EXPOSURE DRAFT FOR COMMENT AND DISCUSSION ONLY …...The emphasis in the King IV Report on Corporate...
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EXPOSURE DRAFT FOR COMMENT AND DISCUSSION ONLY
NOT BE QUOTED OR REFERRED TO UNTIL THE FINAL VERSION IS PUBLISHED
GROUP GOVERNANCE FRAMEWORK - DRAFT 24 AUGUST 2018
CONTENT
EXECUTIVE SUMMARY
INTRODUCTION
CURRENT CHALLENGE: WHAT IS THE PROBLEM
ADDRESSING THE CHALLENGE: BEST PRACTICE GUIDELINES
ROLE CLARITY
GROUP CORPORATE GOVERNANCE
AUTHORITY AND RESERVED POWERS
OPERATING ACROSS JURISDICTIONS
IMPACT OF STRUCTURE ON IMPLEMENTATION OF BEST PACTICES
CONCLUSION
APPENDIX 1: GUIDELINE CONTENT FOR A GROUP GOVERNANCE FRAMEWORK
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EXPOSURE DRAFT FOR COMMENT AND DISCUSSION ONLY
GROUP GOVERNANCE FRAMEWORK
DRAFT 24 AUGUST 2018
EXECUTIVE SUMMARY
The Challenge
A company is a separate legal entity and where a number of companies are linked to each
other this is referred to as a group of companies (or group) for the purposes of this paper.
The holding company, especially in the case of a wholly owned subsidiary, creates a
subsidiary to achieve certain strategic objectives. However, legally, the board of directors of
the subsidiary has authority to direct the affairs of the subsidiary.
In a group context this gives rise to tension between the interests of the shareholder (in
many cases a sole or majority shareholder of the subsidiary – also referred to as the “holding
company”) and the duty of directors of the subsidiary (often appointed by the
shareholder/holding company ) to take decisions in the best interest of such subsidiary.
In the light of the above it is not uncommon to find circumstances that give rise to:
— increased exposure to risk for the group and holding company ,
— inappropriate/excessive oversight by the holding company,
— dilution of accountability at the subsidiary board level and
— lack of strategic and governance alignment between the holding company and
subsidiary.
Addressing the Challenge
A fine balance is therefore needed to ensure alignment regarding the holding company’s
strategic direction and implementing appropriate group governance on the one hand, while
at the same time doing so in a manner that recognises the role and duties of the subsidiary
directors and management, and the context within which they operate, on the other.
The emphasis in the King IV Report on Corporate Governance™ in South Africa 20161 (King
IV™) is on the development of a group governance framework to assist in managing this
relationship.
1 The King IV Report on Corporate Governance for South Africa 2016, Copyright and trademarks are owned by the Institute of Directors in Southern Africa” and the IoDSA website link is: http://www.iodsa.co.za/?page=AboutKingIV
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Group Governance Framework
This paper considers further guidance on the implementation of best practices, in support of
the King IV™ practice recommendations, including the nature and content of such a group
governance framework, which is set out in appendix 1.
In summary it is recommended that a Group Governance Framework should address the
following as a minimum:
In respect of Role Clarity:
Leadership and Governance: The holding company should consider what is of most importance to achieve the group objectives, and set direction for how the relationships and exercise of power within the group should be conducted, and in that context, determine what will be locally or centrally driven.
Strategy and Performance: Clarity regarding the accountability and process for
strategy development and target setting
In respect of group corporate governance:
Monitoring and Oversight: The key governance outcomes and particular governance
issues relevant to the subsidiary should be agreed between the holding company and
subsidiary.
Group Policies: The nature and extent to which policies, structures and procedures will be centralised or devolved to local level should be clear, taking into account the risks a subsidiary represents and the maturity and effectiveness of its governance.
In respect of authority and reserved powers:
Reserved powers: Matters that the holding company wishes to reserve for its decision making (shareholder reserved matters) should be clearly set out in the constitutive documents (memorandum of incorporation or equivalent) of the subsidiary and should be limited to what is reasonably necessary.
In respect of operating across jurisdictions:
Global policies need to be modified for local use to ensure that these are locally relevant, and importantly abide by local laws.
The impact of different legal structures on implementation will also be considered.
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CONTEXT
A company is a separate legal entity and where a number of companies are linked to each
other through direct or indirect shareholding, or one is the subsidiary of another or the same
party directly or indirectly controls each of them, this is referred to as a group of companies
(or group) for the purposes of this paper. It should be noted that a group of companies does
not as such have a legal personality or legally recognised rights and each company within
the group retains its own separate legal personality.
The focus of this paper is on the role of the holding company as a shareholder, and how it
can in that capacity ensure effective governance of its subsidiaries/associated entities within
the context of a group of companies.
While the understanding of the holding company and subsidiary relationship is growing,
some of the recent corporate scandals where a holding company is exposed to risks at a
subsidiary company level has once again focused attention on this important relationship.
The emphasis in King IV™ is on the development of a group governance framework to serve
as a foundation and provide the parameters within which these relationships can be
effectively managed in the interest of all concerned.
This paper will consider further guidance on the implementation of best practices, in support
of the King IV™ practice recommendations regarding group governance.2
It is written with a particular focus on holding companies and subsidiaries operating in South
Africa but may serve as guidance for all companies operating in a multi- jurisdictional group
context.
CURRENT CHALLENGE: WHAT IS THE PROBLEM
The holding company, especially in the case of a wholly owned subsidiary, creates the
subsidiary to achieve certain strategic objectives. A large part of achieving those strategic
objectives requires an alignment with the vision and goals of the holding company. However,
legally, only the board of directors of the subsidiary has authority to manage the affairs of the
subsidiary and, by law, these directors are required to act in the interest of the entity of which
they are directors.
In a group context this gives rise to a tension between the interests of the shareholder (in
many cases a sole shareholder of the company – also referred to as the holding company)
and the duty of subsidiary directors (appointed by the shareholder) to take decisions in the
best interest of the subsidiary (which sometimes could be in conflict with the strategic
direction of the holding company), if not well managed.
As legitimate as these holding company concerns are, imposing its will on the subsidiary
without due regard for the role and duties of the subsidiary directors could expose those
2 Principle 16 of King IV™ refers to the adoption of a stakeholder inclusive approach that balances the needs, interests and legitimate expectations of material stakeholders in the best interests of the organisation over time. This principle is relevant in the context of a group of companies where both holding company and subsidiary could potentially be regarded as an important stakeholder of the other.
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subsidiary directors to liability for failing to fulfil their duties as directors and at the same time
attract direct liability for the holding company.
In the light of the above it is not uncommon to find: increased exposure to risk by the holding
company, particularly reputation and brand risk; or that the subsidiary may fail to achieve its
purpose within the group, inappropriate /excessive oversight over subsidiaries; dilution of
accountability if subsidiary boards become rubber stamps; and a lack of alignment on
strategy and governance.
A fine balance is therefore needed to ensure alignment regarding the holding company
strategic direction and implementing appropriate policies and control on the one hand, while
at the same time doing so in a manner that recognises the role of the subsidiary directors
and its management. A well drafted Group Governance Framework could assist in achieving
this delicate balance.
These challenges are heightened when a group of companies operates in different
jurisdictions and different group structures may also impact how best practices in this regard
can be implemented.
ADDRESSING THE CHALLENGE: BEST PRACTICE GUIDELINES
In terms of King IV™ , the recommended practices regarding group governance requires
that the board of the holding company should assume responsibility for governance across
the group by setting the direction for how the relationship is to be conducted, supported by a
group governance framework to give effect to its direction on the relationship.
In addressing this challenge and in seeking to strike the proper balance, it is important to
start with an understanding of the respective roles of the holding company and subsidiary
boards within the context of a group of companies, having regard to the relevant legal
framework.
This paper will consider further guidance for the nature and content of such a Group
Governance Framework in the context of the following:
• Role clarity
• Group corporate governance
• Authority and Reserved Powers
• Operating across jurisdictions
[In support of King IV™ Principle 16 Practice Recommendation 11-12]
1. There is a need for effective governance of subsidiaries but this needs to be managed within a framework that is consistent with good governance principles and practices.
2. Ultimately, the objective is to achieve balance: alignment and effective monitoring by the holding company whilst respecting the roles and boundaries of the subsidiary and its directors, thereby limiting the risk of liability, both for the holding company and the subsidiary as well as the respective directors.
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There may be other challenges that a group of companies may experience, however, for the
purposes of this paper the focus is on the above which are regarded as the key challenges.
ROLE CLARITY
Role of Holding Company
It is important to bear in mind that the holding company may have different roles in relation to
its subsidiary. The holding company may be a lender and in that capacity may in terms of
contract (the loan agreements), contractually negotiate for whatever rights it may require
similar to any other lender. There may also be a supplier and customer relationship between
these entities in terms of which one provides certain services and/or products to the other.
Again, contractual terms on an arms-length basis should govern this relationship.
Employees of the holding company may have certain managerial roles of support to the
subsidiary management.
Finally, the holding company has a role as shareholder, and in that capacity needs to ensure
effective governance within the context of the governance of the group. In its capacity as
shareholder it has the rights that any other shareholder may have and there is an obligation
on the subsidiary to treat all shareholders equally.
3. Legal and Governance Framework [In support of King IV™ Principle 16 Practice Recommendation 13, 15] 3.1. In South African law, every company, whether a holding company or a subsidiary, is regarded as
a separate legal entity with its own rights and obligations. In fulfilling his/her duties, a director of a company (including a subsidiary) is obliged to act in the best interest of the company (or subsidiary) on which board that director serves.
3.2. Adopting a stakeholder inclusive approach as required by King IV™ and contemplated in South
African law, means that the best interests of the company are not necessarily always equated to the best interests of shareholders. The legitimate and reasonable interests of material stakeholders, including those of shareholders, must be taken into account.
4. Role of holding company vis-à-vis subsidiary [In support of King IV™ Principle 16 Practice Recommendation 16]
4.1. The holding company should consider what is of most importance to achieve the group
objectives, and set direction for how the relationships and exercise of power within the group should be conducted, and in that context, determine what will be locally or centrally driven.
4.2. This may include: 4.2.1. Alignment on the strategy and this may mean input into subsidiary business plans and
budgets 4.2.2. Alignment on processes in to manage key areas 4.2.3. Effective group processes and policies to regulate key matters 4.2.4. Involvement in the appointment of key members of staff in the subsidiary
4.3. The process should allow for the effective input of the subsidiary board into group matters affecting the subsidiary.
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The holding company should consider what is of most importance to achieve the group
objectives. This may include:
Alignment on the strategy and this may mean input into subsidiary business plans
and budgets
Effective group processes and policies to regulate key matters
Involvement in the appointment of key members of staff in the subsidiary
Considering what matters may need to be reserved for shareholder (holding
company) approval
Proportionality ( adapting practices for what is suitable and appropriate for the
particular entity) and the impact thereof on each subsidiary within the group
Role of the Subsidiary
Acting objectively and independently does not mean that subsidiary directors should
disregard any involvement by the holding company.
In certain instances, effective collaboration with a holding company, including alignment with
the group objectives, may indeed be in the best interest of the subsidiary as well.
The important aspect is to ensure that this collaborative relationship allows for the effective
input of the subsidiary board in all subsidiary related matters and the adaptation of group
processes and policies where required, in the interests of the subsidiary.
GROUP CORPORATE GOVERNANCE
5. Group Corporate Governance
[In support of King IV™ Principle 16 Practice Recommendation 14, 16, 17]
5.1. Corporate governance principles and practices as recommended by King IV™ should be
applied across groups based on proportionality, to ensure relevance and appropriateness for subsidiaries.
5.2. The key governance outcomes and particular governance issues relevant to the subsidiary
should be articulated and agreed between the holding company and subsidiary in terms of a Group Governance Framework.
5.3. Some of the important issues that present common challenges and should be considered for
inclusion in a Group Governance Framework include: leadership, strategy and corporate citizenship, information management, integrated reporting and assurance. Further information regarding the content of the Group Governance Framework is set out in appendix 1.
5.4. The nature and extent to which policies, structures and procedures will be centralised or
devolved to local level should be clear, taking into account the risks a subsidiary represents and the maturity and effectiveness of its governance.
5.5. There should be clear accountability at holdings and subsidiary level for engagement, monitoring and communication on governance matters.
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King IV™ defines corporate governance as the exercise of ethical and effective leadership by the governing body towards the achievement of the following governance outcomes:
Ethical culture,
Good performance, which is the result of the value creation process,
Effective control, and
Legitimacy.
It is crucial for the mitigation of risk as well as to ensure alignment regarding performance
and the achievement of the desired governance outcomes, that the holding company and
each company in the group (and therefore the group as a whole), clearly articulate and
agree the expectations regarding governance.
The particular governance issues of importance for each group will need to be determined
by the group as explained above, and will need to specific and relevant for a for a particular
group.
However, some of the important issues that present common challenges in a group context
are discussed below.
Leadership, Strategy and Corporate Citizenship
Integrated thinking is one of the underpinning philosophies of King IVTM and forms the
foundation of the governance outcomes. In a group relationship it is important for the holding
company that the fundamental issues regarding the social, economic and environmental
context, including corporate citizenship are adequately addressed throughout the group.
It is of crucial importance that there is leadership alignment and commitment regarding
integrated performance targets, ethical values and outcomes, and the governance of risk
and ethics in each company within the group structure.
Standardised training programmes across all entities within a group with regard to ethics and
compliance may be appropriate in certain circumstances and can assist in developing a
common culture and values.
Certain areas of risk expose the entire group and not just the particular entity where the risk
arises. Examples include reputation, cybersecurity and the protection of information. For
example, insofar as ethics are concerned, where companies have a South African, USA or
EU presence, the impact of a subsidiary being involved in corrupt activities or bribery could
have significant implications for the entire group, even if that subsidiary is not located in
these jurisdictions.3
The challenge regarding corporate citizenship and social and ethics issues is also increased
when dealing across jurisdictions, and this has been discussed further below.
3 This has been widened in the UN convention to include all countries (to confirm exact reference).
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Policies
There is a need for alignment regarding policies but it can also assist in avoiding duplication of effort. Subsidiary boards should therefore consider and where appropriate adopt the suite of policies required by the holding company, with or without amendment. It is crucial to acknowledge that subsidiary boards cannot replicate everything the holding company does. What is required is the principle of proportionality - the mindful application of governance practices to the specific circumstances of the subsidiary in question in light of its nature, size, and the industry in which it operates, as well as the local institutional and legal framework and operating environment. This approach requires an appropriate approach to these matters by each company within the group. In many groups, standardisation may be required to some extent and this needs to be agreed. For example, standardisation with regard to remuneration, job grading and executive and employee training allows not only for economies of scale but also facilitates mobility within the group.
Information Management
Disclosure of Information
The fact that one is operating within a group context does not necessarily mean that the
information of a particular company can be shared throughout the group.4
Policies and procedures in respect of the disclosure of information internally in groups
should be clear to ensure the appropriate flow of information, particularly in a regulated entity
where the holding company and /or a subsidiary may be listed. This would be of particular
importance at a time where there may be corporate or other similar actions where
information flow has to be strictly controlled and confidentially maintained within the group to
limit the risk of insider trading.
Each company within a group may need to specifically agree that information that individual
directors obtain could be shared outside the particular company within the group, and on the
conditions related to such disclosure. The challenge in this regard is even greater when
dealing with subsidiaries that are not wholly owned as is explained below.
Serving on more than one board could also lead to a situation where a conflict of interest
may arise and will need to be managed effectively. This may mean that certain executives
may need to be excluded from receiving certain information which would compromise their
respective positions vis-à-vis a particular company/ies.
Where a holding company is listed it will be necessary to ensure that access to information
within the group which could be considered price sensitive is controlled as required by the
applicable listing requirements and applicable legislation.
Considering the requirement of most stock exchanges for equal treatment of all shareholders
of the same class of shares, the favourable position of a holding company, for example, in
having access to material information that other shareholders may not be privy to, should be
carefully managed.
4 Sec 76(2) of the Companies Act does allow some flexibility regarding wholly owned subsidiaries regarding the use of information but this does not negate the caution highlighted.
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Information Technology (IT) and the Protection of Information
A number of jurisdictions have implemented laws and regulations for the protection of
personal information of third parties. The absence of adequate systems and processes of
control could render the holding company or associate companies liable, even if a
transgression occurred only in one entity.
More importantly, cybersecurity is crucially important as a breach in IT systems in one entity
could allow access to the information and systems of the entire group where these systems
are shared. It is therefore important that steps are taken to ensure that these matters are
well managed across the group of companies.
Integrated Reporting
Principle 5 of King IV™ provides “that reports need to be issued to enable stakeholders to
make an informed assessment of the performance of the organisation …”
It is also important that the Group Governance Framework clarifies the process for external
reporting, especially in terms of timing. Where the holding company or subsidiary is a listed
company, understanding of the reporting schedules and ensuring the proper timing of
reporting and disclosures is important.
Importantly, there should be alignment on how issues such as materiality and the report
scope and boundary should be addressed, as well as the process and accountability for the
Integrated Report.
In addition, the manner in which the group is governed should also be reported on.
External Audit
In some circumstances, an auditor (the group engagement partner) might involve other auditors (the component auditor) to audit certain business activities or entities which will be included in the group financial statements. These components may sometimes operate in different jurisdictions.
The process of assurance, and in particular the role and appointment of external auditors, is becoming an area that requires attention. In some of the recent corporate scandals, notably in the Steinhoff matter5], the role of the holding company and subsidiary auditors has been put into sharp focus, especially since the group included entities across various jurisdictions, and different auditors who were not always within the same network. The question which arises is whether the group should appoint auditors from the same network across the group, irrespective of whether it is in the same jurisdiction or not, or whether the appointment of different audit firms within a jurisdiction, or audit firms from different networks across jurisdictions, might dilute the assurance which the group auditor (the Group Engagement Partner) provides.
Either model could work and each comes with its own practical challenges. However, the appointment of different auditors to audit components of the group should not affect the assurance provided on the group financial statements by the group auditor.
Where the same audit firm performs the entire group audit, the knowledge and understanding of the entire group and the audit work performed is a useful advantage and provides the group auditor with comfort to accept responsibility for the audit opinion on the group financial statements. Where the group auditor does not audit all the components of the group, he/she nevertheless must perform additional procedures on material components to accept full responsibility for the assurance provided on the group financial statements. For
5 To be inserted
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this the group auditor must communicate with the component auditor directing them to perform sufficient audit work on the component and monitoring whether such work has been performed to the standards expected. Professional scepticism must be applied by the group auditor when evaluating the work of the component auditor in forming the opinion on the group financial statements.
In terms of auditing standards requirements, prior to December 2009, International Standard on Auditing6(ISA) 600, Using the Work of Another Auditor, included a section on the division of responsibility which addressed this issue as follows in this regard: “While compliance with the guidance in the preceding paragraphs is considered desirable, the local regulations of some countries permit a principal auditor to base the audit opinion on the financial statements taken as a whole solely upon the report of another auditor regarding the audit of one or more components. When the principal auditor does so, the principal auditor’s report should state this fact clearly and should indicate the magnitude of the portion of the financial statements audited by the other auditor."
However, this is no longer included in the ISA 600 and the principal auditor (now referred to as the group engagement partner) has to accept full responsibility for the group audit.
Directors, especially the audit committee, should display healthy scepticism before accepting information without questioning its credibility in circumstances where reasonable enquiry is necessary.
The important point is to ensure that there is clarity on the process of appointment, scope of the engagement of each auditor and the manner in which information is shared and exchanged between the respective auditors.
The legislation regarding the appointment and rotation of auditors, especially mandatory audit firm rotation, may differ where the group operates in different jurisdictions, and this should be taken into consideration by the group.”
AUTHORITY AND RESERVED POWERS
6 ISA 600, Special Considerations – Audits of Group Financial Statements (including the work of component
auditors), section 18. The ISA were adopted in January 2005 for use by auditors in South Africa
6. Delegation
[In support of King IV™ Principle 16 Practice Recommendation 16, 11-12]
6.1. Matters that the holding company wishes to reserve for its decision making (shareholder reserved matters) should be clearly set out in the constitutive documents (memorandum of incorporation or equivalent) of the subsidiary.
6.2. The shareholder reserved matters should be limited to what is reasonable necessary, considering the balance of interests required.
6.3. The board of the subsidiary should be consulted regarding the determination of the shareholder reserved matters.
6.4. In instances where the subsidiary board delegates authority to a holding company committee, it should be understood that the holding company committee acts in terms of that delegation and not its shareholder role, and should account to the subsidiary board in this regard. The directors of the subsidiary should integrate the functioning of such a committee into the work of the subsidiary board.
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King IV™ (Part 5.5) recommends that the board of the holding company should ensure that
the Group Governance Framework recognises each subsidiary within the group as a separate
and independent juristic person to whom its directors owe fiduciary duties. It is only possible
to give proper effect to this recommendation if the board of directors of the subsidiary is given
adequate authority to enable such board to be in effective control of the affairs and the
business of the subsidiary.
In a group of companies, the formal delegation of authority framework approved by the board
of directors of the holding company often incorporates the “rules of engagement” as far as a
subsidiary in the group is concerned.
It is also not uncommon to find the delegation by a subsidiary to the committees of the holding
company – for example, regarding investments over a particular threshold. A holding company
may also create committees at the holding company level to serve as the committees for such
for the subsidiary/ies as well (for example, Social and Ethics committee, Audit Committee).
It is important to point out, however, that the board of a holding company is not in effect
“delegating” any functions to the board of directors of the subsidiary as the board of the
subsidiary has the legal authority to direct the business and affairs of the subsidiary.
This does not mean that the holding company, in its capacity as shareholder of the subsidiary,
is not afforded any rights when it comes to the management of the business and affairs of a
company. In addition to the Companies Act, No 71 of 2008 (Act) requiring approval by
shareholders in certain instances, shareholders could potentially negotiate additional approval
powers by including a list of other matters that would require shareholders’ approval,
commonly known or referred to as “shareholder reserved matters”, in the memorandum of
incorporation (MOI) or shareholders agreements.7
Where such limitation on the board of the subsidiary is imposed (whether by the Act or the
MOI), it is important for the processes and procedures to not only be clearly spelled out and
closely followed but also to adequately provide for involvement by the board of the subsidiary
in the actual decision-making process..
This should enable the board of directors of the subsidiary to properly apply its mind to the
matter and to make a recommendation to the board of directors of the holding company that
it honestly believes to the in the best interest of the subsidiary.
The limitation should also be limited to what is reasonably necessary. The holding company
leadership should therefore be mindful of the fact that should they “take over” the running of
the subsidiary, it will expose the holding company and the subsidiary board to liability. This is
the case at common law in jurisdictions like South Africa and may be legislated in others. For
example, in Rwanda, an amendment to the insolvency legislation makes a company related
7 It is important to note however that based on South African law, the MOI takes precedence over the shareholders’ agreement in the event of a conflict between the provisions of these two documents.
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to the company in liquidation liable for its debts if it is found (inter alia) to have taken part in
the management of the company in liquidation.8
Board of directors of subsidiary
As indicated above, one of the important factors to be considered is the need for the board of
the subsidiary to be empowered to effectively fulfil its statutory and fiduciary duties
A board that is seen to be “abdicating” its duties and responsibilities, even if under instruction
of the shareholder to do so, could be regarded as having failed in its duties towards the
company. This could not only put the holding company and its directors at risk, by being held
directly accountable for the decisions made in the subsidiary due to their involvement, but
could also potentially lead to the directors of the subsidiary being held personally liable for the
damages and/or harm caused by the subsidiary or as a result of such failure.
OPERATING ACROSS JURISDICTIONS
In general terms, there is always a challenge when operating in different jurisdictions as the legal, institutional and regulatory frameworks are different and there is a need to adhere to all of the applicable requirements. In addition, the different commercial and marketing environment may also require the implementation of different marketing and commercial strategies.
There is no discretion when considering compliance with laws and the laws of any particular
country will need to be adhered to by those operating in such country. The bigger risk in this
8 South Africa: Pooling of Assets in Rwanda
7. Operating across Jurisdictions
7.1. Global policies need to be modified for local use to ensure that these are locally relevant, and importantly abide by local laws.
7.2. A Group Governance Framework should make it clear that any group requirements will be applicable only insofar as they do not conflict with local laws.
7.3. All companies in the group should apply the highest standard of conduct that is applied by the
group generally, and in particular, regarding social and ethical conduct.
7.4. Social and Ethics Issues
The local organisation needs to be relevant to the market that it operates within. Therefore the holding company and subsidiary should ensure alignment and clarity on the application of key global strategies and policies, in the context of local imperatives, including with regard to the following:
Appointment of expatriate personnel
Recruitment and remuneration
Meaningful investment in skills development
Composition of governance structures
Sourcing and supply chains
Establishing of social and ethics committees
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context and area for attention is not that a group subsidiary will contravene local laws, as the
local board will be held liable.
The area of greater exposure is where activities by a subsidiary, which may be lawful in terms
of local legislation, exposes the holding company to liability or action due to a contravention
of a law or requirement that the holding company is subject to. For example, a holding
company can be listed in a jurisdiction subject to various obligations in terms of sanctioned
countries. These requirements may not have direct application to a subsidiary in South Africa
but a contravention by the subsidiary could make the holding company liable for the subsidiary
action.
Where a subsidiary operates in an environment with a “lower” level of regulatory compliance,
actions by such a subsidiary that may be lawful in its own country, but unlawful in the holding
company jurisdiction, could potentially expose the holding company to liability in instances
where the offence could be imputed to the holding company. For example, the more stringent
bribery legislation in the UK as well as in South Africa have extra territorial effect and could
hold a South African or UK citizen (as may be applicable) liable for a contravention in a
jurisdiction outside of SA or the UK.
Further, even if the holding company could not be held legally liable, the reputational harm
could have a significant negative impact on its brand.
The Group Governance Framework should therefore ensure that these issues are
appropriately regulated.
Corporate Citizenship, Social and Ethics Issues
When operating in different jurisdictions it is important that the organisational values are not
compromised where certain practices that are not acceptable in one jurisdiction may be
acceptable in another. There are different cultures in different operating environments as well.
The highest agreed standard should be applied by each company in the group.
In South Africa there are specific requirements regarding transformation and Broad-Based
Black Economic Empowerment (B-BBEE), the need for establishing social and ethics
committees and an emphasis on responsible corporate citizenship that may not be present
in all other jurisdictions. Similar issues arise for companies operating in African and other
developing country markets, where there is also an emphasis on “indigenisation” programmes
similar to B-BBEE and a great need for access to basic services for a majority of the
population.
In these developing countries, social impact risk is as important to manage and report on as
operational or financial risk. A company’s lack of commitment to issues of gender, race, pay
parity, social cohesion, human rights, and inclusivity could directly result in fines, black-listing
or the increasing threat for a boycott of products of such companies that do not support the
development agenda.9 This could affect the group’s reputation and brand as well as the licence
to operate.
9 In certain instances, if the inclusion of a B-BBEE partner is not allowed to be appropriately involved in the business, it could amount to fronting which could impact that entity’s B-BBEE score, but is also unlawful
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These issues could potentially result in tensions between the holding company and subsidiary,
especially where certain globally driven initiatives bring economies of scale or desired
standardisation.
Therefore, there should be effective alignment and collaboration between a holding company
and subsidiary regarding issues such as:
Human resources and recruitment policies (employment equity) –will the need for employment equity /indigenisation allow a departure from global policies and how will this affect the appointment of expatriate personnel
Composition of Governance structures – how and to what extent will local requirements
regarding transformation, diversity, gender and racial balance be balanced with the
need to appoint holding company employees in key positions Sourcing and supply
chain policies and practices – to what extent will local requirements for B-BBEE allow
a deviation from global policies
Establishing of social and ethics committees where no such requirement exists
elsewhere in the group
Social and ethics standards - what standards and requirements are necessary
regardless of local requirements
Establishing social and ethics committees
This is crucially important to ensure that imperatives regarding social and ethics issues are
managed effectively across the group.
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IMPACT OF STRUCTURE ON IMPLEMENTATION OF BEST PRACTICES
It is now necessary to consider whether and if so, the extent to which, group governance
may need to be adapted when taking into account the nature and structure of the entity one
is dealing with.
50% Joint Venture (JV)
Joint venture structures will be regulated primarily by an appropriate JV agreement and or
shareholders agreement providing inter alia for the rights of both parties in relation to key
aspects of the JV or the relationship.10
In an incorporated JV (i.e. where a JV company has been formed) either shareholders (or
each holding company if you prefer) need to agree as a part of the JV or shareholders
agreement how the affairs of the subsidiary will be managed. In particular, the agreement
10 In certain instances an unincorporated JV is established. This particular structure is not further elaborated on as the unincorporated JV does not fall within the scope of this paper.
8. Impact of Different Group Structures
50% Joint Venture(JV) 8.1. The two holding companies should engage with each other and align on how the subsidiary would
be governed, and how the guidance provided in this paper will be applied.
Minority Shareholder 8.2. As with the 50% JV model, there still needs to be engagement between the various shareholders
regarding the operations and governance of the subsidiary company.
8.3. Special care must be taken to ensure that a minority shareholder is not being prejudiced for the benefit of the majority and/or other minority shareholders.
Non Profit Organisations (NPOs) /Non Profit Companies (NPCs) 8.4. Noting its unique challenges as an NPO/NPC in a group of companies, the group governance
framework should determine the process in terms of which strategy for the subsidiary of a not for profit holding company will be developed and approved, and the principles and processes that will inform the development of commercial policies to the extent required.
8.5. Care should be taken in considering and establishing the governance framework for and relationship between a non-profit holding company and its subsidiary not to compromise the tax status of the non-profit entity.
8.6. Where a for profit company creates a NPO/NPC the application of the holding company
requirements and policies should be considered taking into account proportionality and the particular context within which an NPO/NPC operates.
Private Public Partnerships (PPP) 8.7. It is important to identify the public sector law, policy, governance and operational issues that may
need to take precedence in the PPP, and the extent to which the applicable framework for group governance in the private company group may have to be adapted, and in that context to understand the risk (if any) that result from any deviations that are required. It is also important to consider the extent to which public sector requirements can be limited by agreement.
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should provide for the manner in which key strategies, policies, governance and other
processes, key appointments and structures will be established and managed.11
The main issue to deal with in this structure is how the two “holding” companies engage with
each other and align on what gets proposed for approval to the subsidiary board - or whether
the subsidiary board is allowed the flexibility to determine these choices.
It should be noted that in terms of South African law, the newly formed entity could be
regarded as a subsidiary of both holding companies.
Company with Minority Shareholders
As with the 50% JV model, there still needs to be engagement between the majority and
minority shareholders regarding the operations and governance of the entity in which these
shareholders have invested. The same principles apply as with a wholly owned subsidiary,
but there needs to be a specific discussion between the various shareholders to ensure at
the outset that the relevant agreements provide clarity on operational and governance
matters.
In addition, as holding company strategy and policies are considered by the subsidiary
board, special care must be taken to ensure that the minority shareholder or other
shareholders are not being prejudiced for the benefit of others. The unfair discrimination or
treatment of shareholders, whether majority or minority, should be avoided.
Non Profit Organisations (NPOs) and Non Profit Companies (NPC)
NPOs or NPCs may hold interests in subsidiary companies and may also need to consider
the issue of group governance. There are unique challenges for a group governance
framework relating to NPOs/NPCs as the shareholder or holding entity.
It should be noted that NPOs could be NPCs, trusts or voluntary associations, each with
their unique regulatory universe. In this section, reference is made to NPO which could be
any of the aforementioned legal structures.
First, in the non-profit sector, entities may be public benefit organisations that enjoy tax
exempt status. The subsidiaries could be profit companies and one of the key considerations
in managing the group relationship will be to ensure that the tax-exempt status of the holding
entity is not compromised.
Second, by its nature as an NPO, some of its strategies, policies and practices may be
totally inappropriate in a profit company.
Third, which may be the most important and difficult to manage, is to ensure that in the
pursuit of profits by the subsidiary, it acts as a responsible corporate citizen in a responsible
and ethical manner so that its action should not negatively impact the reputation and work of
the NPO. While this aspect is important for all companies, it is magnified in the context of an
NPO.
For example, through the Group Governance Framework, memorandum of incorporation
and other appropriate instruments, the NPO as holding entity should:
11 Shareholders should be mindful that in terms of South African law the memorandum of incorporation of the JV subsidiary will take precedence in the event of a conflict between the provisions of the shareholders’ agreement and the said memorandum of incorporation. It is vital to ensure alignment between these two sets of legal documents.
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Set out the key policies relating to ethics, corporate citizenship and sustainability that
it wishes to propose for adoption by the subsidiary.
Identify the process in terms of which strategy for the subsidiary will be developed
and approved, and include reserved powers to approve certain critical aspects of the
strategy, relating to, for example, the nature of investments permitted (ethical
investments), and operating in areas prone to human rights violations and labour
practices.
Identify the principles and processes that will inform the development of commercial
policies applicable to the subsidiary.
A similar challenge could arise where the NPC is under the “control” of a profit company as
is common with various foundations that are created by major organisations. The approach
should be similar and the different operating context of the NPC must be taken into account
when considering the implementation of group strategies and policies designed for a
commercial environment. Of course certain issues relating to culture and values, for
example, may be universally applicable.
Private Public Partnerships (PPPs)
PPPs refer to a separately established company that is owned in partnership by a private
company and government (at national, provincial or local level) directly or indirectly through
a state owned entity or company.
The shareholders or “holding companies” in this instance will be government or the relevant
state-owned entity and the private company. The PPP may be part the group of each
shareholder/holding company.
What is set out above regarding the 50% JV entity or a company with minority shareholders
is equally applicable in the PPP structure based on the relative shareholding.
However, it becomes increasingly complicated where the relationship involves government
or a state-owned entity as shareholders, as there needs to be clarity regarding the extent to
which certain public sector policies and legislation will be applicable to the PPP.
In certain instances, for example in South Africa, where government or the state-owned
entity has a majority interest, the PPP may be subject to the requirements of the Public
Finance Management Act, No 1 of 1999 (PFMA). Some of the requirements of the PFMA
which require specific approvals by a particular minister or limit the scope of the PPP may
not be acceptable to the other shareholder.
It will therefore be necessary in these instances to ensure that in the negotiations to
establish the PPP, the implications for the PPP of the public sector policy, governance and
operational issues that need to be clearly understood. Where they are applicable by law, it
means that each party needs to understand the implications of such requirements.
Alternatively, to the extent that they can be agreed or exemptions obtained for the particular
PPP, these need to be properly explored so that the group governance framework to be
implemented has factored in these unique requirements.
In addition, the private shareholder/holding company will need to determine to what extent it
can accept deviations from its own group governance framework, and understand if the risk
(if any) from such deviations are acceptable.
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CONCLUSION
A fine balance is needed to ensure alignment regarding the holding company strategic
direction and implementing appropriate policies and governance on the one hand, while at the
same time doing so in a manner that recognises the role of the subsidiary company directors
and management.
The limitation of the authority of the board of directors of a subsidiary is by itself not an
uncommon or unknown phenomenon. On the contrary, it is very common practice. However,
where such limitation is not carefully thought through and adequately described, limited,
managed and governed, material risks are introduced for all involved, including both the
holding and the subsidiary companies and their boards.
Uniformity and control across a group is not necessarily optimal, efficient or appropriate. It
creates a model that increases risk and relies on a lack of trust and the monitoring of
adherence to rules. What is needed is alignment and empowerment.
A Group Governance Framework, however, can assist in ensuring effective governance within
a group. If implemented effectively, it can be a useful tool to align leadership and strategy,
encourage collaboration and integration while at the same time maintaining accountability and
empowering independent judgement of the various directors within the group.
Most importantly, it can be an effective tool to create value for each entity within a group by
facilitating alignment on the material and important issues, rather than trying to control
administrative processes that frustrate and slow down decision making instead of achieving
alignment.
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APPENDIX 1
GUIDANCE ON THE CONTENT OF A GROUP GOVERNANCE FRAMEWORK
[In support of King IV™ Principle 16 Practice Recommendation 16, 17, 18, 19]
The guidance provided herein should not be regarded as a checklist nor exhaustive of the areas to be considered/included in a Group Governance Framework, and will be impacted by the nature of the company and the industry within which it operates. With regard to the content of a Group Governance Framework, the particular circumstances of the relationship and context within which the holding company and subsidiary operate, will have a significant influence on what is important for the particular entities and how the relationship should be managed. Relevant considerations include, amongst other:
the principle of proportionality,
whether the entities operate across jurisdictions; and
whether one is dealing with a wholly owned subsidiary.
That being said, taking into account the above implementation guidelines, some guidance can be provided regarding what should be considered for inclusion in a Group Governance Framework.
Subject to the above, the following issues should be considered in developing a Group Governance Framework:
AREA CONTENT
Leadership and Governance 1. Protocol on engagement between group entities - including communication between the holding company and subsidiary boards and accountability at holdings and subsidiary level for engagement, monitoring and communication on governance matters.
2. Accountability for and process to determine key governance outcomes including culture, values and vision
3. Minimum governance standards and
principles with regard to strategic direction, policy and planning, effective monitoring and accountability, including reporting and disclosure.
4. Accountability for and process as to how
subsidiaries are established, managed and wound up.
5. Process for appointment to subsidiary boards
and other structures, including minimum requirements regarding induction and ongoing training requirements, as well authority and
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process for approval of key executive appointments.
6. Role and function of holding company board
committees vis-à-vis subsidiaries.
Strategy and performance 1. Accountability and process for strategy development and target setting
2. Clarification of expectations and
determination of integrated performance targets - economic, social and environmental performance
3. Shareholder reserved matters relating, inter
alia, to strategic direction, priorities and geographic markets
4. Risk management: Process for the
identification and managing of risk, especially areas that represent specific risk in the context of the circumstances of the entities - for example, fraud and corruption in certain countries and managing strategic, operational, ethical, reputational and IT/IM risk.
Monitoring and Oversight 1. Reporting format and requirements including alignment on the process of integrated reporting and the Integrated Report in particular.
2. Process to determine issues such as
materiality and the Integrated Report scope and boundary, and accountability for the Integrated Report.
3. Protocol for sharing information, including a
disclosure of information protocol, especially where it is not a wholly owned subsidiary and where the subsidiary is a listed entity
4. Process to appoint external assurance
providers and how they engage with each other across the group, including the requirements (if any) or application of mandatory audit firm rotation
5. Standard and requirements for internal assurance function, including reporting lines.
6. Process to ensure compliance with the Group
Governance Framework
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Group Policies 1. Clarity regarding the nature and extent of policies, processes, structures and procedures to be standardised/centralised or devolved to local level, and the processes for the adoption of group policies at subsidiary level
2. Minimum requirement regarding policies to be in place, including, for example, with regard to HR, dividends, compliance, tax, ethics, risk management, cybersecurity and information management.
3. Minimum criteria or guidelines for policies that
are to be developed by the subsidiary, and criteria and processes for deviations from or adapted application of group policies.
Shareholder reserved powers and Delegation requirements
1. Limitation of authority of subsidiary board or reserved powers (which will need to be given effect through the MOI or appropriate constitutive documents)
2. Minimum requirements for subsidiary delegation of authority framework
Operating Across Jurisdictions 1. The extent of application of key global strategies and policies, in the context of local imperatives, including with regard to the following:
Appointment of expatriate personnel
Recruitment and remuneration
Meaningful investment in skills development
Composition of governance structures
Sourcing and supply chains
Establishing a social and ethics committee
Principles for contracting between group entities
1. Clear and effective dispute resolution mechanism
2. Pricing and cost principles, including transfer
pricing and tax implications 3. Identification of shared services (including
audit, HR, remuneration, payroll, for example)
Implementation in Different Structures
1. Guidelines for the approach and implementation of the Group Governance Framework in 50%JV companies, companies with minority shareholders and PPPs.
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SOURCES
[TO BE COMPLETED LATER ]
Guidance from various articles and professional forums, most notably UK, Canada and
Australia – refer articles attached.
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