Chapter 4: Regulation

Question 1

4 Principle aims of regulations

Answer 1

G - Give & maintain confidence in the financial system
R - Reduce financial crime.
I - to correct perceived market inefficiencies and to promote efficient and orderly markets
P - to protect consumers of financial products

Question 2

Direct costs of regulation

Answer 2

• administering the regulation

- compliance for the regulated firms

Question 3

Indirect costs of regulation

Answer 3

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

Question 4

2 reasons for the need for regulation

Answer 4

• confidence

- asymmetric information

Question 5

7 Functions of a regulator

Answer 5

• VETTING & registration of firms/indivs auth’d to conduct business
• check the PRUDENTIAL management of fin organisations and the way in which they conduct their business
• enforce REGULATIONS
• investigate BREACHES
• impose SANCTIONS
• Review & influence GOV POLICY
• EDUCATE consumers & the public

Question 6

It will be necessary to regulate:

Answer 6

• deposit-taking institutions
• financial intermediaries
• securities markets
• professional advisors
• non-financial companies offering securities to the public

Question 7

Information asymmetry

Answer 7

The situation where at least one party to a transaction has relevant information which the other party or parties do not have.

Question 8

Anti-selection

Answer 8

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.

Question 9

Moral hazard

Answer 9

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.

Question 10

6 key outcomes to be achieved by the FCA’s TCF (Treating Customers Fairly)

Answer 10

• 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.

Question 11

Main influences on policyholder expectations:

Answer 11

• 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.

Question 12

5 Areas addressed by regulation - maintaining confidence

Answer 12

• Capital adequacy
• Competence and integrity
• Compensation schemes
• Investor protection
• Stock exchange requirements

Question 13

Capital Adequacy

Answer 13

Institutions must hold sufficient capital to cover their liabilities

Question 14

Compensation schemes

Answer 14

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.

Question 15

3 Forms of regulation

Answer 15

• Prescriptive
• Freedom of action
• Outcome-based

Question 16

Prescriptive regulation

Answer 16

Detailed rules setting out what may or may not be done.

Question 17

Freedom of action regulation

Answer 17

Involves freedom of action but with rules on publicity so that 3rd parties are fully informed about the providers of financial services.

Question 18

Outcome-based regulation

Answer 18

Prescribe the outcomes that will be tolerated.

Question 19

Advantages of self-regulation

Answer 19

• 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 rapidly to changes in market needs.
• May be easier to persuade firms and individuals to co-operate with a self-regulatory organisation than with a government bureaucracy.

Question 20

Disadvantages of self-regulaton

Answer 20

• Closeness of the regulator to the industry it is regulating. Danger that the regulator accepts the industry’s 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 (existing participants frame rules)

Question 21

Statutory regulation

Answer 21

The government sets out the rules and polices them.

Question 22

Self-regulation

Answer 22

Organised and operated by the participants in a particular market without government intervention.

Question 23

Advantages of statutory regulation

Answer 23

• less open to abuse
• higher degree of public confidence
• may be run efficiently if economies of scale can be achieved through grouping its activities by function rather than type of business.

Question 24

Disadvantages of statutory regulation

Answer 24

• Can be more costly and inflexible than self-regulation

- Outsiders may impose rules that are unnecessarily costly and may not achieve the desired aim.

Question 25

Mitigation tools: information asymmetries

Answer 25

``` S - restrict Selling practices P - impose Price controls I - prevent Insider trading D - disclosure of information in plain language E - Educate consumers R - restrict knowledge to that which is publicly available C - Cooling-off periods for consumers C - Can establish chinese walls ``` - customer legislation on unfair contract terms and TCF - "whistle blowing" by actuaries if they believe the client is treating customers unfairly.

Question 26

5 Types of regulatory regime

Answer 26

- Unregulated markets - Voluntary codes of conduct - Self-regulation - Statutory regulation - Mixed