Subsidiary Boards – a balancing act

Published 5 Apr 2018

By Susan Fadil

Susan Fadil, Director – Funds and Corporate Services at JTC, recently spoke on a panel at an event organised by the Association of Women Chartered Secretaries (AWCS) in London, where she discussed the importance of subsidiary governance and how organisations can approach the challenges it brings…

Modern organisations invariably operate in complex environments and this, coupled with unwieldy group structures, can frequently present challenges when it comes to effective governance and compliance.

Focusing on subsidiary governance and robust legal entity management can help in this regard, not only in terms of protecting shareholder value, but also in safeguarding against more practical issues that have the potential to cause either reputational damage or financial penalties – issues that go right to the heart of shareholder value.

It’s a fact that often corporate governance failings occur at the subsidiary level, largely due to a lack of attention or an ineffective oversight mechanism. It is not good enough to just take a group-wide corporate governance code and ask the subsidiary board to apply it.

Given the increased focus on the governance, compliance and management of all entities within a group from both government and regulators, it’s clear that subsidiary governance should form an integral part of an organisation’s risk management framework.

 

Risks

When it comes to risk at subsidiary level, there are two big dangers.

One is not having a true understanding at the parent level of the culture, climate, and environment that its subsidiaries operate in. The other is to assess risk based solely on materiality, because clearly some risks are extremely disproportionate to their financial materiality.

The risk processes employed by many companies may be very good, but there is still room for improvement, particularly in the way parent and subsidiary boards identify, monitor and mitigate risk.

A lot of that will depend on how the organisation is structured, how centralised or decentralised their compliance and risk processes are, the diversity of their human capital and the parent board’s awareness of cultural norms.

 

Relationships

These risks highlight some key points in terms of the relationship between a parent and its subsidiary board. For instance, to properly carry out their fiduciary responsibilities, subsidiary boards are expected to act in an independent and objective manner.

However, because of their ownership structure, it is often difficult for them to achieve that independence. Usually, for instance, the parent organisation nominates directors to the subsidiary’s board who are often directors, officers, or employees of the parent. For this reason, the interests of the parent may take precedence over those of the subsidiary.

Subsidiary boards need, of course, to act in the best interests of the subsidiary, but also have a responsibility to the parent organisation.

Balancing these responsibilities is vital. Ideally, the interests of the parent and subsidiary would be aligned, but when that isn’t the case, it is the subsidiary board’s responsibility to make sure the parent understands why a particular solution or course of action is not a good one for the subsidiary.

In these situations, it is important for the subsidiary board to make its case to the parent so it is aware of the issues and the related consequences. This will allow the parent to weigh all of the pros and cons when making choices, ultimately for the overall benefit of the entire organisation, its shareholders and wider stakeholders.

 

Common Platforms

There are of course resource implications for placing a greater focus on subsidiary governance, but the benefits in the long-term are considerable and the costs of integrating subsidiary governance into an organisation’s framework are likely to be reduced by embracing technology and ensuring boards are working through common platforms.

For instance, where collecting and analysing data is concerned, automation can significantly improve governance processes, by making it possible to retrieve accurate, good quality data in multiple formats in real time.

Where parent and subsidiary organisations are not on common platforms, data collection and analysis can be a real challenge. In order to maximise the effectiveness of technologies, including from a governance perspective, there is a definite trend for organisations to move increasingly towards centralised data systems and common platforms.

Of course, it may not be possible to implement all practices identically across an entire organisation. It is important that subsidiaries have the ability to adjust policies and practices to reflect their operational needs and ownership structure as well as their local jurisdiction’s tax, legal, and other business regulations.

 

Balance

The truth is that parent company boards can’t do it all, from a practical or legal point of view – particularly in the case of complex multinational organisations.

Ensuring that the organisation has an effective subsidiary governance programme in place is critical for the parent board to ensure that its subsidiary governance reflects the same values, ethics, controls and processes as at parent board level.

For this reason, ongoing dialogue between subsidiary and parent boards is absolutely vital to make sure that all parties clearly understand each other’s objectives. If they can do this, they will be a good way along the road to achieving an effective balance between the level of independence of the subsidiary and the needs of the group as a whole.

Susan spoke on the panel alongside Evelyn Akadiri, Senior Company Secretary, BNY Mellon, Richard Sheath, Partner Independent Audit Limited, and Laura Fisher, Lawyer, Baker MacKenzie LLP.