Chapter 5

Question 1

State the advantages of regulations for providers of financial products. [2]

Answer 1

Regulation serves to reduce the consequence✓ of information asymmetry✓ between product or benefit providers and consumers✓.
Regulations may increase the efficiency of the market✓, by…
* reducing transaction costs✓,
* increasing the effectiveness of competition between providers✓,
* reducing moral hazard✓ and opportunistic behaviour by providers✓, and
* ensuring that products meet the reasonable expectations of purchasers✓.

Question 2

Why are regulations particularly important for financial products? [2]

Answer 2

• The financial literacy of most consumers is low but providers are sophisticated.✓✓
• Products can easily be made very complex. e.g. tiered CI products.✓✓
• The benefit may be intangible, e.g. peace of mind.✓✓
• Benefits may be received many years after the product is first purchased.✓✓

Question 3

Describe the regulations around “market structures”. [2.5]

Answer 3

• Often covers licensing requirements✓, capital adequacy rules✓, ownership✓, and governance standards✓, and other operational aspects✓ of financial institutions.
• May also include restrictions on the types of benefits an entity can offer.✓✓
• Uptake of benefits can be regulated✓—benefits can either be mandated or left as voluntary✓, with or without incentives✓.

Question 4

Prudential Regulation

Answer 4

l Regulation regarding the solvency of financial product providers, such as adequacy of assets relative to liabilities, minimum solvency requirements, or types of assets permitted to demonstrate solvency.
l May require advance funding of benefits or separation from other assets. l May cover the authorisation of individuals or organisations that manage or invest funds.

Question 5

Product Regulation

Answer 5

Product regulation l Buy-side product standards—where individuals may not purchase products that do not comply with certain standards—may be used to limit tax incentives to certain classes of products sold by providers.
l Sell-side standards tend to be more general in scope and may be used to increase competition between different providers in financial product markets by making different products more comparable.
l Other examples of regulation on the sell-side include retirement fund charges, PMI conditions, underwriting decisions, new product launches, benefit schedules, retirement fund increase policies, and surrender or withdrawal terms.

Question 6

Market conduct regulation l Regulation of the relationship between financial product providers and their customers, and service providers.
l Examples include unambiguous product names and descriptions, sales process, policy wording or benefit arrangement rules, communication to policyholders and members, disclosure, fit and proper requirements, complaints procedures, and outcomes, and premiums or premium increases.