CH3 - Regulation Flashcards
(36 cards)
What is the most important cause of market failure in the financial services market?
The lack of (perfect) information available, in particular to the investors about the services that they are buying and the risks taken by the institutions that they invest in
What is the nature of the financial services products that make the extent of regulation greater in that market than in other markets
- They are long term
- They are complex
- They potentially have large sums of money involved
What are the principal aims of regulation?
- To limit the likelihood and potential cost of failures of financial companies
- To limit the need for the government to step in as a lender of last resort
- To correct perceived market inefficiencies and promote efficient, orderly markets
- To protect the consumers of financial products
- To maintain the confidence in the financial system
- To help reduce financial crime
How would consumers of financial services make the market inefficient
By making incorrect choices.
- This may occur due to the lack of information available and the expertise of private investors
What is the optimal level of regulation?
The optimal level is one such that the marginal benefits of regulation are equal to the marginal costs of regulation
- It is important for regulators to come up with a system that has a minimum cost and hope that the benefits outweigh these costs
What are the benefits of regulation?
They arise from the principal aims of regulation being met:
- Reduced financial crime
- Consumers are protected
- Reduced inefficiency in the market and orderly and efficient markets are promoted
- Confidence in the financial system is maintained
What are the direct costs of regulation
- Administering Regulation
- Compliance for the regulated firms
- The costs borne by the customer in the form of higher tax to fund the regulator or higher charges or fees for services
What are the indirect costs pf regulation
- Alteration in the behaviour of consumers who are given a false sense of security and reduced sense of responsibility in their actions
- An undermining sense of professional responsibility among the intermediaries and advisors
- Reduction in consumer protection mechanisms that are developed by the market itself
- Reduction in product innovation
- Reduced competition : The regulations may serve as a barrier to entry
Why is the need for regulation greater in financial markets than it is in other markets
- Confidence
- Asymmetric information
What is systemic risk
The risk of the failure of one financial institution leading to failure of another financial institution
- Causes difficulties for a third institution and so on
How is a systemic collapse or loss of confidence prevented
By ensuring that the failure of one institution will not threaten the whole system
What is asymmetric information
This is a situation where a better informed party will use its informational advantage for its own benefit and to the detriment of the other party
What are typically the main functions of the regulator?
- Influencing and reviewing government policy
- Vetting and registration of firms and individuals authorised to conduct certain types of business
- Supervising the prudential management and conduct of financial organisations
- Enforcing regulations , investigating suspected breaches and imposing sactions
- Providing information to customers and the public
Financial Services regulation would typically deal with which types of investment business?
- Dealing in investments as the principal or agent
- Arranging for a third party to make investments
- Managing investments for another person
- Giving advice on investments
- Operating collective schemes
- Assessing the solvency of investment business providers
- Specifying the design of investment products
What difficulties are there in regulation being segregated by the type of financial business?
It may prove difficult where the providers of financial services provide more than one type of financial service or products have aspects of both/multiple types of business
What institutions is it necessary to regulate?
- Deposit taking institutions (E.g retail banks)
- Financial institutions( pension schemes, insurance, etc.)
- Securities markets
- Professional advisors ( merchant / investment bank)
- Non -financial companies offering securities to the public
Why is the asymmetry of information between the product provider and the end customer of most concern to regulators
- There is a difference in the expertise and negotiating strength that will exist in financial transactions
- The product provider will have access to more information and expertise than the customer
- Information concerning financial services is widely available, however, obtaining this information involves a cost.
- In most countries, the majority of the population is not educated in financial markets and finds the range of solutions offered to meet the needs are complex and confusing
What does disclosure and education involve in dealing with information asymmetry?
- Requiring a service provider to disclose full information about it’s products or itself in an understandable form.
- Consumer education by the regulator
What does the conflicts of interest aspect of dealing with information asymmetry involve?
- The knowledge held by a service provider about third parties can be restricted to that which is publicly available by insider trading regulations
What does the negotiation aspect of dealing with information asymmetry involve?
- The weakness of an individual in negotiating a deal with a large institution may be addressed by price controls or regulating selling practices
- The customers position may be strengthened by devices such as giving them the right to terminate the sales process at any time or by providing a ‘cooling off’ period during which they can cancel the policy with no penalty
What is whistle blowing
Where an actuary has statutory responsibilities, it includes the requirement to notify the regulatory authorities if they believe that a product service provider is acting in a way that would prejudice the interests of it’s customers
What is PRE
These are the Policyholder’s Reasonable Expectations
The influences on policyholder expectation includes :
- Statements made by the product provider, especially those to the customers in the marketing literature
- Past practice of the product provider
- General practice of other product providers in the market
What are the 5 areas addressed by regulation in maintaining confidence?
1) Capital Adequacy
2) Competence and Integrity
3) Compensation Schemes
4) Other Protection for investors
5) Stock Exchange Requirements
What forms do the statutory requirements related to the coverage of liabilities take?
- Assets must be equal to a specified proportion of liabilities, with both assets and liabilities being valued using the same prescribed basis
- Sufficient assets must be held to ensure that the probability of insolvency over a particular time period is lower than a specified level, taking the company’s risks into account
