Chapter 4: Regulation Flashcards

1
Q

What ware the 2 competing goals regulations are concerned with?

A

2 competing arguments:

(a) Consumer protection - Protect the public as it is uncertain whether a free market will act in their interest e.g. asymmetric info, consumer confidence, barriers to entry
(b) Support mkt. freedom - Public benefits from free mkt. because it makes financial services efficient i.e. legislation should encourage competition

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2
Q

Direct costs of regulation

A
  • administering the regulation (eg. costs for collection/examination of information from mkt. participants & monitoring their activities)
  • Cost incurred by regulated firms to comply to regulation (compliance of the regulated firms)
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3
Q

Indirect costs of regulation

A

P - reduced product innovation
- reduced competition

U - an undermining of the sense of professional responsibility amongst intermediaries and advisors
M - a reduction in consumer protection Mechanisms developed by the market itself
A - alteration in the behaviour of consumers, who may be given a false sense of security and a reduced sense of responsibility for their own actions

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4
Q

How does regulations protect consumers?

A

TAX MISSIONS

  • Raise tax revenue to ensure gvt. debt can be financed so it can enforce regulation/provide benefits (social objectives)
  • Encourage/discourage certain behavior (saving for retirement vs smoking tobacco)

MARKET MISSIONS

  • Address mkt failure when it doesn’t operate efficiently
  • Ensure access to products/reasonable prices eg price controls, commission limits, setting up state insurance company
  • Favour local economy eg import tariffs, control currency flow

SOCIETAL MISSIONS

  • Prevent discrimination by age, sex, race. Or allowed on basis of credible data
  • Social objectives (eg consumer protection, TCF)
  • Educate public about financial products/services
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5
Q

How do regulators impact solvency and take precaution against insolvency of institutions?

A

PURPOSE

  • They increase strength of financial institutions
  • They serve as early warning system to reduce losses for customers of institutions that fail

LOGISTICS

  • Capital adequacy requirements
  • Risk management reqs. + asset & reinsurance reqs.
  • Accounting standards
  • Set up compensation scheme (either govt. or mkt. sponsored)
  • Review & influence govt. policy

COMPANY CHECK

  • Vetting of companies auth’d to operate
  • Requirement of qualified/fit staff to run businesses
  • Need regulator’s approval for a change in control of business (if an individual seeks to acquire or increase control of a regulated firm, the regulators must approve)

DISCLOSURE

  • Provide info to public
  • Disclosure of info to p/h
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6
Q

It will be necessary to regulate:

A
  • deposit-taking institutions
  • financial intermediaries
  • securities markets
  • professional advisors
  • non-financial companies offering securities to the public
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7
Q

Information asymmetry

A

The situation where at least one party to a transaction has relevant information which the other party or parties do not have.

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8
Q

Anti-selection

A

People will be more likely to take out contracts when they believe their risk is higher than the insurance company has allowed for in its premiums.

Can also arise where existing policyholders have the opportunity of exercising a guarantee or an option. Those who have most to gain from the guarantee or option will be the most likely to exercise it.

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9
Q

Moral hazard

A

Action of a party who behaves differently from the way they would behave if they were fully exposed to the consequences of that action.
The party behaves less carefully, leaving the organisation to bear some of the consequences.

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10
Q

6 key outcomes to be achieved by the FCA’s TCF (Treating Customers Fairly)

A
  • Consumers can be confident that they are dealing with firms where the FAIR TREATMENT of customers is central to the corporate culture.
  • Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly.
  • Consumers are provided with CLEAR INFORMATION and are kept appropriately informed before, during and after the point of sale
  • Where consumers receive advice, the ADVICE IS SUITABLE and takes account of their circumstances,
  • Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an ACCEPTABLE STANDARD and as they have been led to expect
  • Consumers do not face unreasonable post-sale BARRIERS imposed by firms to change product, switch provider, submit a claim or make a complaint.
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11
Q

Main influences on policyholder expectations:

A
  • statements made by the provider, especially those made to the client in marketing literature and other communications
  • the past practice of the provider
  • the general practices of other providers in the market.
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12
Q

5 Areas addressed by regulation - maintaining confidence

A
  • Capital adequacy
  • Competence and integrity resulting from regulation of professions
  • Compensation schemes
  • Investor protection (regulators seek to ensure that the mkt. is transparent, orderly and protects investors)
  • Stock exchange requirements
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13
Q

Capital Adequacy

A

Institutions must hold sufficient capital to cover their liabilities

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14
Q

Compensation schemes

A

Compensation schemes - funded either by the industry or by government - provide recompense to investors who have suffered losses.
Typically losses due to fraud, bad advice or failure of the service provider rather than market-related losses.

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15
Q

3 Forms of regulation

A
  • Prescriptive
  • Freedom of action
  • Outcome-based
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16
Q

Prescriptive regulation

A

Detailed rules setting out what may or may not be done.

17
Q

Freedom of action regulation

A

Involves freedom of action but with rules on publicity so that 3rd parties are fully informed about the providers of financial services.

18
Q

Outcome-based regulation

A

Prescribe the outcomes that will be tolerated.

19
Q

Advantages of self-regulation

A
  • System implemented by the people with the greatest knowledge of the market, who also have the greatest incentive to achieve the optimal cost benefit ratio.
  • Should be able to respond rapidly to changes in market needs.
  • May be easier to persuade firms and individuals to co-operate with a self-regulatory organisation than with a government bureaucracy.
20
Q

Disadvantages of self-regulation

A
  • Closeness of the regulator to the industry it is regulating. Danger that the regulator accepts the industry’s POV and is less in tune with 3rd parties.
  • Can lead to a weaker regime than is acceptable.
  • May inhibit new entrants to a market (existing participants frame rules)
21
Q

Statutory regulation

A

The government sets out the rules and polices them.

22
Q

Self-regulation

A

Organised and operated by the participants in a particular market without government intervention.

23
Q

Advantages of statutory regulation

A
  • less open to abuse
  • higher degree of public confidence
  • may be run efficiently if economies of scale can be achieved through grouping its activities by function rather than type of business.
24
Q

Disadvantages of statutory regulation

A
  • Can be more costly and inflexible than self-regulation

- Outsiders may impose rules that are unnecessarily costly and may not achieve the desired aim.

25
Q

Mitigation tools: information asymmetries

A

S - restrict Selling practices
P - impose Price controls
I - prevent Insider trading
D - disclosure of information in plain language
E - Educate consumers
R - restrict knowledge to that which is publicly available

W - “Whistle blowing” by actuaries if they believe the client is treating customers unfairly.
I - INDEPENDENT FINANCIAL ADVISORS can be used for a fee. These professionals are regulated through a PROFESSIONAL BODY.
C - Cooling-off periods for consumers
C - Can establish Chinese walls
C - Customer legislation on unfair contract terms and TCF
o Minimum SURRENDER values
o Not allowed to CHANGE CONTRACTS without valid reasons

ASYMMETRY=> SYMMETRY=>SPIDER WICCC => 4 LEGS EACH SIDE (SYMMETRIC)

26
Q

5 Types of regulatory regime

A
  • Unregulated markets
  • Voluntary codes of conduct
  • Self-regulation
  • Statutory regulation
  • Mixed (combination of multiple approaches)
27
Q

Main levels of regulation:

A
  • Primary legislation: Acts & laws less detailed, providing authority to make subsidiary legislation
  • Subsidiary legislation: More detailed & easier to amend
  • Court decision and precedent: disputes about the meaning of the law may be referred to courts (T&Cs may be ambiguous in insurance contract)
  • Regulatory & Self regulatory bodies: Either industry-specific e.g. FCA, market controllers e.g. Stock exchange, professions e.g. IFoA
  • *They may have legal power to regulate members or sectors
28
Q

What does regulator do when an institution is at risk of insolvency?

A

Arrange an orderly exit:

  • No new business is written, existing business run-off gradually
  • Struggling institution taken over by another institution or govt.
  • To maintain public confidence & to avoid moral hazard from other institutions regulator may choose to not disclose rescue involvement
29
Q

What does regulator do to address mkt. failure?

A

Anti-competitive behaviour may emerge due to:

  • high barriers to entry
  • Compulsory insurance
  • Difficult to change providers of long term products e.g life assurance

There may be need for regulations to:

  • Promotes competition & limit concentration of providers
  • Ensure fair minimum surrender terms & opt-out arrangements