3. Regulation Flashcards
(22 cards)
What are the aims of regulation?
GRIP
- Give confidence in the system
- Reduce financial crime
- Inefficiencies in the market corrected, and efficient and orderly markets promoted
- Protect consumers of financial products
How each of the aims of regulation is met?
Give confidence in the market - Another CARD
Reduce financial crimes - Functions of regulator (SERVICE)
Inefficiences - ensured sufficient liquidity, provision of settlement systems, stock exchange requirements
Protection - CIIRCLED
Outline two direct and five indirect costs associated with regulation
CC - RA
Direct costs
- Cost to the regulator for administering the regulation
- Cost to the regulated firms for complying with it
Indirect costs:
- Alteration of consumer behaviour=> given a false sense of security or reduced sense of responsibility for their own actions
- An undermining of the sense of professional responsibilities amongst intermediary and advisors
- A reduction in the market’s own consumer protection mechanism
- Reduced product innovation
- Reduced competition
Why is the need for regulation in financial markets greater than the need for regulation of most other markets?
5
- Confidence in the financial system
- Risk if one company collapses=> systemic financial collapse of the system
- Asymmetric information, expertise and negotiating strength that exist between the product provider and the end customer.
- Financial transactions are long term in nature=> significant effect on the future economic welfare of individuals
- In general majority of the population is not well educated on financial matters and find the range of products offered both complex and confusing.
What actions can the regulator take to help ensure confidence in the financial system?
5
- Regularly monitoring => institution holds sufficient capital to meet liabilities
- Ensuring that financial practitioners and managers are competent, act with integrity and are fit and proper
- Establishing industry compensation schemes
- Ensuring that the market is transparent, orderly and provides proper protection to investors
- Ensuring listed companies fulfil certain criteria regarding financial stability and disclosure information.
What steps can a regulator take to help reduce information asymmetries?
CIIRCLED
- Cooling-off period for consumers
- Imposing price controls
- Insider-trading regulations enforcement
- Regulating selling practices
- Chinese-walls
- Legislation on treating customers fairly and ensuring no unfair contract terms
- Educating consumers
- Disclosure of information in simple language
What is anti-selection?
- People will be more likely to take out contracts
- Or exercise a guarantee or option
- When they believe their risk is higher than the insurance company has allowed for in its premium setting
- Or pricing of guarantees or options
What is moral hazard?
- The action of a party
- Who behaves differently from the way they would behave
- If they were fully exposed to the consequences of their action.
- Party behaves inappropriately or less carefully otherwise.
- Moral hazard=> information asymmetry=> party causing the action having more info than the party who bears the consequences
- Not the same as anti selection
- Who takes advantage of particular aspects of an insurance contract
- But within the terms of the contract
Describe, giving examples, the consequences of asymmentries of information where a policyholder has an information advantage over an insurer
- Information asymmetries could lead to both anti-selection and fraud
- Options on contracts are taken by those with the most to gain
- Option to renew a contract without further underwriting
- Taken up by an individual with less than average health
- Fraud example => individual lying on a proposal form
- Consequently, Worse than expected claims experience
- And inequity between policyholders, and between policyholder and insurer.
What is prescriptive regulation?
- Detailed rules on what can and cannot be done
What is freedom of action?
- Freedom but with rules on publicity
What is outcome based?
- Freedom but with prescribed tolerance outcomes
What are the main functions of a regulator?
SERVICE
- Setting sanctions
- Enforcing regulation
- Reviewing and influencing government policy
- Vetting and registering firms and individuals
- Investigating breaches
- Checking prudential management and conduct of providers
- Educating consumers and the public
What are the 5 main types of regulatory regime?
- Self-regulatory systems=> operated and organised by market participants=> without government intervention
- Statutory regimes=> where rules are set and policed by government
- Voluntary codes of conduct=> choice of whether to adhere
- Unregulated markets/lines of business=> no regulation
- Mixed regimes=> combination of the above
What are the advantages and disadvantages of a self regulatory regime?
3/2
- +Implemented by the people with the greatest knowledge of the market and greatest incentive to maximise cost-benefit ratio
- +Should respond rapidly to changes in market needs
- +Easier to persuade firms and individuals to co-operate than under a statutory regime
- -Low public confidence => regulator close to the market
- -High barriers to entry
What are the advantages and disadvantages of statutory regulation?
3/3
- +Less open to public abuse
- +Instils more public confidence due government involvement
- +more efficient if economies of scale can be achieved
- -Costs and inflexibility
- -Outsiders may impose rules unnecessarily costly, inefficient and which may not achieve the desired aim
- -Government may be inexperienced in regulation
What are the advantages and disadvantages of voluntary code of conduct
2/2
- +Reduced cost of regulation
- +Rules set by those with the greatest knowledge of the industry
- -Low public confidence
- -Rogue operators who refuse to co-operate
What are influencers on policy holder expectations?
3
- Statements made by the provider=> especially those made to clients in marketing literature and other communications
- Past practices of the provider
- General practises of other providers in the market
How can regulation do to ensure that customers are treated fairly?
2
- Providers may be directly required by legislation to demonstrate that they are treating customers fairly
- Actuaries in statutory positions may be required to whistle blow=> if they believe that a provider is prejudicing the interests of a customer
What are the functions of the central bank ?
7
- Control the money supply
- Determine or influence interest rates
- Determine or influence inflation rates
- Determine or influence exchange rates
- Target macro-economic features such as growth and unemployment
- Ensure stability of the financial system
- Lender of last resort to commercial banks
What are the large market participants influences
4
- Monopolize the regulator’s time
- Influence premium rates
- Allow niche markets for smaller participants
- Distort the market. Need for regulation to prevent monopolices
Regulations on financial institutions, to limit the impact of climate change on the financial system
7
- Disclose and report on climate-related risks and opportunities
- Use scenario analysis to identify and understand the impact of financial risks arising from climate change
- Adopt a consistent approach to assessing, pricing and managing climate-related risks
- Consider climate change in decision making and strategic planning
- Incorporate environmental, social and governance (ESG) factors into investment decisions
- Incorporate climate change related financial risks into management processes
- Consider the impact of climate risks on ability to meet obligations towards policyholders and other key stakeholders
