Chapter 10: Applications of the legislative and regulatory framework (2)

Question 1

g.ii)legislative and regulatory framework

List ten key principles relating to the provision of financial services, which govern the relationship between an intermediary and a customer.

Provision of services

Answer 1

1. Skill, care and due diligence
2. Integrity
3. conflicts of interest
4. Information for customers
5. Financial resources
6. Other factors influencing the legislation
7. Relations with regulators
8. Market practice
9. Information about customers
10. Customer assets
11. Internal Organisation

Question 2

g.ii)legislative and regulatory framework

Explain what is covered by:
- integrity
- skill, care and diligence
- market practice

Provision of services

Answer 2

Integrity:
Firms should observe high standards of integrity and fair trade (by acting in the best interests of customers)

Skill,care and diligence
Firms should act with due skill, care and diligence

Market practice
Firms should observe high standards of market conduct and comply with any code or standard in forms as it applies to the firm (either according to its terms or by rulings made under it)

Question 3

g.ii)legislative and regulatory framework

Explain what is covered by:
- information about customers
- information for customers

Provision of services

Answer 3

Information about customers:
Firm should seek from customers it advises, or for whom it exercises discretion, any information about their circumstances and investment objectives which might be expected to be reasonably relevant in enabling it to fulfil its responsibilities to them.

Information for customers
Firm should take reasonable steps to give customer it advises, in a comprehensible and timely manner, any information needed to enable him to make a balanced and informed decision.

Firm should similarily be ready to provide customers with full and fair account of its fulfilment of its responsibilities to them.

Question 4

g.ii)legislative and regulatory framework

Explain what is required under the heading:
- conflict of interest

Provision of services

Answer 4

Firm should avoid conflict of interest arising or, where conflicts arise, should ensure fair treatment of all customers by disclosure, internal rules of confidentiality and declining to act or otherswise.

Firm should:
- not place its interests above those of its customers
- place customers interest above its own, where customer would reasonably expect this.

Provision of services

Question 5

g.ii)legislative and regulatory framework

Explain what is required under the heading:
- customer assets
- financial resources

c

Answer 5

Customer assets:
if firm responsible for customer’s assets, then it should arrange proper protection of them, by way of segreggation and identification of assets or otherwise

financial resources:
Firm should ensure it maintained adquate financial resources to meet its investment commitments and withstand riskss to which it is subject.

Question 6

g.ii)legislative and regulatory framework

Explain what is required under the heading:
- Internal organisation
- relations with regulators

Provision of services

Answer 6

Internal organisation:
Firm should organise and control its internal affairs in a responsible manner and keep proper records.

Relations with regulators:
Firm shuld deal with the regulator in an open and co-operative manner and keep regulator informed of anything concerning firm that might be reasonably expceted to be disclosed to it.

Question 7

g.ii)legislative and regulatory framework

List the set of ten principles relating to institutional investment practices, which are relevant to any situation where an investor employs an investment manager to invest moeny on their behalf.

Institutional Investment practices

Answer 7

1. Regular reporting
2. Effective decision-making
3. Performance measurement
4. Expert advice
5. Activism
6. Transparency
7. Clear objectives
8. Appropriate benchmarks
9. Focus on asset allocation
10. Explicit mandates

Question 8

g.ii)legislative and regulatory framework

Explain what is meant by:
- effective decision-making
- the clear objectives principle

Institutional Investment practices

Answer 8

Effective decision making:
- Decisions should be taken by persons or organisations with skills, information and resources necessary to take them effectively.
- in particular, trustees should have appropriate knowledge to question advice of investment consultant.

Clear objectives:
- Requires trustees to set out overrall investment objectives for fund that:
- …represents their best judgement of what is necessary to meet the fund’s liabilities, and
- …takes into account their attitude to risk
- Objectives should not be expressed in terms unrelated to liabilities, e.g., performane relative to other funds or market index

Question 9

g.ii)legislative and regulatory framework

Explain the principles underlying ‘focus on asset allocation.
State two recommendations of the ‘expert advice’ principle.

Institutional Investment practices

Answer 9

Focus on asset allocation:
- Asset allocation should receive sufficient level of attention…
- …that fully reflects the contribution they can make towards acheiving the fund’s investment objectives
- …especially as it typically has greater impact on results than stock selection
- Decisions makers should consider full range of investment, opportunities not excluding consideration of any major asset class.
- Asset allocation should reflect funds’ own characteristics ( both nature of liabilites and risk appetite) and not average allocation of other funds.

Expert advice
- Contracts for actuarial services and investment advice should be opened to separate competition at regular intervals.
- Fund should be prepared to pay sufficient fees for each service to attract broad range of kinds of potential providers.
- So ought to consider employing different advisors to help to:
- …value the investment fund’s assets and liabilities
- …choose the investment strategy
and perhaps choose the investment managers

Question 10

g.ii)legislative and regulatory framework

Institutional Investment practices

Question 11

g.ii)legislative and regulatory framework

State the recommendations of the ‘explicit mandates’ principle

Institutional Investment practices

Answer 11

• Trustees should agree explicit mandates with each investment manager, setting out:
  -…objectives, benchmark(s) and risk parameters that, together with all other mandates, are coherent with fund’s aggregate objective and risk tolerances
  -…manager’s approach in attempting to achieve objective
  -…clear time scales of measurement and evaluation
• Mandate should not exclude the use of set of financial instruments without clear justification in light of specific circumstances of fund.

Question 12

g.ii)legislative and regulatory framework

State the recommendations of the ‘activism’ principle

Institutional Investment practices

Answer 12

Managers should incorporate explicit strategy on activism, elucidating:
- circumstanes in which they will intervene in a company
- approach they will use in doing so
- how they measure the effectiveness of this strategy.

Question 13

g.ii)legislative and regulatory framework

State the recommendations of the ‘appropriate benchmarks’ principle

Institutional Investment practices

Answer 13

Trustees should:
- explicitly consider, in consulation with their investment managers, whether index benchmarks they have selected are appropriate
- if setting limits on divergence from index, ensure they reflect approximations involved index construction and selection
- consider explicitly, for each asset class, whether active or passive management is more appropriate given efficiency, liquidity and level of transaction costs in market concerned
- where they believe active management has potential to achieve higher returns, set both targets and risk controls that reflect this, giving managers freedom to pursue genuinely active strategies.

Question 14

g.ii)legislative and regulatory framework

State the recommendations of the ‘transparency’ principle

Institutional Investment practices

Answer 14

The Statement of Investment Principles should set out:
- who is taking decisions, and why this structure has been selected
- fund’s investment objective
- fund’s planned asset allocation strategy, included projected investment returns for each asset class, and how this strategy has been arrived at.
- Mandates given to all advisers and investment managers
- nature of all fee structures in place for all advisers and investment managers, and why this set of structures has been selected

Question 15

g.ii)legislative and regulatory framework

State the recommendations of the:
- performance measurement principle
- regular reporting principle

Institutional Investment practices

Answer 15

Performance measurement:
1. Includes considerations of:
- any changes in the nature of liabilities
- any changes affecting risk appetite
- the appropriateness of the performance measures imposed
- the trustees’ role and whether they are carrying out their duties to the required standards
2. Trustees should arrange for measure of performance of fund and should make formal assessment of:
- own procedures and decisions as trustees
- performance and decision making delegated to advisers and managers

Regular reporting:
- trustees publish SIP and results of monitoring advisers and managers
- send them annually to members of the fund
- SIP to explain why fund has decided to depart from any of these principles

Question 16

g.ii)legislative and regulatory framework

Outline the roles and responsibilities of directors

Roles of responsibilities of directors

Answer 16

Direct responsible:
- Fair and true accounts and financial reporting
- Asset safeguard and prevent and detect fraud and other irregularities
- ensure Trade slovency and compliance with regulation
- Legal obligations carried out and met
- Appoint management
- Dividend payment approval

Question 17

g.ii)legislative and regulatory framework

Outline the need for IFRS and state the main areas of difference across the world of accounting standard.

Development of IFRS

Answer 17

Need for IFRS:
1. The globalisation of capital markets has intensified the need for IFRS (one set of financial reporting standards acceptable to all listing authorities in the major financial centers and which all investors use)

2. Makes it easier to list on different exchanges and help investors make comparisons between companies listed on different exchanges
3. lack of transparency and reliable financial information exacerbates loss of confidence in markets –> leading to uniformed decisions —> increase cost of capital

Main areas differences across the world relate to treatment of:
- assets and derivatives
- provisions
- the funding of employee benefits
- income tax

Question 18

g.ii)legislative and regulatory framework

List the three main aims of the International Financial Reporting Standard

Development of IFRS

Answer 18

1. to encourage reliable and consistent accounting data
2. to produce transparent accounts, that give insight into financial condition of firm
3. to have single set of standards world wide, which enables access to financial markets and prevent companies having to produce results on several bases.

Question 19

g.ii)legislative and regulatory framework

State two requirements of IFRS 9 for institutions trading in investments.

State arguments against these requirements.

Development of IFRS

Answer 19

For institutions trading investments, IFRS 9 requires:
1. Investments to shown at fair value on BS.
2. Any resultant loss or profit on revaluation to be shown on in the statement of comprehensive income.

Arguements against:
The requirements above have proved to be contravensial with the following arguments:
- Investments are a part of a long-term pf and so their value should not be viewed on one particular day
- …and with resultant fluctuations in the assets and income figures