Chapter 3 - Regulation Flashcards
What are the aims of regulation?
GRIP
• Give and maintain confidence in the financial system
• Reduce financial crime
• Inefficiencies in market corrected = promotes efficient and orderly markets
• Protect consumers of financial products
How can a regulator meet the aims of regulation?
• Give and maintain confidence in the financial system
o Checking ongoing solvency of authorised providers
o Enforcing strict accounting information requirements
o Ensuring competence and integrity of financial practitioners
• Reduce financial crime
o Vetting firms/individuals authorised to conduct certain activities
o Enforcing regulations
o Investigating suspected breach of regulation
o Imposing sanctions if regulations not met
• Inefficiencies in market corrected = promotes efficient and orderly markets
o Ensuring sufficient liquidity in market place i.e. by having market makers
o Provision of settlement systems (ensuring trades carried out in fair and efficient way)
o Imposing stock exchange requirements on listed companies
• Protect consumers of financial products
o Disclosure of information and product literature
o Cooling off periods
o Initial authorisation of main players in market
o Schemes to compensate investors for breaches in regulations
o Legislation preventing use of unfair contract terms
o Legislation on treating customers fairly
Direct costs of regulation?
- Regulator: administering regulation (collecting and examining information provided by participants)
- Regulated: compliance w/ regulation (maintaining appropriate records, collating and providing information)
Indirect costs of regulation?
AUS PC
• Alteration in consumer behaviour resulting from:
o reduced sense of responsibility for actions
o false sense of security
• Undermining in sense of professional responsibility amongst intermediaries and advisors
• Self-regulation and protection methods developed by the market itself reduced
• Product innovation reduced
• Competition reduced
What are the functions of the regulator?
SERVICE
• Setting sanctions
• Enforcing regulations
• Reviewing and influencing 𝔾 policy
• Vetting and registering firms and individuals authorised to conduct certain types of business
• Investigating breaches
• Checking management and conduct of providers
• Educating and providing information to consumers and the public
Mitigation tools for maintaining confidence
- Checks on capital adequacy of providers (financial strength of providers)
- Ensuring financial practitioners are competent and act with integrity
- Industry compensation schemes
- Ensuring orderly and transparent markets
- Stock exchange requirements
Define information asymmetry
• Information asymmetry is where at least one party to a transaction has relevant information which the other party or parties do not have
Define anti-selection
- Anti-selection may arise when the customer has more information than the insurer which they use to their advantage to act in their own best interests.
- This is a behaviour in which customer more likely to take out contract if believe their risk is higher than insurer has allowed for in premiums.
- Anti-selection can also arise where ∃ p/hs have the opportunity to exercise a guarantee/option. Those who have most to gain from the guarantee or option will be the most likely to exercise it.
Define moral hazard
- The action of an individual behaving differently from the way they would behave if they were fully exposed to the consequences of that action.
- The party behaves inappropriately or less carefully than they would otherwise, leaving the organisation to bear some of the consequences of the action.
Mitigation tools dealing with information asymmetry
- Disclosure of full information about products in plain English and educating consumers
- Insider trading regulation or chinese walls (dealing w/ COI)
- Dealing with negotiating power differences
- Consumer protection legislation to deal w/ unfair contract terms
- Consumer protection legislation to ensure providers act in customer’s best interests and TCF
What are the forms of regulation?
- Prescriptive: with detailed rules as to what may or may not be done
- Freedom of action: freedom to do what want but with rules on publicity of information to 3rd parties
- Outcome-based: freedom to do what you want but with a set of prescribed tolerated outcomes (eg: TCF)
What regulatory regimes are there?
Unregulated markets Voluntary codes of conduct Self-regulation Statutory regulation Mixed
Role of the state re: regulations
- In some countries, certain financial products may only be sold by state monopolies
- In others, tariff premium rates set by gov. for certain classes of business to protect customers
- If full tariff rates not prescribed, may still require approval of or set a maximum level of charges than an insurance company may impose
Role of the central bank
• Can play part in regulatory regime for financial product providers
• Function of central bank to meet government targets:
o Control money supply
o Determine or influence:
Interest rates
Inflation rates
Exchange rates
o Target macroeconomic features e.g. growth and unemployment
o Ensure stability of financial system
o Be lender of last resort to commercial banks
Role of large market participants
- Large companies can allow smaller companies to find niche markets and help stabilize premium rates, however:
- Risk that very large participants could distort market to detriment of consumer
- In most developed markets, competition legislation in place to avoid monopolies and anti-competitive practices (reduces power of large market participants)
- Concern that certain market participants take up significant share of available resources of regulator – limited resource to monitor smaller participants
