CH:3 Regulation

Question 1

Why do financial services need stricter regulation?

(3)

Answer 1

• Lack of info mainly causes financial failure.
• Especially info concerning risk and the product being taken on.
• Financial services need stricter regulation due to the complexity of their products and the long-term nature and large financial impact their products might have

Question 2

Aims of financial regulation

Answer 2

• Correct perceived market inefficiencies and promote an efficient and orderly market
• Protect consumers of financial products
• Give confidence in the financial system
• Reduce financial crime
• Limit the likelihood and intensity of potential failures in the financial system and the need to step in as a lender of last resort

Acronym:
G = Give confidence
R = Reduce financial crime
I = Inefficiencies in market corrected
P = Protect consumer
L = Lender of last resort

Question 3

Examples of direct regulatory cost

(2)

Answer 3

• Administering regulation (cost to regulator)
• Compliance of regulated firms (cost to firms complying with the regulation)

Question 4

Examples of indirect regulatory cost

(5)

Answer 4

• Alteration in the behaviour of consumers
• Undermining the sense of responsibility among intermediaries and advisers
• Reduction in consumer protection mechanisms developed by the market
• Reduce product innovation
• Reduce competition

Question 5

Functions of regulator

Acronym

Answer 5

Acronym
S = Setting sanctions
E = Enforcing regulation
R = Reviewing and enforcing government policy
V = Vetting and registering individuals
I = Investigte breaches
C = Check management and conduct of providers
E = Educate consumers and the public

Question 6

How does the regulator protect consumers from information asymmetry?

(7)

Answer 6

• Disclosure of information pertaining to the product in simple language
• Educating consumers
• Reducing possible conflicts of interest (e.g. chinese walls)
• Negotiation weakness of consumer by allowing cooling-off periods at no penalty
• Regulate sales practice, e.g., including cooling off periods
• Price controls
• Unfair features of insurance contracts
• Treating customers fairly

Question 7

Outline the five main types of regulatory regime

Answer 7

• Self-regulatory systems, which are organised and operated by the market participants without government intervention
• Statutory regimes, where the rules are set and policed by the government.
• 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

Question 8

What actions can the regulator take to reduce asymmetries of information?

Answer 8

SPIDER CC

• Selling practices regulated
• Price controls imposed
• Insider trading prevented
• Disclosure of understandable information
• Educating consumers
• Restricting knowledge to publicly available
• Consumer cooling off period
• Chinese walls established

Also,
Fairness

Question 9

What are the advantages and disadvantages of statutory regulation?

Answer 9

Advantages:
* Less open to abuse
* Instills more public confidence due to government involvement
* Should be more efficient if economies of scale can be achieved

Disadvantages:
* Costs and inflexibility
* Outsiders may impose rules that are unnecessarily costly, inefficient and which may not achieve the desired aim
* Government may be inexperienced in regulation

Question 10

How can a regulator address maintaining confidence

Answer 10

• Capital adequacy - holding sifficient finanical resources to cover liabilities
• Competene and integrity of financial practitioners and managers
• Compensation schemes set up - typically cover losses due to fraud, bad advice or failure of the service provider
• Market is orderly, transparent and provides proper protection to investors
• Stock exchange requirements

Question 11

How are regulators addressing climate change on financial systems

Answer 11

Ensuring financial institutions:
* consider climate risk in business decision making and strategic planning
* effectively disclose and report climate-related risks
* adopt a consitient and reliable means of assessing, pricing and managing climate-related risks
* incorporate environmental, social and governance factors into investment decisions
* use scenario analysis to inform risk identification and to estimate the impact of fiancial risks arising from climate risk
* incorporate financial risks from climate change into existing risk management processes