CH 3 Regulation Flashcards
What are aims of regulation:
PFECCL
- Protect consumers of FS
- Limit likelihood of failure of FS companies
- Promote market efficiency
- Maintain confidence in financial system
- Reduce financial crime
- Act as lender of last resort
What are the functions of a regulator (SERVIIC)
- Imposing sanctions
- Enforcing regulations
- Influencing and reviewing government policy
- Vetting and registering firms and individuals authorised to conduct business
- Giving info to consumers and public
- Supervising conduct of FSPs, taking enforcement action where necessary
What are the costs of regulation
AC PUMAC
Direct costs (born my investor, higher tax and fund regulator, higher charges and fees for FS purchased:
Administering regulation (collecting examining info, monitoring activities) Complience for regulated firm (maintaining records, collecting info, supply of info)
Indirect costs (economic costs of reg)
Reduced product innovation
Undermining sense of professional responsibilities among intermediaries and advisors
Reduced development of consumer protection mechanisms by market, reduction in self regulation by market
Alteration in consumer behavior (false sense security)
Reduced competition
What are the areas addressed by regulation
- Confidence in financial system
- financial collapse cause huge damage to fin system, spread to other parts of economy
- must ensure solvency of every financial institution, or whole system threatened with bankruptcy - Information asymmetries
- between provider and customer
- one party advantage at expense of another
Define information asymmetry, and sources of it
Situation where one party to a transaction has relevant info the other does not have, leading to sub-optimal choices.
Anti-selection
Moral hazard
Fraud
Define Anti-selection, Moral hazard and fraud
Anti-selection: people more likely to take out contract when they believe the risk is higher than insurance company priced for
Moral hazard: Action of a party who behaves differently to if they were fully exposed to the consequences of that action
Fraud: intentionally witholding information legally required (lying on insurance applications)
How do regulators deal with info asymmetry? (DUNIT)
- Disclosure and education in understandable plain language
- Unfair features of insurance contracts: legislation saying unfair terms in contract must be set aside
- Negotiations (Price controls, regulation of selling practice ,right to terminate sales process at any time, cooling off period where consumer can cancel contract without penalty)
- Conflicts of interest: Chinese walls (separation of functions between organisations), Insider trading regulations
- Treating customers fairly (must act in best interest of customer, meet policyholder reasonable expectations)
- Whistleblowing: notify regulatory authorities if providing not acting to TCF
How to deal with maintaining confidence in financial system. (CCIOS)
- Capital adequacy of provider (institution must have sufficient resources to meet financial liabilities in face of adverse experience. ) (Must have accurate models of business in place, monitor risk levels with competence)
- FSPs COMPETENT, act with integrity (qualifications, fit and proper)
- Industry compensation schemes (policholders compensated for losses from poor practise by FSP, but not protected from market related losses). Limit compensation so investor still must check integrity of provider.
- ensuring ORDERLY and TRANSPARENT markets that provide proper protection to investors
- Stock exchange requirements (listed companies fulfill criteria of financial stability, disclose fin info). (Record trading volumes to identify insider trading, large aquisitions policyholders can’t act to) (Regulate issues of new shares and takeover bids)
What are the forms of regulation
Prescriptive: rules setting out what can and cannot be done
Freedom of action: only rules on publicly available information (third parties fully informed about FSP)
Outcome based: freedom of action but allow for prescribed outcomes to be tolerated
List the types of regulatory regimes
- Unregulated market
- Voluntary codes of conduct
- Self regulation
- Statutory regulation
- Mixed
Explain the roles of major financial institutions in supporting regulatory and wider business environment.
- Central bank
- controlling or influencing economic variables
- meeting govt objectives
- lender of last resort - State intervention
- Provision of products (through state monopoly companies)
- control premium rates
- These features restrict free market, control # market participants. limit innovation and new developments - Large market participants
- Helping small participants find niche markets
- stabilize premium rates
- problem: may distort market, use up too much of regulator’s limited resources.
- Regulations to avoid monopolies: competition legislation
Give aims of competition legislation
- Reduce power of large market participants
- Ensure sufficiently competitive markets
- Participants cant collude and set prices
- Participants can’t block new entrants
Give the aims of climate change related financial regulations
Ensure financial institutions:
- Consider climate risk in decision making
- Have reliable methods of assessing, pricing and managing these risks
- Incorporate environmental, social and governance (ESG) factors into management decisions (investment)
- Incorporate financial risk from climate change in existing risk management processes
- Use scenario analysis in risk identification, estimate impact of financial risk from CC
- Consider impact of C risks on ability to meet obligations
Advantages and disadvantages of self regulation
Advantages and disadvantages of statutory regulation
