Chapter 4: Regulation Flashcards
What ware the 2 competing goals regulations are concerned with?
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
Direct costs of regulation
- 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)
Indirect costs of regulation
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
How does regulations protect consumers?
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
How do regulators impact solvency and take precaution against insolvency of institutions?
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
It will be necessary to regulate:
- deposit-taking institutions
- financial intermediaries
- securities markets
- professional advisors
- non-financial companies offering securities to the public
Information asymmetry
The situation where at least one party to a transaction has relevant information which the other party or parties do not have.
Anti-selection
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.
Moral hazard
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.
6 key outcomes to be achieved by the FCA’s TCF (Treating Customers Fairly)
- 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.
Main influences on policyholder expectations:
- 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.
5 Areas addressed by regulation - maintaining confidence
- 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
Capital Adequacy
Institutions must hold sufficient capital to cover their liabilities
Compensation schemes
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.
3 Forms of regulation
- Prescriptive
- Freedom of action
- Outcome-based
