Chapter 9

Question 1

What is the primary focus of this chapter on the legislative and regulatory framework?

Answer 1

The regulation of the financial services market and the principles underlying the investment manager/client relationship.

Question 2

List the sections covered in this chapter.

Answer 2

• Key principles for financial services intermediaries
• Principles for client and investment manager agreements
• Roles and responsibilities of directors
• Development of International Financial Reporting Standards

Question 3

What are the four principal aims of financial services regulation discussed in Chapter 7?

Question 4

What is essential for promoting investment confidence between financial service providers and clients?

Answer 4

The intermediary being fully aware of the client’s needs and keeping the client informed.

Question 5

What problems arise from the asymmetry in knowledge between financial service providers and clients?

Answer 5

Investors may make suboptimal choices when selecting financial services.

Question 6

What are the key principles underlying financial services regulation?

Answer 6

• Integrity
• Skill, care, and diligence
• Market practice
• Information about customers
• Information for customers
• Conflicts of interest
• Customer assets
• Financial resources
• Internal organisation
• Relations with regulators

Question 7

Define integrity in the context of financial services regulation.

Answer 7

The firm should observe high standards of integrity and fair dealing, acting in the best interests of customers.

Question 8

What does skill, care, and diligence entail for a firm?

Answer 8

A firm should act with due skill, care, and diligence.

Question 9

What is meant by market practice in financial services?

Answer 9

A firm should observe high standards of market conduct and comply with applicable codes or standards.

Question 10

What information should a firm seek from customers it advises?

Answer 10

Information about their circumstances and investment objectives.

Question 11

Fill in the blank: A firm should take reasonable steps to give a customer information needed to make a _______.

Answer 11

[balanced and informed decision]

Question 12

How should conflicts of interest be managed by a firm?

Answer 12

By avoiding conflicts or ensuring fair treatment through disclosure and internal rules.

Question 13

What is the responsibility of a firm regarding customer assets?

Answer 13

To arrange proper protection for customer assets through segregation and identification.

Question 14

What financial responsibility must a firm maintain?

Answer 14

Adequate financial resources to meet investment business commitments.

Question 15

What is the purpose of internal organisation requirements in a firm?

Answer 15

To organise and control internal affairs responsibly and ensure proper staff training and supervision.

Question 16

What should a firm do in its relations with regulators?

Answer 16

Deal in an open and co-operative manner, keeping the regulator informed.

Question 17

What factors influence the nature of legislation in financial services?

Answer 17

The degree of asymmetry experienced and the distinction between different classes of investors and asset classes.

Question 18

What principles should be adhered to when drawing up an investment agreement in institutional investment practices?

Answer 18

• Effective decision-making
• Clear objectives
• Focus on asset allocation
• Expert advice

Question 19

What are the key principles underlying the legislation and regulation of institutional investment practices?

Answer 19

• Effective decision-making
• Clear objectives
• Focus on asset allocation
• Expert advice
• Explicit mandates
• Activism
• Appropriate benchmarks
• Performance measurement
• Transparency
• Effective operations
• Regular reporting.

These principles are adaptable to all investment management scenarios.

Question 20

What is effective decision-making in the context of investment management?

Answer 20

Decisions should be taken by persons or organizations with the necessary skills, information, and resources.

Trustees need to appoint investment managers with expertise to manage assets effectively.

Question 21

What should trustees set out as an overall investment objective for the fund?

Answer 21

• Represents their best judgment of what is necessary to meet the fund’s liabilities
• Takes account of their attitude to risk, including willingness to accept under-performance.

For example, mature pension schemes may adopt low-risk strategies while less mature schemes may invest heavily in equities.

Question 22

What is strategic asset allocation?

Answer 22

The process of determining the asset sectors for investment and the guidelines for the investment manager.

Asset liability modeling can help determine optimal strategic asset allocation.

Question 23

Why are asset allocation decisions more significant than stock picking decisions?

Answer 23

Asset allocation should reflect the fund’s characteristics and not the average allocation of other funds.

Fund characteristics should be the key determinant of investment strategy.

Question 24

What should contracts for actuarial services and investment advice consider?

Answer 24

They should be opened to separate competition to attract a broad range of service providers.

Regular reviews of service providers may also be sensible.

Question 25

What should an explicit written mandate between trustees and investment managers cover?

Answer 25

* Objectives * Benchmarks * Risk parameters * Managers' approach * Clear time scales of measurement and evaluation. ## Footnote The mandate should not exclude any financial instruments without justification.

Question 26

What is the role of activism in investment management?

Answer 26

Managers should have a strategy on activism, detailing circumstances for intervention and how effectiveness will be measured. ## Footnote There is a trend towards shareholders becoming more active in corporate governance.

Question 27

What should trustees consider regarding benchmarks?

Answer 27

* Appropriateness of selected benchmarks * Limits on divergence from an index * Active vs. passive management appropriateness. ## Footnote Active management should be pursued if it has the potential for higher returns.

Question 28

What should performance measurement by trustees include?

Answer 28

* Changes in the nature of liabilities * Changes affecting risk appetite * Appropriateness of performance measures * Assessment of performance against benchmarks. ## Footnote Trustees should also evaluate the performance of advisers and managers.

Question 29

What should a Statement of Investment Principles include?

Answer 29

* Decision-making structure * Fund's investment objective * Planned asset allocation strategy * Mandates for advisers and managers * Fee structures. ## Footnote This statement should clarify why decisions are made and how the strategy was developed.

Question 30

What is the importance of effective operations in selecting managers?

Answer 30

Selection should consider operational aspects, such as separation of front office and back office functions.

Question 31

What should trustees do regarding regular reporting?

Answer 31

Publish their Statement of Investment Principles and monitoring results annually to fund members. ## Footnote The statement should explain any deviations from established principles.

Question 32

What is the primary responsibility of directors in a company?

Answer 32

To ensure the overall direction of the company for the benefit of shareholders and to meet legal obligations.

Question 33

What is the primary responsibility of directors?

Answer 33

To ensure a company meets all its legal obligations and is responsible for the solvent trading of the company. ## Footnote This includes arranging timely accounts that give a true and fair view, appointing management, and approving dividend payments.

Question 34

What are the steps directors must take to safeguard the company?

Answer 34

Directors must take reasonable steps to: * Safeguard the assets of the company * Prevent and detect fraud and other irregularities. ## Footnote These responsibilities emphasize the accountability of directors in protecting shareholder interests.

Question 35

True or False: Directors are required to hold an executive position in the company.

Answer 35

False ## Footnote There is no necessity for directors to have any executive position, full or part time, in the company.

Question 36

What is the principle of agency in corporate governance?

Answer 36

The principle of agency states that directors act on behalf of shareholders. ## Footnote Agency problems arise when the interests of directors and shareholders do not coincide.

Question 37

What is the aim of the legal framework proposed for directors?

Answer 37

To protect shareholders and stakeholders from director abuse. ## Footnote This includes proposals from the Higgs Review regarding the role of non-executive directors.

Question 38

What are some components of the proposed governance framework for directors?

Answer 38

Components include: * Establishment of formal audit committees * Independent remuneration committees to monitor pay and benefits. ## Footnote These committees would be composed solely of non-executive directors.

Question 39

What could happen if the proposed extension of directors' liability is enacted?

Answer 39

Shareholders may be able to sue directors for failures to act according to their moral, ethical, and fiduciary duties. ## Footnote This would enhance accountability among directors.

Question 40

What has intensified the need for International Financial Reporting Standards (IFRS)?

Answer 40

The globalization of capital markets. ## Footnote IFRS aims to provide one set of financial reporting standards acceptable to all listing authorities.

Question 41

What are the aims of IFRS?

Answer 41

The aims are: * To encourage reliable and consistent accounting data * Transparency of accounting data * To have a single set of standards worldwide. ## Footnote This reduces the burden on companies of producing multiple sets of accounts.

Question 42

Which areas commonly differ in accounting practices worldwide?

Answer 42

Common areas of difference include: * Treatment of assets and derivatives * Provisions * Funding of employee benefits (e.g., pensions) * Income taxes. ## Footnote These differences can significantly impact financial reporting.

Question 43

How does IFRS relate to UK GAAP?

Answer 43

IFRS is close to UK GAAP, but there are differences that may impact earnings and net assets. ## Footnote Differences include the revaluation of assets and liabilities to reflect fair value.

Question 44

What is the definition of 'fair value' in accounting?

Answer 44

Fair value is the amount at which a willing seller and a willing buyer would trade an asset. ## Footnote It is often equated to market value or the present value of future cash flows from the asset.

Question 45

What does IFRS 9 require regarding investments?

Answer 45

Investments must be shown at fair value in the statement of financial position and any resultant profit or loss must be shown in the statement of comprehensive income. ## Footnote This has led to controversy regarding the volatility of reported values.

Question 46

What are the key principles underlying legislation of financial services?

Answer 46

The key principles are: * Integrity * Skill, care and diligence * Market practice * Information about customers * Information for customers * Conflicts of interest * Customer assets * Financial resources * Internal organization * Relations with regulators. ## Footnote These principles aim to ensure accountability and transparency in financial services.

Question 47

What principles govern institutional investment regulation?

Answer 47

The key principles are: * Activism * Appropriate benchmarks * Performance measurement * Transparency * Effective operations * Effective decision-making * Clear objectives * Focus on asset allocation * Expert advice * Explicit mandates * Regular reporting. ## Footnote These principles guide institutional investors in making informed decisions and maintaining accountability.

Question 48

What factors should be considered regarding client fees?

Answer 48

Factors include: * How much the client is able/willing to pay * How much the school fees will be * When the fees will be required * The number of years fees are required for * How fees will increase * Client's attitude to risk * Other sources of income/capital * Security of the client's future income * Client's other short-term liabilities * Client's tax position * Any special requirements, eg ethical investment.

Question 49

What is operational risk?

Answer 49

Operational risk is defined as the risk of losses due to fraud or mismanagement within the intermediary itself or due to failed or inadequate people, processes, systems, and external events.

Question 50

What information should be disclosed regarding regulatory breaches?

Answer 50

Information that should be disclosed includes: * Any breaches of regulations * Any significant events, eg merger of firms * Concerns regarding clients, eg money laundering * Procedures for dealing with customer complaints.

Question 51

Why is asset allocation significant?

Answer 51

Asset allocation is significant because there is less correlation between the returns on assets in different sectors than between returns on assets in the same class.

Question 52

What is the impact of sector selection on investment management?

Answer 52

Sector selection allows investment managers to add value as the relative prices of different asset sectors move over time, affecting the proportions invested in those sectors.

Question 53

What are the arguments for a passive investment strategy?

Answer 53

Arguments for a passive investment strategy include: * Focus on minimizing risk of under-performance * Lower dealing costs * Holding a well-diversified portfolio if a well-diversified index is tracked.

Question 54

What factors determine the appropriateness of active versus passive investment strategies?

Answer 54

The appropriateness depends on the skills of the active investment manager, specifically their ability to generate a higher net return than a purely passive approach.

Question 55

What is the purpose of a Statement of Investment Principles?

Answer 55

The purposes include: * Ensuring clear understanding of the investment strategy among investment managers, trustees, and investors * Focusing trustees on their responsibilities towards investment * Helping trustees and investment managers understand and explain deviations from the strategy.

Question 56

What is the main role of non-executive directors?

Answer 56

The main role is to provide an impartial view on the board of directors and represent the interests of the shareholders.

Question 57

Fill in the blank: The requirement to have a __________ ensures that investment strategy is clearly understood.

Answer 57

[Statement of Investment Principles]

Question 58

True or False: Operational risk only pertains to external events.

Answer 58

False