As an organization grows and begins to enter new markets, it’s natural that new entities and new subsidiaries will start to appear. However, these subsidiaries cannot and should not just be set up willy-nilly; there must be a robust growth strategy behind them, and there must be an enhanced and documented corporate governance approach enforced across the whole organization.
Without this robust corporate governance approach, the organization may come up against regulatory issues, and find themselves in non-compliance somewhere along the subsidiary structure. And without that robust corporate governance approach, those minor issues along the subsidiary structure can blow up into major problems for the parent or holding company. There’s a risk of fines, reputational damage and even jail time for directors in some jurisdictions.
What is a subsidiary structure?
A group may decide to set up a new subsidiary to take advantage of a new market or new conditions. It may be that for a subsidiary to move into a new country, local regulation demands a partition between the group head and the local entity, or it may be that an organization wants to trial a new service or product and wants to protect the rest of the subsidiary structure from the experiment.
Subsidiaries can also enter a group as a result of merger or acquisition, with an organization inheriting a subsidiary structure from its acquisition or merger target.
New subsidiaries, though, can bring their own intricacies. Setting up a subsidiary is not as easy as just setting up a new board and incorporating the entity — far from it. When an organization decides a new subsidiary is needed, they’re not just creating a branch of the parent business. Subsidiaries are legally separate, have their own boards and management teams, and are answerable to the regulators, sometimes in different parts of the world to those its parent answers to. Those in charge of entity management must also consider the relationship between the new subsidiary and all other entities within the subsidiary structure, especially given the increasing demand for transparency through global regulations such as the OECD’s Base Erosion and Profit Shifting, or BEPS, project.
Some refer to subsidiary governance as “the elephant in the room,” because exercising due oversight and control over the subsidiary structure can be a real challenge.
The challenges of subsidiary structures
It’s clear, then, that a growing subsidiary structure faces greater financial, tax, commercial and operational risks — especially when it contains subsidiaries in foreign jurisdictions. While there are moves toward global harmonization of compliance, there is still no complete alignment and local regulators are free to impose their own sets of regulations and deterrents for entities incorporated in that jurisdiction.
And we’re not just talking about international jurisdictions here — even within a single country, there can be multiple jurisdictions; each of the 50 states of the US could and do impose their own company regulations, making cross-border operation within that vast market a challenge for entity managers looking after subsidiary structures, while some growing markets offer free zones within their cities to attract businesses.
Adding to complexity can be the question of listing: If the subsidiary structure contains some public entities and some private entities, then the listed subsidiaries will have to face a more robust and prescriptive set of corporate governance codes than the private subsidiaries, which are free to operate within more broad bounds.
“With regulation, risk and responsibilities for directors around the management of legal entities all increasing, having a strong global subsidiary governance framework can prevent costly financial and reputational damage,” writes PwC Legal’s Entity Governance and Compliance Team, noting that regulators have focused attention on governance and compliance since the 2008 global financial crisis. “Quite often when you look at corporate governance failings, they have occurred at subsidiary level.”
What does good subsidiary governance look like?
So a subsidiary structure needs clear, robust corporate governance guidelines to ensure every entity at every level of the subsidiary structure is working toward the right compliance levels in the right ways.
However, at the parent company level, it can be difficult to know for sure that your corporate governance is being upheld to an adequate level throughout the chain. It’s important to get a handle on this, as regulators are increasingly saying the parent must be held responsible for the actions of entities in all parts of the subsidiary structure.
In fact, a survey by Deloitte found that parent companies often take much of the governance and compliance burden for the whole subsidiary structure:
- 68% indicated parent company boards spend significant time overseeing the business and risks of the subsidiaries
- 84% of parent companies have specific approval levels in place where the parent must approve the actions or spending of the subsidiary
That said, it’s just not practical to assume the parent company will take care of the regulatory and compliance needs for every subsidiary, so a strong subsidiary governance framework becomes an essential document and process to ensure good subsidiary governance.
ICSA’s subsidiary governance framework template checklist aims to help corporations operating across multiple jurisdictions and business areas to ensure corporate governance is maintained across the subsidiary structure. That list includes advice to:
- Get buy-in and establish process, setting the tone from the top
- Build in some flexibility to allow for local laws, regulations and customs in different jurisdictions
- Review the composition and effectiveness of subsidiary boards, and make these reviews a regular thing
- Make sure all group-wide policies are easily accessible to all staff, as lack of awareness is not an acceptable excuse for non-compliance
- And, ensure there are clear reporting lines within the subsidiary structure, ensuring the flow of communication is kept open across the group
How can technology support corporate governance and subsidiary structure?
Large or complex subsidiary structures can add a heavy compliance burden to an organization, but with careful attention to corporate governance — and a little help from technology — that burden can be eased.
Proactive governance reduces reactive compliance, but entity managers are often bogged down in the day-to-day burden of compliance. To ensure entity managers have the time and space to be proactive, technology can be deployed to:
- Have a central calendar of filing deadlines
- Enforce clear and efficient governance workflows
- Ensure everyone knows their roles and responsibilities, and is able to act at the appropriate time
- Install notifications, workflows and electronic filing with regulators to ensure an efficient and timely corporate governance process across the subsidiary structure
Technology can also help the parent company to maintain oversight of the subsidiary structure, with any potential risks or issues being flagged automatically on a dashboard so they can be dealt with before they become major problems.
Entity management software, such as Diligent Entities, brings transparency and proactive governance to the entire subsidiary structure, getting the right information to the right people at the right time and in the right format. Get in touch and schedule a demo to see how Diligent’s Governance Cloud can support corporate governance in the subsidiary structure.