Regulation Flashcards
Aims of regulation of financial services
Correct market inefficiencies and to promote efficient and orderly markets
Protect consumers of financial products
Maintain confidence in the financial system
Help reduce financial crime
Direct cost
Administering the regulation
Compliance for the regulated firms
Indirect costs
• alteration in consumer behavior
• undermining the sense of professional responsibility among intermediaries and advisors
• reduction in self-regulation by the market
• reduced product innovation
• reduced competition
Need for regulation
Maintain confidence in the sector
Deal with information asymmetries
Functions of a regulator
• influencing and reviewing government policy
• vetting and registering firms and individuals authorized to conduct certain types of business
• supervising the prudential management of financial organizations
• supervising the conduct of financial businesses, and taking enforcement action where appropriate
• enforcing regulations, investigating suspected breaches and imposing sanctions
• providing information to consumers and the public
Areas addressed by regulation:
Information asymmetry
• asymmetries occur when one party has relevant information or expertise or negotiating strength not shared by another party
• this can lead to anti-selection
• the asymmetries are exacerbated by the complex and long term nature of financial contracts
• mitigation tools include:
- disclosure of information in plain language
- Chinese walls
- cooling off periods
- customer legislation on unfair contract terms and TCF
- “whistle blowing” by actuaries if they believe the client is treating customers unfairly
Areas addressed by regulation:
Maintaining confidence
• there is a danger that problems in one area of the financial system spread, leading to the collapse of the whole system
• mitigation tools include
- check on capital adequacy of providers
- ensuring practitioners are competent and act with integrity
- industry compensation schemes
- ensuring orderly and transparent markets
- stock exchange requirements
The main types of regulatory regimes
Unregulated markets - where no financial services specific regulations apply; market participants are instead subject to normal legislation
Voluntary codes of conduct - drawn up by the financial services industry itself
Self regulation - organized and operated by the participants in a particular market without government intervention
Statutory regulation - in which a government body sets out the rules and policies them
Mixed - a combination of the above (many countries adopt such a mixture)
Each of the regimes may adopt any of the following forms:
• prescriptive regimes - with detailed rules as to what may or may not be done
• freedom of action - with rules only on publicity of information
• outcome based regimes - with prescribed tolerated outcomes
Role of major financial institutions
Central bank - controlling or influencing economic variables, such as lender of last resort
State intervention - provision of products (e.g. through state monopoly companies), control of premium rates
Large market participants - influencing premium rates, allowing smaller participants to find niche markets; however, may distort the market and use up too much of the regulator’s limited resources
Regarding climate change
Regulators are working on regulations with aims to
• consider climate risks in business decision making and strategic planing
• effectively disclose and report on climate related risks and opportunities
• adopt a consistent and reliable means of assessing, pricing, and managing climate related risks
• incorporate environmental, social and governance (ESG) factors into investment 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 arising from climate change
• consider the impact of climate risks in the ability to meet obligations towards policyholders and other key stakeholders
