Ch 3: Regulation Flashcards
Prescriptive regulation
Detailed rules on what can and can’t be done
Freedom of action regulation
Freedom but with rules on publicity
Outcome-based regulation
Freedom but with prescribed, tolerated outcomes
List possible functions of the central bank, as part of the regulatory or supervisory regime for financial product providers
To meet government targets, the central bank can:
- Control the money supply
- Determine or influence interest rates
- Determine or influence inflation rates
- Determine or influence exchange rates
- Ensure stability of the financial system
- Lender of last resort to commercial banks
- Target macro-economic features such as growth and unemployement
List 2 problems associated with voluntary codes of conduct
- There may be low public confidence in the approach
2. There may be a few rogue traders who refuse to cooperate
Outline the five main types of regulatory regime
- Self-regulatory systems, which are organised and operated by the market participants without government intervention
- Statutory regimes, where the rules are set and policed by the government.
- Voluntary codes of conduct, where there is a choice as to whether to adhere
- Unregulated markets / lines of business, with no regulation
- Mixed regimes, involving a combination of the above
What actions can the regulator take to help ensure confidence in the financial system
- Regularly monitoring that institutions hold sufficient capital to meet their liabilities
- Ensuring that financial practitioners and managers are competent, act with integrity and are “fit and proper”
- Establishing industry compensation schemes
- Ensuring that the market is transparent, orderly, and provides proper protection to investors
- Ensuring that listed companies fulfill certain criteria regarding financial stability and disclosure of information
List the main functions of the regulator
SERVICE
Setting sanctions
Enforcing regulations
Reviewing and influencing government policy
Vetting and registering firms and individuals
Investigating breaches
Checking management and conduct of providers
Educating consumers and the public
What actions can the regulator take to reduce asymmetries of information?
SPIDER CC
Selling practices regulated Price controls imposed Insider trading prevented Disclosure of understandable information Educating consumers Restricting knowledge to publicly available
Consumer cooling off period
Chinese walls established
Also,
Fairness
What are the advantages and disadvantages of statutory regulation?
Advantages:
- Less open to abuse
- Instills more public confidence due to government involvement
- Should be more efficient if economies of scale can be achieved
Disadvantages:
- Costs and inflexibility
- Outsiders may impose rules that are unnecessarily costly, inefficient and which may not achieve the desired aim
- Government may be inexperienced in regulation
Describe two ways in which regulation can try to ensure that customers are treated fairly
- Providers may be directly required by the regulator to demonstrate that they treat customers fairly
- Actuaries in statutory roles may be required to whistle blow if they believe that a provider is prejudicing the interests of the customer
Why is the need to regulation of the financial markets typically greater than for most other markets?
Firstly, the importance of confidence in the financial system. There is the risk that if one company collapses, it can cause a systemic financial collapse of the system.
Secondly, the asymmetry of information, expertise and negotiating strength that exists between the product provider and end customer.
These issues are exacerbated by the fact that:
- financial transactions are often long term in nature and can have a significant impact on the future economic welfare of individuals
- in general, most of the population is not well educated on financial matters and find the range of products offered both complex and confusing
What are implications of information asymmetries?
Information asymmetries lead to both anti selection and fraud.
An example of anti-selection is where options on contracts are taken up by those with the most to gain.
An example of fraud is where a policyholder does not answer questions on a proposal form fully and truthfully.
The consequences of both anti-selection and fraud are:
- worse than expected claims experience
- inequality between policyholders, and between the policyholder and the insurer
List the principle aims of regulation
GRIP
Give confidence in the system
Reduce financial crime
Inefficiencies in the market corrected
Protect consumers
Indirect costs of regulation
PUMA
Product innovation reduced
Undermining of intermediaries and advisors professionalism
Market reduces its own consumer protection mechanisms
Alteration of consumer behavior, false sense of security and a reduced sense of responsibility