Corporate governance for UK group companies and subsidiaries

Out-Law Guide | 18 Aug 2020 | 1:35 pm | 6 min. read

Subsidiaries within a group have separate corporate governance needs to their parent companies. They have their own customers, employees, suppliers and other stakeholders and as independent legal entities have obligations to each as well as to their shareholder.

Retaining sufficient control of what the subsidiary is doing while honouring the independence established by company law is not an easy balance for a group to achieve. It also will be the subsidiary's directors who are responsible for decisions taken in their company's name, and they must act in line with their duty to the subsidiary rather than to the wider group.

Recent changes to UK company law, motivated by a series of high profile corporate failures, require individual companies to disclose more about their internal governance, even when they are part of a wider group.

The regulations

The 2018 Companies (Miscellaneous) Reporting Regulations amend the 2006

Companies Act by adding a number of new disclosure requirements for a company's annual report, each with different thresholds for compliance. The thresholds apply to individual companies regardless of whether they are part of a larger group.

Any UK companies which has either:

  • more than 2,000 employees; or
  • a turnover of more than £200 million and a balance sheet total of more than £2 billion

must now publish an annual governance statement. Companies already required to report on their governance are excluded – for example, those with a premium or standard listing in the UK, which are already required to publish a corporate governance statement by the UK's Disclosure Guidance and Transparency Rules.

The subsidiary's directors are responsible for decisions taken in their company's name, and they must act in line with their duty to the subsidiary rather than to the wider group.

The employee test is most likely to bring companies within scope, particularly in a group where HR policies dictate that all staff are employed through one group company. An employment vehicle with more than 2,000 employees will need to produce a governance statement, even though it may not otherwise trade and have few interactions with other stakeholders. By contrast, other companies that do trade and enter into transactions with a variety of third parties may escape the reporting obligation if they do not hit the employee threshold and are not large enough to meet the turnover and balance sheet tests.

Voluntary compliance is a possibility for those companies that do not satisfy the tests but which nonetheless want to talk publicly about their governance arrangements.

Where a governance statement is required, the company's directors' report will each year need to state which corporate governance code, if any, has been applied by the company during the year; how the code was applied; and any departures from the code and the reasons why. If the company did not apply a named code for the year it must explain that decision, along with the governance arrangements that it applied that year.

Unquoted companies which are under no obligation to publish their accounts on their website must nonetheless make the statement available either on their own website, or on a website that identifies the company in question – for example, a group website.

Only UK companies are caught by the regulations. A non-UK company will not be caught, even if operating in the UK and part of a UK-owned group.

The new rules apply for accounting periods beginning on or after 1 January 2019, which means that annual reports for the year to 31 December 2019 will be the first to carry these new disclosures.

Which code?

Companies caught by these new rules have a number of possible options for compliance.

The UK Corporate Governance Code

The best known corporate governance code is the UK Corporate Governance Code (Code), first produced in 1992 and most recently revised in 2018. Although considerably more concise than previous editions, it retains a formidable set of 18 principles for good governance, along with 41 detailed provisions which a company either complies with or explains why it has failed to comply and what it has done instead.

The Code is designed for UK premium listed companies and so requires, amongst other things, independent non-executive directors; audit, remuneration and nomination committees; and tight controls on director pay. The Code is prescriptive, with many of its detailed provisions having little application for most wholly-owned subsidiaries and other unlisted companies. Adoption of the Code by these entities will therefore often result in a long list of the provisions not followed, with explanations for the reasons why. This is likely to be of limited use to most stakeholders.

The QCA Code

The UK's Quoted Companies Alliance (QCA) produces a more generous code.

The 2018 edition of the QCA Code is widely used by companies whose shares are traded on London's Alternative Investment Market (AIM). It covers many of the same areas as the Code, while giving more latitude to companies to find their own solutions to comply with its 10 principles. It avoids the 'comply or explain' terminology of the Code and instead calls on companies to explain how the broad principles have been applied and to give clear and well-reasoned explanations of any practices that differ from its expectations.

Like the Code, the QCA Code is not designed for subsidiaries and, if adopted by a group company, there would again often be a need for lengthy explanations for non-compliance. The QCA Code has the further disadvantage of not being publicly available, although copies can be obtained at a modest cost and are available to QCA members.

Overseas corporate governance codes

For UK companies owned by a parent incorporated outside of the UK, a third option could be to follow the overseas corporate governance code already adopted by the parent.

UK government guidance accepts this as a possibility, but stipulates that the code should be easily accessible in English via a website and free of charge. This requirement also casts further doubt on the use of the QCA Code.

The Wates Principles

Because of the unsatisfactory fit of both the Code and the QCA Code to companies whose shares are not publicly traded, the UK government commissioned a new code specifically to address the need created by the governance statement requirement.

The Wates Corporate Governance Principles for Large Private Companies (Wates Principles) were published in December 2018 and contain several explicit references to subsidiaries and how they might apply the principles. The Wates Principles do not describe themselves as a code and contain few prescriptive requirements. However, the UK government clearly considers them as comprising a corporate governance code for the purposes of the reporting regulations.

There are six "flexible and high-level" principles:

  • purpose and leadership;
  • board composition;
  • director responsibilities;
  • ·opportunity and risk;
  • remuneration; and
  • stakeholder relationships and engagement.

Each principle is followed by brief guidance setting out what a company might report on. There are no hard and fast rules. Instead, the approach is one of 'apply and explain' - a company should apply the principles in the context of its own circumstances, and then explain how its governance practices achieve what each principle sets out.

The Wates Principles are clearly the most flexible of the available codes and the most adaptable for a subsidiary looking to follow a governance code. However, they still suggest reporting in areas that may not fall fully within the remit of a subsidiary company board - for example, remuneration policy or risk policy.

An internal governance framework

Although the Wates Principles have many advantages for listed groups contemplating how their largest UK subsidiaries should comply with the governance statement requirement, early indications are that a number have decided against selecting any one code or set of principles. Instead, they have opted for the alternative offered by the regulations: to explain why existing codes are not thought entirely suitable and to instead set out their own corporate governance arrangements that have been applied during the year.

This should not be too burdensome a task for a group that already has a well-developed internal governance set-up, even if those arrangements have not always been formalised. Where a group is run on a more ad hoc basis, the requirement to condense governance practices into a public governance statement could be an opportunity to review and re-think what is done and to record these practices in writing in one easily accessible package.

In either case, crafting a bespoke governance practice to suit the needs and circumstances of the business may be preferable to accepting the constraints - however flexible and high-level - of a code designed elsewhere and intended, perhaps, to be applied in a different setting. The headings used by Wates may be a good starting point, with the welcome opportunity to drop those that might not be relevant and to add and adapt others.

A version of this guide first appeared as a chapter by Martin Webster and Tom Proverbs-Garbett in The International Comparative Legal Guides (ICLG) Corporate Governance Guide.