Chapter 1 - The Financial Services Industry

Question 1

1. The Role Of The Government

Answer 1

1. 1 General Economic Policy Aims
2. 2 Fiscal Policy
3. 3 Monetary Policy

Question 2

1.1 General Economic policy aims

Answer 2

Sustainable growth
Control inflation
Full employment
Balance of payments - creditworthiness of a country

Question 3

1.2 Fiscal Policy

Answer 3

This is a government policy on taxation, public borrowing and public spending.

• Direct taxations is the taxation of incomes of individuals on the profits of companies as well as wealth in the form of inheritance tax.
• Indirect taxation is the taxation of products and services that consumers or companies purchase and use, ie, value added tax (VAT).

Question 4

1.3 Monetary Policy

Answer 4

Monetary policy is concerned with changes in the amount of money in circulation (the money supply) and with changes in the price of money – interest rates. These variables are linked with inflation in prices generally, and also with exchange rates – the price of the domestic currency in terms of other currencies.

The MPC influences interest rates by deciding the short-term benchmark repo rate – the rate at which the BOE deals in the money markets. This is known as the BoE’s base lending rate, or base rate for short.

Question 5

1.3.1 Monetary Policy Committee (MPC) Meetings

Answer 5

The MPC meets every month to set the interest rate. Throughout the month, the MPC receives extensive briefing on the economy from BoE staff. This includes a half-day meeting – known as the pre-MPC meeting – which usually takes place on the Friday before the MPC’s interest-rate-setting meeting. The nine members of the committee are made aware of all the latest data on the economy and hear explanations of recent trends and analysis of relevant issues. The committee is also told about business conditions around the UK from the Bank’s agents. The agents’ role is to talk directly to business to gain intelligence and insight into current and future economic developments and prospects.

Question 6

1.3.2 Public Accountability: Explaining Views and Decisions

Answer 6

Minutes of the MPC meetings are published two weeks after the interest rate decision. The minutes give a full account of the policy discussion, including differences of view. They also record the votes of the individual members of the committee. The committee has to explain its actions regularly to parliamentary committees, particularly the Treasury committee.

Question 7

2. Financial Investment in the Economy

Answer 7

2. 1 Primary Markets
3. 2 Secondary Markets
4. 3 The Balance of Payments
5. 4 Exchange Rates

Question 8

2.1 Primary Markets

Answer 8

The term primary market refers to the market for new issues of shares or other securities (for example, loan instruments).
Organisations such as companies and governments need capital in order to carry out their activities (for example, to buy premises and invest in machinery). In order to raise this capital they may issue securities such as shares or loan stock.
• Shares represent a share in the ownership of a company. Investors buy them in the hope of either capital appreciation of the value of the company, and therefore of the price of the share, or of income, if the company earns profits and pays them to its investors in the form of dividends.
• Loan instruments represent borrowings by the issuer, which would normally expect to be repaid at some time. They therefore have a capital repayment value to the investor and (usually) a coupon, which represents the interest that will be paid periodically to the investor. An example of a loan instrument issued by a company is a debenture; an example of a loan instrument issued by the UK government is a gilt.

Question 9

2.2 Secondary Markets

Answer 9

Once an investor has bought a holding in shares or loan instruments, however, they may not wish to hold them indefinitely. They may stop satisfying their needs because:
• their circumstances change (they may need the money back, or their investment objectives change); or
• the investment itself changes (it rises in value, so that the investor wants to sell it to capitalise on the gain. Alternatively, if the securities are shares, the company may have become less profitable and stopped paying worthwhile dividends; the investor wants to switch to an investment paying them better dividends).
The secondary markets offer a mechanism for the investor to sell or switch investments; they are the market in which investors sell shares that have already been introduced to the market. Thus, they offer an exit route for investors who want to sell their investments. They also offer a route for investors to buy securities which are already in existence from other investors.

Question 10

2.3 The Balance of Payments

Answer 10

The balance of payments in an economy measures the payments between that country and others. It is therefore made up of the country’s exports and imports of goods and services and of transfers of financial capital. It thus measures all the payments received, and money owed, from overseas parties – less all the payments made, and debts owed, to people overseas.

Question 11

2.3.1 Current and Capital Accounts

Answer 11

The accounts used to measure the UK’s balance of payments are:
• the current account; and
• the capital and financial account.
The balance of payments figures also include a balancing item to correct any statistical errors and to
make sure the accounts balance.

The current account measures flows in relation to trade in goods and services, income from investment and as compensation of employees, and current transfers (eg, private sector gifts to people overseas, or government aid to abroad). The current account balance is usually seen as the most important component of the balance of payments, because it has the greatest impact on other economic factors such as output and employment.
The capital and financial account measures flows in such things as overseas investment in the UK, UK private-sector investment abroad, foreign currency borrowing by, and deposits with, UK banks, and changes in official reserves.
The balancing item is included to deal with errors and omissions in the accounts: if more currency flows into the UK than is recorded in actual transactions, the balancing item will be positive, and vice versa.

Question 12

2.4 Exchange Rates

Answer 12

The balance of payments between the UK and other countries is important for a number of reasons, not least the impact that it may have on UK exchange rates (and therefore on the competitiveness of UK exports and of imports into the UK economy).
A deficit on the current account means that the country is not matching its overseas expenditure with its current overseas income. How much this matters depends on the size of the deficit and on how persistent it is; a small negative balance, or one which only lasts for a short time, may not be regarded as too serious; it can be financed by the country running down its reserves somewhat, or by capital inflows. But one which lasts for longer has to be financed from somewhere – and a country’s reserves are not infinite, so cannot be run down indefinitely. The alternative is to increase overseas borrowing, so as to finance the deficit; but to do this too much is not in the country’s interests either, since the larger the UK’s debts to the outside world, the greater the servicing requirements (repayment of interest and capital) on that debt.
One method of correcting a current account deficit is to allow sterling to fall in value against other currencies. This tends to make foreign goods and services more expensive for UK buyers and so encourages them to reduce imports and buy British instead. In addition, it makes UK goods and services cheaper for overseas customers, helping UK exports. Both these factors will help to restore a positive current account balance.
However, if the current account is also being financed by rising overseas debt, this can create concerns about the stability of the economy, which may lead to government action to raise interest rates (so as to prevent an outflow of investment funds). Higher interest rates can encourage foreign investors to invest in sterling assets – pushing up the exchange rate as they buy sterling to do so. Rising interest rates may well lead to a strengthening of the currency – which is clearly at odds with the strategy, discussed in the previous paragraph, of trying to manage the current account through a low exchange rate.
Thus, persistent surpluses and deficits on the balance of payments can create a considerable headache for a government and can impact on exchange rates, interest rates and consequently other activity in the economy.

Question 13

3. Global Financial Services

Answer 13

3. 1 Financial Services in the UK
4. 2 Financial Services in Europe
5. 3 Financial Services in the US
6. 4 Financial Services in Asia

Question 14

3.1 Financial Services in the UK

Answer 14

The structure of financial regulation is covered in detail in Chapter 5, where the relationship between Her Majesty’s Treasury (HMT), the BoE, the Financial Policy Committee (FPC), the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) is explained.
The Treasury is the UK’s economics and finance ministry. It is responsible for formulating and implementing the government’s financial and economic policy. Its aim is to raise the rate of sustainable growth, and achieve rising prosperity and a better quality of life with economic and employment opportunities for all.

Question 15

3.2 Financial Services in Europe

Answer 15

3. 2.1 The Lamfalussy Process
4. 2.2 The UK Regulators’ (FCA and PRA) Priorities for Work in the EU and International Arena
5. 2.3 The European Central Bank (ECB)

Question 16

3.2.1 The Lamfalussy Process

Answer 16

European Insurance and Occupational Pensions Authority (EIOPA)
European Banking Authority (EBA)
European Securities and Markets Authority (ESMA)

Question 17

3.2.2 The UK Regulators’ (FCA and PRA) Priorities for Work in the EU and International Arena

Answer 17

The following are the FCA’s and PRA’s key priorities in relation to EU and international regulation:
• Better regulation, ie, extensive consultation with stakeholders, consideration of the use of non-legislative tools, rigorous impact assessments of policy options, and subsequent review of measures to assess their actual impact.
• Continued commitment to a strengthened Lamfalussy structure.
• Enhanced supervisory co-operation in the EU and international context to improve oversight of
firms operating on a cross-border basis.
• Promotion of principles-based and risk-based approaches in global forums, such as the sectoral
committees and the Financial Stability Forum (FSF).

Question 18

3.2.3 The European Central Bank (ECB)

Answer 18

The ECB is the central bank for Europe’s single currency, the euro. The ECB’s main task is to maintain the euro’s purchasing power and thus price stability in the euro area. The euro area comprises the 17 EU countries who have adopted the euro since 1999.
The ECB and the national central banks together constitute the eurosystem, the central banking system of the euro area.

Question 19

The European System of Central Banks (ESCB)

Answer 19

The ESCB is comprised of:
• the European Central Bank (ECB); and
• the national central banks (NCBs) of all 28 EU member states.
This means that the ESCB includes the national central banks of those EU member states that have not
yet adopted the euro.

Question 20

Tasks of the ECB

Answer 20

In particular, the ECB is responsible for:
• defining eurosystem policies;
• deciding, co-ordinating and monitoring the monetary policy operations;
• adopting legal acts;
• authorising the issuance of bank notes;
• interventions in the foreign exchange (FX) markets;
• international and European co-operation.
Further, the ECB is responsible for:
• statutory reports;
• monitoring financial risks;
• fulfilling advisory functions to community institutions and national authorities;
• running the IT systems;
• strategic and tactical management of the ECB’s foreign reserves.

Question 21

3.3 Financial Services in the US

Answer 21

3. 3.1 The Regulatory Agencies
4. 3.2 The Securities and Exchange Commission (SEC)
5. 3.3 The Federal Reserve
6. 3.4 The Office of the Comptroller of the Currency (OCC)
   3.3.5 The US Treasury
7. 3.6 The Financial Industry Regulatory Authority (FINRA)
8. 3.7 Commodity Futures Trading Commission (CFTC)

Question 22

3.4 Financial Services in Asia

Answer 22

3. 4.1 China
4. 4.2 Hong Kong
5. 4.3 Japan
6. 4.4 Singapore

Question 23

3.4.1 China
• The main bodies responsible for regulating financial services in China are:

Answer 23

The China Securities Regulatory Commission (CSRC).
The China Banking Regulatory Commission (CBRC).
The China Insurance Regulatory Commission (CIRC).
The People’s Bank of China (PBOC).

Question 24

3.4.2 Hong Kong
• The main bodies responsible for regulating financial services in Hong Kong are:

Answer 24

Securities and Futures Commission (SFC).
Stock Exchange of Hong Kong (SEHK).
Hong Kong Futures Exchange (HKFE).
Hong Kong Monetary Authority (HKMA). Office of the Commissioner of Insurance (OCI).

Question 25

3.4.3 Japan
• The main bodies responsible for regulating financial services in Japan are:

Answer 25

Financial Services Agency (FSA), which includes planning, supervisory and inspection functions. Securities and Exchange Surveillance Committee (SESC), which is part of the FSA and works closely with its inspection function.
Self-regulatory organisations (SROs), such as the various Japanese securities exchanges and the Japan Securities Dealers’ Association (JSDA).

The FSA and SESC are under the direction of the Commissioner of the FSA, who reports to the Minister for Financial Services.

Question 26

3.4.4 Singapore
•
The main bodies responsible for regulating financial services in Singapore are:

Answer 26

Monetary Authority of Singapore (MAS). 
Singapore Exchange (SGX) Securities Trading.
Securities Industry Council (SIC).