Chapter 4 - Regulation Flashcards
What are the aims of regulation?
- To reduce financial crime
- > Vetting organisations and individuals who are authorised to conduct certain activities
- > Enforce legislation, impose sanctions and investigate suspect breaches
- To correct inefficient markets and promote efficient and orderly markets
- > Ensure liquidity e.g. money markets
- > Provide proper settlement systems
- > Stock exchange with requirements of listed companies
- Maintain confidence in the financial system
- > Supervise authorised firms (solvency and accounting information)
- To protect consumers of financial products
- > Legislation i.t.o. Treating Customers Fairly
- > Disclosure of information and product literature
- > Initial authorization of the main participants of a market
- > Schemes compensate investors for breaches of regulation
- > Cooling off periods
Name the costs relating to regulation.
Direct Costs
- Administering of the regulations
- Compliance for the regulated firms
Indirect Costs
- Moral hazard
-> Consumer behaviour
-> Undermining sense of professional responsibility
-> Reduction in consumer protection mechanis,s
- Reduced innovation
- Reduced competitionWhy do we need regulation?
- Confidence
2. Asymmetry of information
Name 6 functions of the regulator.
Vetting and registration of firms and individuals who are authorised to conduct certain types of business. Decide on what is meant by financial services business.
Provide information to consumers and public.
Influence and reviwe government policy
Enforce regulations, investigate suspect breaches and impose sanctions
Supervise the prudential management of financial organisations and the way in which they conduct business.
Who must all be regulated?
Deposit-taking institutions Non-financial companies offering shares to the public Financial intermediaries Professional advisers Security markets
Define information asymmetry.
It is when one (or more) party (parties) to a transaction has relevant information which the other party/parties do not have. This can lead to anti-selection.
Define anti-selection.
People are more likely to take out contracts if they believe their risks are higher than what the insurance company allowed for in their premiums. Also, when existing policyholders can exercise a guarantee or an option. Those with the most to gain are the most likely to exercise it. Within terms of the contact.
Define moral hazard.
Party that behaves differently from the way they would have if they were fully exposed to the consequences of that action. Party behaves less carefully. Relates to information asymmetry, where the party causing the action has more info than the organisation who bears the consequences.
Discuss information asymmetry in light of regulation. Include mitigating tools.
Information asymmetry, anti-selection and moral hazard definition.
Mitigating tools
- Conflicts of interest
->Chinese walls
-> Insider-trading regulations
- Unfair features of insurance products
->Consumer protection legislation - literature, contract terms and discontinuance benefits
->TCF
Confident customers, corporate culture
Meet needs of consumer groups
Clear info before and after sale
Suitable advice
Services standards and product performance
Not facing unreasonable post-sales barriers
-> Whistle blowing by actuaries
- Negotiation
-> Price controls
-> Regulation of selling practices
-> Cooling of periods
- Disclosure and education
Discuss the mitigating tools for maintaining confidence i.t.o. Regulation.
Capital adequacy Competence and integrity Compensation schemes Other protection for investors Stock exchange requirements
What are the 3 forms of regulation?
Prescriptive -> detailed rules
Freedom of action -> Rules on publicity
Outcome-based -> prescribed outcomes that will be tolerated
Discuss the regulatory regimes.
Unregulated markets Voluntary codes of conduct Self-regulation Statutory regulation Mixed regimes
What are the advantages and disadvantages of statutory regulation?
+ Less open to abuse
+ Higher degree of public confidence
+ Group activities by function rather than sector -> efficient regulatory body
- Costly and inflexible
- May not reach aim (outside party)
- Gvt attempt to imporve efficiency usually fails
- Better developed by the market itself
What are the advantages and disadvantages of self regulation?
+ Implemented by people with greatest knowledge
+ Companies care about their reputation
+ Can respond rapidly to changes in market needs
+ Easier to convince organisations to comply
- Closeness of regulator to the industry (ignores 3rd parties)
- Low public confidence in the system
- May inhibit new entrants to the market
