3. Regulation

Question 1

Aims

Answer 1

1. Correct perceived market inefficiencies and promote efficient and orderly markets
2. Protect consumers
3. Maintain confidence in financial system
4. Reduce financial crime

Question 2

Direct costs of regulation

Answer 2

1. Costs of administering the regulation

2. Costs of compliance

Question 3

Indirect costs of regulation

Answer 3

1. Changed consumer behaviour
2. Undermining of the sense of professional responsibility among intermediaries and advisors
3. Reduced market consumer protection mechanisms
4. Reduced product innovation
5. Reduced competition

Question 4

Functions of a regulator

Answer 4

• Influence and review govt policy
• Vet and register firms
• Supervise prudential management of orgs
• Enforce regulations, investigating suspected breaches + imposing sanctions
• Providing info to consumers and the public

Question 5

Information asymmetry

Answer 5

Regulators mostly interested in IA between provider and end customer because of the difference in expertise and negotiating strength

Question 6

Managing information asymmetry

Answer 6

1. Disclosure requirements.
2. Education
3. TCF
4. Avoiding conflicts of interest
5. Whistleblowing
6. Price controls

Question 7

Aims of Treating customers fairly (TCF)

Answer 7

• Products work as expected
• Customers receive suitable advice
• Information is clearly communicated
• Products designed to meet customer needs
• No unreasonable barriers to entry
• Must be embedded in corporate culture

Question 8

Maintaing public confidence

Answer 8

1. Solvency requirements
2. Compensation schemes
3. Stock exchange requirements
4. Competency and integrity standards

Question 9

Forms of regulation

Answer 9

1. Freedom of action
2. Outcome-based
3. Prescriptive

Question 10

Freedom of action

Answer 10

Now regulation on governance, but there may be disclosure requirements for 3rd parties wishing to join market.

Question 11

Outcome-based

Answer 11

Allows freedom of action, but prescribes outcomes that will be tolerated

Question 12

Prescriptive

Answer 12

Detailed rules as to what may or may not be done

Question 13

Regulatory regimes

Answer 13

• Unregulated markets
• Voluntary codes of conduct
• Self-regulation
• Statutory

Question 14

Unregulated markets

Answer 14

Usually where costs > benefits

Examples:

• Markets where only professionals operate
• Commodity products with guaranteed benefits that are sold only on price (e.g. term assurance)

Question 15

Merits of voluntary codes of conduct

Answer 15

Advantages:

1. Likely reduced costs
2. Rules may be set by those with greatest industry knowledge

Disadvantages:
1. Greater incentive to breach voluntary code, which may have no legal backing and most likely less severe penalties than statutory regulation

Question 16

Merits of self-regulation

Answer 16

Advantages:

1. Implemented by those with greatest knowledge of market&raquo_space;> incentive to achieve optimal cost-benefit ratio.
2. Theoretically, should be able to respond quickly to market changes
3. Easier to persuade firms to co-operate than with govt reg

Disadvantages:

1. Closeness of regulator with industry its regulation&raquo_space;> may accept industry’s POV and not consider others’
2. Can lead to weaker regime than acceptable to public and consumers&raquo_space;> low public confidence in system even if its operating efficiently
3. May inhibit new entrants to market

Question 17

Merits of statutory regulation

Answer 17

Advantages:

1. Less open to abuse than alt
2. Greater public confidence
3. May be run efficiently, if e.o.s can be achieved by grouping activities by function and not type of business

Disadvantages:

1. May be more costly and inflexible than self-regulation
2. May impose unnecessary rules that are costly and not achieve desired aim.

Question 18

State’s role in governing markets

Answer 18

1. Some fin products may only be sold by state monopoly companies
2. Tariffs premium rates

Drawbacks:

1. Lower product innovation
2. Restricts free market
3. Limits # of participants

Question 19

Large institutions

Answer 19

1. Risk of market distortions

2. Risk of taking up too much of regulator’s resources

Question 20

Why regulators are concernced with information asymmetry

Answer 20

• Concerned about interest of customers
• Not enough info = suboptimal choices = inefficient allocation of financial resources
• Difference in expertise and negotiating strength
• May be costly to acquire information
• Significant financial effect on financial well-being of customers
• Majority of population not well educated and may find product terms complex and confusing

Question 21

Why regulators are concernced with information asymmetry

Answer 21

• Concerned about interest of customers
• Not enough info = suboptimal choices = inefficient allocation of financial resources
• Difference in expertise and negotiating strength
• May be costly to acquire information
• Significant financial effect on financial well-being of customers
• Majority of population not well educated and may find product terms complex and confusing