CH3 - Regulation Flashcards
Principal aims of the regulation of financial services (4) GRIP
- Correct market inefficiencies and promote efficient and orderly markets
- Protect consumers of financial products
- Maintain confidence in the financial system
- Help reduce financial crime
Direct costs of regulation (2)
- Administering the regulation
This includes, for example, collection and examination of information provided by market participants and otherwise monitoring their activities. - Compliance for the regulated firms
This includes, for example, maintaining appropriate records, collating the requisite information and supplying it to the regulator and/or the investor.
Indirect costs of regulation (5)
- Alteration in consumer behaviour, who may be given a false sense of security and a reduced sense of responsibility for their own actions
- Undermining of the sense of professional responsibility amongst intermediaries and advisors
- Reduction in self-regulation by the market (reduction in consumer protection mechanisms developed by the market itself)
- Reduced product innovation
- Reduced competition
Need for regulation in the financial markets (2)
The need for regulation is greater in the financial world than in other markets in order to:
- Maintain confidence in the sector
- Deal with information asymmetries
Functions of a regulator (5) SERVICE
The main factors of a regulator are typically:
- Influencing and reviewing government policy
- Vetting and registering firms and individuals authorised to conduct certain types of business
- Supervising the prudential management of financial organisations and the way in which they conduct their business
- Enforcing regulations, investigating suspected breaches and imposing sanctions
- Providing information to consumers and the public
Information asymmetries (4)
- Asymmetries occur when one party has relevant information or expertise or negotiating strength not shared by another party
- They can lead to anti-selection
- The asymmetries are exacerbated by the complex and long-term nature of financial contracts
- Mitigation tools include:
- disclosure of information in plain language
- Chinese walls
- cooling off periods
- customer legislation on unfair contract terms and TCF
- ‘whistle-blowing’ by actuaries if they believe the client is treating customers unfairly
Maintaining confidence (2)
- There is a danger that problems in one area of the financial system spread, leading to the collapse of the whole system
- Mitigation tools include:
- checks on capital adequacy of providers
- ensuring practitioners are competent and act with integrity
- industry compensation schemes
- ensuring orderly and transparent markets
- stock exchange requirements
Regulatory regimes (5)
The main types of regulatory regimes are:
- Unregulated markets - where no financial services specific regulations apply; market participants are instead subject to normal legislation
- Voluntary codes of conduct - drawn up by the financial services industry itself
- Self-regulation - organised and operated by the participants in a particular market without government intervention
- Statutory regulation - in which a government body sets out the rules and policies them
- Mixed - a combination of the above (many countries adopt such a mixture)
Forms of regulatory regimes (3)
- Prescriptive regimes - with detailed rules as to what may or may not be done
- Freedom of action - with rules only on publicity of information
- Outcome-based regimes - with prescribed tolerated outcomes
Role of major financial institutions (3)
Major financial institutions support the regulatory and wider business environment:
- Central bank - controlling or influencing economic variables, acting as lender of last resort
- State intervention - provision of products (e.g. through State monopoly companies), control of premium rates
- Large market participants - influencing premium rates, allowing smaller participants to find niche markets; however, may distort the market and use up too much of the regulator’s limited resources
The cost of regulation
Regulation has a cost. Regulators must attempt to develop a system that can achieve the aims specified above at a minimum cost and hope that the benefits, which are difficult to measure, outweigh the costs.
The costs are of two main types - direct costs and indirect costs.
List possible activities relating to investment business that might be covered by financial services (7)
Financial services regulation might typically cover the following activities relating to investment business:
- Dealing in investments as principal (i.e. on one’s own behalf) or agent (i.e. on behalf of a third party)
- Arranging for a third party to make investment deals
- Managing investments for another person
- Giving advice on investments
- Operating collective investment schemes
- Assessing the solvency of investment business providers
- Specifying the design of investment products
Example of a deposit-taking institution that is necessary to regulate
A clearing bank
Examples of a financial intermediary that is necessary to regulate (3)
Insurance companies, pension funds and collective investment vehicles
Examples of securities markets that is necessary to regulate
Securities markets are markets in financial securities such as money market instruments, bonds, equities and derivatives. Property is not strictly security, and different regulations may apply to the operation of property markets.
