The UK’s Treasury Select Committee (TSC) has just published an exchange of correspondence between Andrew Tryie MP (Chair of the TSC) and Andrew Bailey (CEO of the Prudential Regulation Authority (FCA)). In his last letter, Tyrie asks the PRA to reassure the TSC that the PRA is not being too intrusive.

Tyrie accepts that a more intrusive regulator is “inevitable” after a crisis, and that intrusive regulation “may be appropriate“. However, he expresses concern about the “danger[s]” that overly intrusive supervision might bring: “the PRA could be regarded as a shadow director. This would pose risks to the proper operation of the market. It might relieve boards of too much responsibility. It could also pose financial risks to the government. The PRA has argued that the proper discharge of its statutory duties would not make it a shadow director. The PRA must ensure that it has persuasive legal assurance on this point. The PRA board should keep this risk under review. The [TSC] would be grateful for renewed assurances from the PRA on this point“.

This is quite a challenge, given the recent furore over the alleged HM Treasury interference with the independence and decision making of the Financial Conduct Authority.  It’s also interesting because the shadow director risk, and the moral hazard associated with it, were often in the Financial Services Authority’s mind, and could easily have contributed to what Tyrie now describes as “the plainly inadequate standards of regulation prior to the crisis“.

This challenge is also interesting from a legal perspective, because it’s easy to imagine the PRA falling into the shadow director trap, and not really being able to do much about it. In legal terms, a shadow director is “a person [other than a professional advisor] in accordance with whose directions or instructions the directors of [a] company are accustomed to act” (*). A legal or natural person doesn’t have to influence every board decision to become a shadow director; influencing a certain category of decision on a sufficiently continuous basis can be enough, if the board effectively cedes management autonomy to the shadow director when that category of decision comes before it (**).  It may therefore be true that, if the PRA properly discharges its statutory duties, and the board of the relevant PRA authorised firm properly discharges its duties as well, the PRA will not become a shadow director. But this depends, at least in part, on the response of the relevant board to the pressure the PRA is placing on it … and that will sometimes be outside the PRA’s control. Everything will be fine, if the board retains and exercises the power to decide whether to meet the PRA’s expectations and, if so, how (even if the board has no practical alternative but to do exactly what the PRA has effectively required it to do (***)). However, the opposite could easily be true if the board simply chooses to meet the PRA’s expectations, without more. The PRA does therefore seem to have a case to answer; and these risks are something it will need to keep firmly in mind, whenever it communicates with the board of an authorised firm.

Tyrie’s has also asked the PRA about its approach to the “‘doctrine’ of supervisory confidentiality“, and whether it could and should release more firm-specific information than it does at present. We’ve published a separate post about these risks and issues.

More to follow, when the PRA’s response to Tyrie’s latest letter has been published.

UPDATE:The TSC has now published the PRA’s response to Tyrie’s letter.

(1) On intrusiveness of regulation & shadow directors: Although the FSA often pulled its punches because (a) it was concerned about its “shadow director” risk; and (b) it thought that it was up to the senior management of an authorised firm (not their regulator) to manage that firm and to accept responsibility for the consequences for the consequences, if they failed in some way, the PRA has no such qualms: “the PRA does not consider that actions it takes in the proper discharge of its statutory duties could result in it being regarded by the courts as a shadow director within the meaning of the Companies Act 2006“.

(2) On supervisory confidentiality: The PRA acknowledges Tyrie’s question (“you asked whether the Bank is confident that the current balance between regulatory confidentiality and public disclosure is appropriate“); before giving some examples of the indirect work it’s doing to enhance transparency, without ever actually answering the question – perhaps suggesting that the PRA thinks more could and should be done … it’s just that it can’t properly say so (yet). .   

* See section 251 of the Companies Act 2006.

** See, for example, Secretary of State for Trade and Insdustry -v- Becker [2003].

*** See, for example, Re Hydrodan (Corby) Limited [1994].

Posted by Cooley