Navigating the new landscape

Nov 01, 2009
<ul> <li>Subsidiary management is becoming more complicated</li> <li>Growth in emerging markets presents specific challenges</li> <li>Local expertise vital for a successful compliance program</li> <li>Certain jurisdictions require domestic directors and secretaries</li> <li>Well-designed programs boost cost-efficiency and long-term performance</li> </ul>

As the global economy shows nascent signs of being on the road to recovery, many businesses are looking to adapt quickly to take advantage of the change and near-term opportunities. This will mean different routes for different businesses – merger and acquisition activity for some, unlocking value through divesting of non-core divisions for others. Certain private equity houses are likely, in time, to look at realizing many of their investments through IPOs if the capital markets continue to strengthen; other firms will seek to expand internationally, and into emerging markets in particular.

All of these options will have a significant impact on the time commitments of in-house legal teams and corporate secretariats, which typically bear the brunt of a greater level of compliance activity. Nowhere, perhaps, is the challenge of trying to do more with fewer resources more demonstrable than in the field of international legal entity compliance.

Many of these challenges are by-products of – or at least accelerated by – the economic downturn. A push into emerging markets to tap into growth opportunities will result in a greater regulatory focus on corporate governance and internal controls over special-purpose entities in particular, as well as ‘downstream’ international legal entity corporate governance controls and reporting requirements in general. Allied to the greater level of enforcement of the Foreign Corrupt Practices Act, ensuring auditable and robust internal controls over international subsidiaries has never been so vital.

People, process and technology

Conversely, legal and secretarial departments are seeing downward pressure on costs as many companies seek to work in a leaner and more efficient way in order to sustain profitability in a generally deflationary environment. A key starting point for assessing this new landscape, then, is: how can in-house legal teams get more value from current resources? 

The key to this question is to ensure that people, processes and technology are aligned around the world as part of an efficient process approach. Using technology in internet-based legal entity databases plays a vital role in enabling a greater level of transparency of information and immediacy of access, including across functions within the organization.

This does, however, place an even higher premium on the integrity of the database content – and the people and processes involved in maintaining an efficient but rigorous methodology for updating data. This is particularly relevant during a transaction or corporate action, when inaccurate information about directors, signing authorities and share capital structure can cause significant deal drag. 

Some common issues surrounding global entity compliance include the sheer coordination challenges that can be involved in having a large number of subsidiaries. Therefore, all measures should be sought to reduce complexity by looking to simplify each supporting element of compliance as much as is feasible. One obvious step is to consolidate the number and scope of external service providers used, both domestically and internationally. This should make information control easier.

On a forward-looking basis, fully embedding a legal entity management life-cycle approach across the organization, including active monitoring and dissolution of dormant and obsolete subsidiaries, can reduce the compliance burden on the in-house legal team and enable it to meet the needs of the front-office business during demanding times.

Emerging markets, changing regulations

Theories of decoupled global economies were shown to be trailing reality somewhat by the economic crisis. But sources of growth may come from emerging markets, including resource-rich Brazil, which appears to have recently moved out of recession. China also remains a growing powerhouse, fuelled by its large stimulus program. A growing middle class with disposable income in China and Brazil, as well as Russia and India, has made these countries attractive destinations for foreign investors. There can, however, be significant risks to foreign investors if they are not in compliance with local regulations in such emerging markets. 

From a compliance perspective, it’s key to have local knowledge on the ground. In China, for example, corporate regulations vary from province to province. When entering into a joint venture, in particular, it can be a vital control mechanism for a foreign investor to have a local independent service provider that can take custody of the statutory records of the Chinese entity, ensure compliance and – importantly – keep custody of the company chops (an equivalent but more pervasive version of a western company seal).

Gaining control and assurance over filings and compliance with local legislation and any applicable corporate law changes is fundamental. It’s also a great way for the corporate secretariat to demonstrate added value across the business. 

Partially due to differing civil and common law heritage, compliance requirements can vary widely around the world. For example, many countries in Latin America have extensive foreign investment registry compliance requirements. Some countries, such as Brazil and Argentina, in differing ways, place additional compliance burdens on foreign shareholders in terms of domiciliation of legal representation and compliance filings. These can equal the actual compliance burden on the foreign subsidiary itself, and so must be taken into account when incorporating and running entities in these countries.

Another factor to monitor in some countries – such as Switzerland and Brazil – is the need for local resident directors. A variation on this theme to watch out for is the requirement to have a local resident corporate secretary; this is compulsory in Hong Kong and Singapore.

Many countries are making such changes to boost investment and simultaneously crack down on non-compliance. For example, Ireland and the UK are key areas of investment for US multinationals and have both recently changed aspects of their respective corporate law regimes. The staged implementation of the Companies Act 2006 in the UK and the implementation of the Irish Companies (Amendment) Act 2009 in Ireland have, in some cases, eased certain compliance rules, but in other areas have increased penalties for non-compliance and, specifically, placed a greater emphasis on regulations concerning directors’ conduct. 

Germany has also tightened up on the enforcement of preexisting compliance provisions in recent years and has moved from a situation where five years ago 80 percent of entities did not comply with the requirement to file financial statements and suffered no dire consequences. Contrast that position with today, where failing to file financial statements for two years is likely to mean the entity being dissolved and the assets passing to the German state.

Robust entity governance, good record keeping and demonstrable, auditable internal controls and processes are vital elements in the management of the risks of operating global subsidiaries, and in taking advantage of the opportunities that globalization and emerging markets present.

Indeed, as WPP chief Sir Martin Sorrell, quoted in the Wall Street Journal in September 2009, remarked when asked about the biggest threat to the advertising world, ‘I don’t think there are threats – there are opportunities. The trouble with opportunities is, if you don’t deal with them, they can become threats.’

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