Managing complexity: governance in a fragmenting international framework

One of the most persistent narratives since the global financial crisis has been the sheer volume of new regulation introduced across the globe. For example, there was a 492% increase in global regulatory requirements between 2008 and 2015, according to one estimate. A new source of complexity is now arising from the fragility of transnational institutions and trade relationships.

As complexity increases, so does risk

The largest problem created by complexity is that it increases the likelihood of mistakes. ICSA, the International Association for Corporate Governance, has shown that errors in subsidiary governance are virtually inevitable when a portfolio exceeds a certain size. As the number of moving parts that need to be incorporated into a company’s governance framework grows, so does the number of potential mistakes, which can be costly.

A lack of operational visibility can cause a host of issues. For example, when acquiring an asset in a foreign jurisdiction, it can be extremely difficult to ensure full compliance across a portfolio of multinational subsidiaries that is serviced by a combination of internal and external parties. Issues as simple as company directorships can be potential stumbling blocks when the surrounding rules differ from country to country. There can be serious mismatches between a company’s records and the underlying reality.

One of the most surprising problems that can be caused by cross-jurisdiction acquisitions is where a company has not been properly liquidated - and has become, in effect, a “zombie entity”.

In one such case, a multinational company acquired a portfolio domiciled in Trinidad.

At acquisition, the new owners believed that the company had been liquidated when, in fact, it was still extant and dormant. Worrying scenarios like this can derail an otherwise successful cross-border transaction and will become increasingly common as international regulatory frameworks change.

Three key tips to effectively managing emerging risks and complexity

While the regulatory environment is growing in complexity, there are three relatively simple steps that ensure companies have the correct foundations in place to manage emerging risks.

The first step is that multinational companies must put in place a framework around existing governance rules and regulations, which allows them to understand how they are applicable to its entities. Ultimately, responsibility for outlining and maintaining this framework falls to a company’s secretarial governance. For this framework to be effective, the secretarial officers’ responsibilities on particular rules and frameworks must be clear at the outset.

Within the context of international acquisitions, there is an immediate issue if there is incomplete, missing or incorrect information at the due diligence stage. The information should already be available and visible at the pre-due diligence stage to avoid costly remedies later.

The second step is to assign responsibility for updating and maintaining this information when rules change or new jurisdictions come into play. A corporate structure that operates across borders, time zones and languages is very likely to lack a unified approach to subsidiary governance. This is due to the many internal and external parties who play supporting roles in maintaining governance structures. Inevitably, there will be outside service providers, lawyers, company management firms and audit firms. Naturally, local firms prefer to hire local service providers, but this can undermine a centralized framework.

A particular risk for multinational companies is that corners are cut in an effort to keep operations lean and profitable. However, it is important to ensure cost-cutting is appropriate. Overheads should be reduced through operational efficiencies, not by reducing oversight. Cost-cutting that makes it harder to have full visibility of the entity’s governance can be a short-sighted approach. 

Finally, transparency has to work end-to-end; accountability needs to work in both directions. For example, how can a company know that documentation produced for the Indian market is valid and the requisite deadlines are correct? The ultimate precaution in any framework is to vet locally the validity of any governance-related documentation to ensure compliance with divergent regulation. This is similar to double entry book-keeping.

As the number of jurisdictions a company operates in increases, so does the number and complexity of rules and local advisers. For this reason, it is critical that every effort is made to ensure governance is managed centrally, but tied off locally.

If this does not become the catch-cry of multinational companies, the alternative will be oversights that can be very costly to remedy in future.

By Kariem Abdellatif
Head of Citco Global Subsidiary Governance Services (GSGS)

Citco GSGS Focus, Winter 2019