3. Regulation Flashcards
Aims
- Correct perceived market inefficiencies and promote efficient and orderly markets
- Protect consumers
- Maintain confidence in financial system
- Reduce financial crime
Direct costs of regulation
- Costs of administering the regulation
2. Costs of compliance
Indirect costs of regulation
- Changed consumer behaviour
- Undermining of the sense of professional responsibility among intermediaries and advisors
- Reduced market consumer protection mechanisms
- Reduced product innovation
- Reduced competition
Functions of a regulator
- 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
Information asymmetry
Regulators mostly interested in IA between provider and end customer because of the difference in expertise and negotiating strength
Managing information asymmetry
- Disclosure requirements.
- Education
- TCF
- Avoiding conflicts of interest
- Whistleblowing
- Price controls
Aims of Treating customers fairly (TCF)
- 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
Maintaing public confidence
- Solvency requirements
- Compensation schemes
- Stock exchange requirements
- Competency and integrity standards
Forms of regulation
- Freedom of action
- Outcome-based
- Prescriptive
Freedom of action
Now regulation on governance, but there may be disclosure requirements for 3rd parties wishing to join market.
Outcome-based
Allows freedom of action, but prescribes outcomes that will be tolerated
Prescriptive
Detailed rules as to what may or may not be done
Regulatory regimes
- Unregulated markets
- Voluntary codes of conduct
- Self-regulation
- Statutory
Unregulated markets
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)
Merits of voluntary codes of conduct
Advantages:
- Likely reduced costs
- 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
Merits of self-regulation
Advantages:
- Implemented by those with greatest knowledge of market»_space;> incentive to achieve optimal cost-benefit ratio.
- Theoretically, should be able to respond quickly to market changes
- Easier to persuade firms to co-operate than with govt reg
Disadvantages:
- Closeness of regulator with industry its regulation»_space;> may accept industry’s POV and not consider others’
- Can lead to weaker regime than acceptable to public and consumers»_space;> low public confidence in system even if its operating efficiently
- May inhibit new entrants to market
Merits of statutory regulation
Advantages:
- Less open to abuse than alt
- Greater public confidence
- May be run efficiently, if e.o.s can be achieved by grouping activities by function and not type of business
Disadvantages:
- May be more costly and inflexible than self-regulation
- May impose unnecessary rules that are costly and not achieve desired aim.
State’s role in governing markets
- Some fin products may only be sold by state monopoly companies
- Tariffs premium rates
Drawbacks:
- Lower product innovation
- Restricts free market
- Limits # of participants
Large institutions
- Risk of market distortions
2. Risk of taking up too much of regulator’s resources
Why regulators are concernced with information asymmetry
- 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
Why regulators are concernced with information asymmetry
- 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
