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Keeping a financial eye on commercial subsidiaries

Posted: 06/03/2023

It is crucial for the board of a registered provider with commercial subsidiaries to ensure that it has a clear understanding of their financial viability, and the impact that their failure could cause to the association. In most cases, stress testing of the subsidiary’s business plan and financial reporting should alert a board to potential problems and enable it to take action. However, on occasion, this is not enough, and the board needs to be able to spot an impending problem before it is revealed in the figures and charts.

The Social Housing Regulator recently issued a regulatory judgement against a registered provider and downgraded its governance grading from G1 to G2, and its financial viability grading from V1 to V2. This particular registered provider does fantastic work, and through its previous commercial subsidiary, helped encourage young people into apprenticeships and employment for many years. However, the impact of the pandemic and other factors had a negative effect on this commercial subsidiary, and it was unable to generate profit, thereby making a loss.

Whilst the full details are not clear, it appears that, despite closing it down, the registered provider had not picked up in good time that the commercial subsidiary was suffering a loss which would ultimately have to be paid by the registered provider. As a result, the regulator concluded that the board of the registered provider did not have sufficient awareness of the financial exposures associated with its loss-making commercial subsidiary, and that there was a weakness in its financial planning and risk control.

This regulatory judgement shows how a once thriving and successful commercial subsidiary that is brought down by events beyond its own control can cause loss to its registered provider parent. The lesson is therefore that boards need to ensure they are getting the information they need to assess the ongoing viability of their commercial subsidiaries, and that their monitoring mechanisms operate to give the board time to take remedial action to protect the social housing assets.

This is easier said than done. In many cases, these situations will be ‘grey areas’ where the ongoing viability of the commercial subsidiary is in doubt, but there may still be reasonable prospects of it getting back to profitable trading. The difficulty for the board is assessing when the risks of continuing, in the hope of a turnaround, are outweighed by the impact on the registered provider if the commercial subsidiary fails and has to be wound up.

There have likely been many cases where the commercial subsidiaries of registered providers were struggling, but were ultimately able to turn things around and return to profitable trading. However, the success of the turnaround means that they will go unreported.

Balancing these risks and coming to a decision is a subjective matter for the board of the registered provider to take. The regulator’s decision in this recent case draws attention to the need for boards of registered providers generally to ensure that their reasons for continuing to support their commercial subsidiaries that get into difficulties are well documented, including their assessment of the risks should they fail. In this way boards can satisfy the regulator’s demand that registered providers with commercial subsidiaries maintain close supervision of them to ensure that when things get tough, the board is in control and can take actions necessary to preserve the registered provider’s assets.

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Penningtons Manches Cooper LLP is a limited liability partnership registered in England and Wales with registered number OC311575 and is authorised and regulated by the Solicitors Regulation Authority under number 419867.

Penningtons Manches Cooper LLP