Recently at Akira Consult Limited , we’ve found that many Clients, who serve as the ‘Parents’ of Group entities, have been operating based on “mutual understanding”. This approach has raised questions about authority and responsibility within the Group and its subsidiaries. In our effort to support Clients, we came across a valuable paper by Takahiro Yasui on Corporate Governance of Financial Groups, paper 20 from the OECD – OCDE, which truly enlightened us.
It was interesting to read that in German law, two types of corporate groups are stipulated: contractual and de facto. A contractual group is formed when the parent and the subsidiary enter into the contract that gives the parent the right to control the subsidiary. In this case, the management board of the parent can issue direct instructions to that of the subsidiary even if the instructions disfavour the subsidiary, as long as they serve the interest of the parent and they do not threaten the existence of the subsidiary. In the case of loss, the Parent would bear the liability. When the parent has effective control over the subsidiary without such a controlling contract, a de facto group is considered to form. In a de facto group, all acts and transactions induced by the parent that disadvantage the subsidiary must be reported, audited and fully compensated within a year.
Simply put, a governance structure is a system of rules, practices, and processes that guide how an organization is directed, controlled, and held accountable. This concept applies to group entities just as it does to individual ones, and the choice of structure can be centralized or localized.
Centralized corporate governance treats subsidiaries as branches of the parent organization. The parent oversees operations and control, often appointing the subsidiary’s Board while limiting its role to management monitoring. This works best when the subsidiary is wholly owned by the Parent, avoiding conflicts with other shareholders.
On the other hand, a Localized governance structure recognizes that the subsidiary may be part of a joint venture or have significant independent shareholders. The subsidiary’s Board operates with independence, factoring in the parent’s views as part of its decision-making process.
When establishing a governance structure for a group, Parents should consider:
1. Understanding the group’s structure, member entities, ownership, and operational jurisdictions.
2. Their representation on subsidiary Boards.
3. Establishing the right committees, potentially including a group oversight committee.
4. Aligning group-wide objectives, policies, culture, and management systems.
5. Developing a method to cascade group strategy and reporting.
6. Implementing controls for risk management, internal audit, and compliance oversight.
We’re here to discuss and guide you through developing your frameworks. The time to shape effective governance is now! 😎