C3 - Regulation

Question 1

Four main aims of regulation

Answer 1

PRIM

1. Protect consumers of financial products
2. Reduce financial crime
3. Correct market Inefficiencies
4. Maintain confidence in financial system

Question 2

Costs of regulation

Answer 2

Direct:
1. Cost to regulator in administering regulation
2. Cost to the regulated firms in complying with it

Indirect: C PAIR
1. Competition Reduced
2. Professionalism undermined
3. Alteration of consumer behaviour -false sense of security, reduced sense of responsibility in their own actions
4. Innovation reduced
5. Reduce market mechanisms to protect customers

Question 3

Need for regulation

Answer 3

1. Confidence in the financial system : Risk that if one company collapses, it can cause a systematic financial collapse of the industry. Ensure that the failure of one participant does not threaten whole system.

A regulator can help ensure confidence by:
1. Regularly monitoring that institutions hold sufficient capital to meet their liabilities
2. Ensuring that financial practitioners and managers are competent, act with integrity and are ‘fit and proper’
3. Establishing industry compensation schemes

2. Asymmetry of Information
   Reducing asymmetries of information
3. Requiring full disclosure of information in an understandable form
4. Educating consumers
5. Imposing price controls
6. Regulating selling practices
7. Giving consumers a cooling off period after purchase of a financial contract
8. Restricting knowledge for everyone to that which is publicly available
9. Enforcing insider-trading regulations
10. Requiring the establishment of ‘Chinese walls’

Question 4

Effect of information asymmetries

Answer 4

Information asymmetries could lead to both anti-selection and moral hazard
(anti-selection is where options on contracts are taken up by those most likely to gain, e.g. option to renew contract without further U/W is more likely to be exercised by a policyholder in worse than average health.
(an example of moral hazard is where a policyholder does not answer questions on a proposal form fully and truthfully)

Consequences of both anti-selection and moral hazard are:
Worse than expected claims experience (which is difficult to quantify)
Inequity between policyholders, and between policyholder and insurer

Question 5

State the 7 main functions of a regulator

Answer 5

SERVICE
1. Setting sanctions
2. Enforcing regulations
3. Reviewing and influencing government policy
4. Vetting and registering firms and individuals
5. Investigating suspected breaches
6. Checking the capital adequacy, management and conduct of providers
7. Educating consumers and the public

Question 6

Three forms of regulation

Answer 6

PFO
1. Prescriptive : Detailed rules on what can and can’t be done
2. Freedom of action : Freedom but with rules on publicity
3. Outcome based : Freedom but with prescribed tolerated outcomes

Question 7

Types of regulatory regime

Answer 7

1. Self regulated
2. Unregulated markets
3. Statutory
4. Voluntary codes of conduct
5. Mixed regimes