employed by the company during the three years immediately preceding the appointment.

(ii) If he has had a ‘material business relationship’ during the 3 years immediately preceding with the company directly or indirectly. Here ‘material business relationship’ means a relationship resulting in income or non-cash benefits equivalent to 20% of the individual’s annual income.

(iii) Has had a close family member who was/is a director and/or CEO of the listed company currently or during the preceding financial year.

(iv) Has a ‘significant shareholding” (a shareholding carrying not less than 10% of the voting rights) in the listed company.

(v) He has served an aggregate period of 9 years on the board of the listed company from the date of the first appointment.

(vi) Is employed in another company or business   

a. In which a majority of the other directors of the listed company are employed or are directors; or 

b. in which a majority of the other directors of the listed company have a significant shareholding or material business relationship; or 

c. that has a significant shareholding in the listed company concerned, or with which the listed company has a Business Connection (i.e., a relationship resulting in a transaction value equivalent to 10% of the turnover of that company or business);

(vii) Is a director of another company;

a. In which a majority of the other directors of the listed company are employed or are directors; or 

b. That has a Business Connection in the listed company; or 

c. A Significant Shareholding.

(viii) Has a Material Business Relationship or a Significant Shareholding in another company or business; 

a. In which a majority of the other directors of the listed company are employed or are directors; and / or

b. Which has a Business Connection with the Listed company or Significant Shareholding ; and / or 

c. Where the core line of business of such company is in direct conflict with the line of business of the listed company.

In terms of the above criteria, a director of a listed company who does not come within any circumstances listed above shall nonetheless be deemed non-independent upon the occurrence of the following (whichever comes first):

(a) he reaches the age of 70 years; or

(b) he completes an aggregate period of 9 years as an ‘independent’ director.

However, such a director can continue to function as a ‘Non-Independent Director’ on the Board provided his period of serving on the Board has not exceeded nine (9) years.

The age limit of 70 years to function as an “independent director” on the Board of a listed company is in direct contrast with the Rules made by the Central Bank of Sri Lanka. The Central Bank Rule prohibits a director on the Board of a Licensed Bank or finance company from functioning as a director whether ‘independent’ or not once he/she reaches the age of 70 years. Therefore ‘independent directors’ serving on the boards of banks and finance companies which are listed WILL NEVERTHELESS HAVE TO STEP DOWN FROM THEIR BOARD POSITIONS ONCE THEY REACH THE AGE OF 70 YEARS.

Another significant factor is that independent directors who serve on the board of a listed company that is a holding company of another listed subsidiary will not be deemed to be “independent” if they serve on the board of the listed subsidiary.

Furthermore, a director of a listed company will not be deemed to be “independent” if he has a Material Business Relationship or a Significant Shareholding in another company which has a core line of business in direct conflict with the line of business of the listed company; even if the other company has no connection whatsoever with or to the listed company.

Each ‘independent’ director will be required to make a written declaration annually as to his ‘independence’ or ‘non-independence’ against the criteria specified above and in accordance with the format provided in Appendix 9A of the Listing Rules of the Colombo Stock Exchange.

Based on the Annual Declaration made by each independent director, the Board of Directors will be required to make an annual determination as to such director’s ‘independence’ or ‘non-independence’ and no longer will such director be permitted to function as an ‘independent’ director if the Board determines that his independence is impaired. Additionally, the Board is also precluded from determining that a director is nevertheless ‘independent’ even in instances where his ‘independence’ is not in conformity with the assessment criteria as has been the practice in the past.

Alternate Directors

Henceforth listed companies will be permitted to appoint alternate directors only in ‘exceptional circumstances “and for a maximum period of one year. The rules are silent as to the nature of the “exceptional circumstances”.

If an alternate director is appointed for a non-executive director, the alternative should not be an executive of the company. If it is for an independent director the alternate should meet the criteria of independence specified above. The Nominations and Governance Committee must review and determine that the person so nominated qualifies to be an ‘independent director’ before such appointment is made. After such appointment, an immediate market disclosure must be made including all the relevant details and the circumstances under which the alternate director is being appointed.

The above Rules will be effective from 1 April 2024.

FITNESS AND PROPRIETY OF DIRECTORS AND CEOs OF LISTED COMPANIES

Section 89(2) of the Securities and Exchange Commission of Sri Lanka Act, No. 19 of 2021, (SEC Act) stipulates that the Board of Directors of every listed company shall ensure compliance with the fit and proper criteria specified by the Securities and Exchange Commission (“Commission”) by way of rules or in the rules of an exchange approved by the Commission.

In keeping with the above provisions, the Colombo Stock Exchange has (after obtaining the approval of the Commission) for the first time introduced Fit and Proper rules to be complied by not only the Directors but also the CEO of every listed company.

Rule 9.7.1 of the Listing Rules mandates all listed companies to ensure that directors appointed to the Board and their CEO are “fit and proper” persons in keeping with the assessment criteria as provided under Rule 9.7.3 of the Listing Rules.

The “Fit and Proper” criteria is assessed under three broad categories;

a. Honesty, Integrity and Reputation

A director or a CEO shall not be considered to be ‘fit and proper’ if he/she

(i) Has been convicted by a court of competent jurisdiction of a capital market offence under the SEC Act or any Securities Law abroad;

(ii) In his individual capacity, has been in any business which has had a license or a registration cancelled by the Commission or any other regulatory authority;

(iii) Has been convicted of an offence within or outside Sri Lanka involving fraud, dishonesty or misappropriation or a finding that he or she has acted fraudulently or dishonestly. 

(iv) Has been convicted within or outside Sri Lanka of an offence for violating any law established to protect members of the public against financial loss due to dishonesty, incompetence, or malpractice in the provision of financial services.

(v) Due to mismanagement of funds or an offence which involves the commission of financial fraud, has been disqualified from acting as a Director or a CEO of a company or has been dismissed or requested to resign from any position by the Commission or any other statutory regulatory body in terms of their respective laws, rules or regulations.

(vi) Has been disqualified from acting as a CEO/Key Management Person/Director of a company regulated by the Central Bank of Sri Lanka (CBSL) and or the Insurance Regulatory Commission of Sri Lanka (IRCSL) as may be applicable for failure to satisfy the fit and proper assessment criteria of the CBSL and/ or the IRCSL respectively. 

(vii) has been the Director or the CEO of any listed company which has been delisted by the Colombo Stock Exchange under rule 11.3 of the Listing Rules. 

In terms of the abovementioned criteria, it is clear that disqualifications have been extended covering convictions of foreign jurisdictions, not only with regard to capital market offences but also to any offence involving fraud or misappropriation. Additionally, disqualifications have been extended to even key management personnel where the Commission or any other regulatory body has requested such person to resign from his position due to fraud or mismanagement of funds. Thirdly, the assessment criteria has also recognized the fit and proper criteria issued by the CBSL and the IRCSL in addition to those of the Commission.

It is also significant that there need not be an adverse finding by a Court of Law to attract the disqualifications stipulated in criteria (v) and (vi) above. It appears that a mere adverse finding by any of the regulatory bodies mentioned therein is sufficient.

b. Competence and Capability

An individual will not be deemed to be “fit and proper” to hold office as a director or CEO of a listed company if he/she 

(i) Does not possess suitable academic or professional qualifications or necessary skills, competence and experience, which are required to efficiently contribute to the business operations of the Company as determined by the Nominations and Governance Committee of the listed company in terms of Rule 9.11.5 of the Listing Rules.

(ii) Has been declared by a court of competent jurisdiction within or outside Sri Lanka to be of unsound mind.

Certain amount of subjectivity has been brought into determining the competence of a person in terms of criteria (i) above. Since the determination is made by a committee of persons, it is hoped that subjectivity will be diluted to a greater extent and more objectivity will be brought into bear on the decisions made by the Nominations and Governance Committee. The rule is silent of the exact qualifications a person must have and gives a wide discretion to the Nominations and Governance Committee. Although there can be much merit to this rule, the question arises as to whether the wordings used in criteria (i) above will effectively leave out highly talented or financially sound persons lacking in formal academic or professional qualifications who would otherwise qualify and could contribute to the efficient running of the business operations of a company from the position of a director? To what extent good ‘horse sense’ will prevail in the Nominations and Governance Committees of listed companies is yet to be seen. One will never know a listed company’s missed opportunities of having the benefit of such persons.

On the other hand is the stamp of an academic or professional qualification alone a guarantee for good governance or the efficient running of a business? The “Lessons Learnt from the Global Financial Crisis” will tell you a different story. The rule is also silent about the relevance of the academic or professional qualification concerned to the particular business. Though it will be the exception than the norm, it is hoped that good ‘sense’ will prevail over the decisions made by the Nominations and Governance Committees when making their determinations with regard to persons lacking in formal academic or professional qualifications under the category of competence and capability and not leave out a genius such as ‘Steve Jobs’.

In the case of company takeovers and mergers, does it then mean that in a company buy out situation an offeror cannot sit on the board of a company if he lacks any formal academic or professional qualification or is he going to be prevented or precluded from acquiring a company for falling short of any of the criteria listed under b (i) above simply because he cannot sit on the board of a company? Some may argue that it is a good ‘poison pill’ to discourage takeovers. Listed Companies will have to come up with practical solutions in such situations to comply with these requirements pertaining to competency and capability.

c. Financial Soundness

No individual will be deemed to be fit and proper to hold the position of a director or CEO of a listed company if he/she 

(i) Is an undischarged bankrupt or a person on whose behalf a receiver or manager or liquidator or an equivalent person has been appointed within or outside Sri Lanka. 

(ii) Has been the subject of a judgment debt which is unsatisfied, either in whole or in part, whether in Sri Lanka or outside Sri Lanka.

(iii) Has been in a position capable of exercising significant influence in a company that has;

(a) Been declared bankrupt within or outside Sri Lanka; or 

(b) Its assets sequestrated for the non-satisfaction of a judgment debt. 

All directors and CEOs are expected to make declarations on an annual basis confirming their conformity with the fit and proper criteria mentioned above during the financial year and the company shall include a disclosure in its Annual Report confirming compliance by its directors the fit and proper criteria mentioned above. In the event of any non-conformity with the criteria by any director or the CEO, the listed company must disclose the particular non-compliance and the remedial action taken to rectify the same.

The Nominations and Governance Committee

For the first time the Listing Rules have mandated the establishment of a new Board Sub-Committee called the Nominations and Governance Committee for listed companies consisting of a minimum three directors out of which two must be independent directors of the company. The Committee must not comprise of any executive directors and the Chairman of the sub-committee shall be an independent director. This Board Committee is in addition to the Audit Committee, Remuneration Committee, and the Related Party Transactions Review Committee.

Functions of the Nominations and Governance Committee

(i) To evaluate the appointment of directors to the Board of Directors of the listed company. When a member of the nominations and Governance Committee is being evaluated such member shall not participate in the decisions made with respect to his own appointment as director. 

(ii) To establish and maintain a transparent procedure to evaluate, select, appoint, and re-appoint directors within a set of established criteria.

(iii) To establish a suitable process for the periodic evaluation of the performance of the Board of Directors and the CEO of the listed company.

(iv) To develop a succession plan for the Board and for key management personnel of the listed company. 

(v) To review the structure and size of the Board and its committees with regard to the effective discharge of duties and responsibilities 

(vi) To review and recommend the overall corporate governance framework of the listed company and to update the said framework where necessary; and 

(vii) To review reports from the management on compliance with the corporate governance framework of the listed company including compliance with the provisions of the SEC Act, the Listing Rules and other applicable laws together with any deviations / non compliances thereon and the reasons for the same.

Disclosures in the Annual Report

The Annual Report of the listed company must contain a statement signed under the hand of the Chairman of the Nominations and Governance Committee setting out inter alia the following information;

(i) A disclosure on the Board diversity in the range of experience, skills, age, and gender as an essential factor for effective board performance;

(ii) Whether periodic evaluations have been conducted on board performance and the CEO of the listed company; 

(iii) Details to demonstrate the effective implementation of policies and processes relating to the appointment and re-appointment of directors; 

(iv) Whether induction/orientation programs have been held for newly appointed directors on corporate governance, listing rules, securities market laws and regulations or an appropriate negative statement.

(v) Annual updates given to existing directors on the rules and regulations mentioned in the preceding paragraph

(vi) A statement that the independent directors meet the criteria for determining independence; and 

(vii) A statement that the corporate governance requirements stipulated in the Listing Rules of the Colombo Stock Exchange have been met and if not, a statement explaining the reason for such non-compliance and the proposed remedial action taken for rectification.

These are some of the information to be contained in the report of the Nominations and Governance Committee in the Annual Report of the listed company.

The rules aim to foster not only financial stability within Sri Lankan corporates but also to enhance directors’ accountability and transparency to the shareholders, the investors and to the community at large.

* The writer is currently a Partner of Varners and was formerly the Director Legal and Enforcement of the Securities and Exchange Commission of Sri Lanka.