O Chapter 3 Regulation Flashcards
Principle aims of regulation
GRIP
- Give cinfidence in the system
- Reduce financiaal crime
- Inefficiencies in the market correxted
- Protect consumets
Direct costs of regulation
- administrating the regulation (e.g. costs for collection/examination of information from mkt. participants and monitoring their activities)
- the cost incurred by regulated firms to comply with regulation (compliance of the regulated firms)
Indirect cists of regulation
PUMA
- product innovation reduced
- undermining of intermediaries and advisors professionalism (sense of professional responsibility)
- market reduces its own consumer protection mechanisms
- alternation of consumer behavior, false sense of security and a reduced sense of responsibility
- reduced competion
Grater need for regulation in the financial indestry
Firstly importance of confidence in the financial system. There is the risk that if one company collapses, it can cause a systemic financial collapse.
Secondly the asymmetry of information, expertise and negotiating strength that exists between the product provider and end customer.
These issues are exacerbated by the fact that:
* finanncial transactions are often long term in nature and can have a significant impact on the future economic welfare of indiciduals
* in general, most of the population is not well educated on financial matters and find the range of products offeted both complex and confusing
The main function of the regulator
SERVICE
Setting sanctions
Enforcing regulations
Reviewing and influencing govetnment policy
Vetting and registeting firms and individuals
Investigating breaches
Checking management and conduct of providets
Educating consumets and public
Institutes that require regulation
- deposit taking institutions
- financial insturions
- securities markets
- professional advisers
- non-financial companies offering securities to the public
Prescriptive regulation
Detailed rules on what can and can’t be done
Information asymmetry
The situetion where at least one party to a transaction has relevant information which the othet 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 oprion. Those who have the most to gain from the guarantee or option will be the most likely to exercise it.
Moral hazard
The action of a party who bahaves differently from the way they would behave if they were fullly exposed to the consequences of that action.
The party behaves less carefully, leaving the organisation to bear some of the consequences of the action. Moral hazard is related to information asymmetry, with the party causing the action generally having more information than the organisation that nears the consequences.
(This is not the same as anti-selection, which is also taking advantage of particular aspects of an insurance contract, but within the terms offered by the insurer)
What are implications of information asymmetries
Information asymmetries leads to both anti selection and fraud.
An example of anti selection is where options on comtracts are taken up by those with the most to gain.
An example of fraud is where a policyholder does not answer questions on a proposal form fully and truthfully.
The consequences of both anti selection and fraud are:
* worse than expected claims experience
* inequality between policyholders, and between the policyholder and the insurer
Actions of regulator to reduce asymmetries of information
SPIDER CC
Selling practices regulated
Price controls imposed
Insider trading prevented
Disclosure of understandable information
Educating consumets
Restricting knowledge to publicly available
Consumet cooling off period
Chinese walls established
Also,
Fairness
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 genetal practices of othet providers in the market.
Action the regulator takes to help ensure confidence in the financial system
- Regularly monitoring that institutions hols sufficient capital to meet their liabilities
- Ensuring that financial practitioners and managers are competent, act with integrity and are “fit and proper”
- Establishing indistry compensation schemes
- Ensuring that the market is transparent, orderly, and provides proper protection to investors
- Ensuring that listed companies fulfill certain criteria regarding financial stability and disclosure of informarion
5 Areas addressed by regulation - maitaining confidence
- Capital adequacy
- Competence and integrity
- Compensation schemes
- Investor protection ( regulators seek to ensure that the mkt. is transparent, orderly and protects investors)
- Stock exchange requirements
5 Main types of regulatory regime
- Self regilatory systems, which are orgenised and opersted by the market participents without govetnment intervention
- Statutory regimes, where the rules are set and policed by the govetnment
- Voluntary codes of conduct, where there is a choice as to whether to adhere
- Unregulated markets/lines of business, with no regulation
- Mixed regimes, involving a combination of the above
Pescriptive
It can be prescriptice, with detailed rules setting out what may or may not be done.
Freedom of action regulation
Freedom but with rules on publicity
Outome based regulation
Freedom but with prescribed, tolerated outcomes
Advantages of self regulation
- The 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 repidly to changes in market needs
- May be easier to persuade firms and individuals to co-operate with a self regulatory organisation than wit a government bureaucracy
Disadvantages of self regulation
- The closeness of the regulator to the industry it is regulating. The danger that the regulator accepts the industrys 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 (rules discorage new entries into the market)
- low publick confidence
Advantages of statutort regulation
- Less open to abuse
- Installs more public confidence due to govetnment involvement
- Should be more efficient if economies of scale can be achieved
Disadvantages of statutory regulation
- Costs and inflexibility
- Outsiders may inpose rules that are unnecessarily costly, inefficient and which may not achieve the desired aim
- Govetnment may be inexperienced in regulation
Mixed regimes
Often developed by market driven private institutions (e.g. stock exchanges) as well as by governments
The possible functuins of the central bank, as part of the regulatory or supervisory regime for financial product prociders
To meet governemtnt taregts, the central bank can:
* control the money supply
* determine or influence interest rates
* determine or influence inflation rates
* determine or influence exchange rates
* ensure stability of the financial system
* lender of last resort to commercial banks
* target macro-ecinimic features such aas growth and unemplouement
The state
sometimes financial products of certakn classes:
may only be sold by state monopoly compamies
tariff premium rates or set max rates
restrics new axcess, damaging innovation and new development
Large market particapent
regulations to avoid monopolies and anty-competative practices in the market so prevent distortion of the market
if large proportion of recorces taken up by one participant then regulator has few recorces to monotor smallet companys
Problems associated with voluntary cofes of conduct
- there may be low public confidence in the approach
- there may be a few rogue traders who refuse to cooperate
Describe two ways in which regulation can try to ensure that customets are treated fairly
- Providers may be directly required by the regulator to demonstrate that they treat customets fairly
- Actuaries in statutory roles may be required to whistle blow if they believe that a provider is prejudiceing the interests of the customer
Compensation schemes
- funded either by the industry or by the govetnment
- provide recompense to investors who have suffered losses. Typically losses due to fraud, bad advice or failure of the service provider rathet than market-related losses.
The aims of climate change related financial regulations
- consider climate risks in business decision making and strategic planning
- effectively disclose and report on climate related risks and opportunities
- adopt a consistent and reliable means of assessing, pricing and managing climat related risks
- incorporate environmental social and governance(ESG) factors into invsestment management decisions
- incorporate financial risks from climate change into existing risk management processes
- use scenario analysis to inform risk identification and to estimate the impact of financial risks areising from climate change
