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The essential functions of the financial services industry

- Provide a vehicle to protect savings and channel into capital management
- Provides a mean of matching savers needs for access to their capital with borrowers requirements for long term funds, whilst allowing financial institutions to take long term positions to achieve potentially high returns
- Allows individuals and companies to insure against risks they don't wish to take but which others are prepared to assume in return for payment - risk transfer mechanism
- Allows investors to disperse risk across different investment products


Short term savings (Banks, BS)

Banks/building societies
- Developed from individuals need to keep money safe but accessible
- Offer protection whilst using the money to make a return
- Banks owned by shareholders

Building societies
- Developed as mutually owned organisations
- Originally to lend money to members to buy houses
- Owned by members so no dividend to pay

Both have diversified into other areas of financial services acting as intermediaries for their own/other institutions products


Government Savings

- Government traditionally used savings of private individuals to fund own borrowing
- Acts as financial institution in own right
- Using fixed interest investments (gilts) via debt management office (for hm treasury)
- Index linked guilts to protect against inflation
- investment for individuals (offers fixed level of interest paid at regular intervals) and loans for government
- National savings and investment (NS&I) issues premium bonds and other savings and products


Insurance and risk management

•Protect and safeguard assets from effect of financial loss due to damage or loss
•Options - either insure or manage risk
•Individuals and companies have protection needs for:
o Physical assets, earnings and profit potential, financial transactions

•Insurance policies for:
o General - car, buildings
o Individual - life/health insurance
o Business - keyperson
o Employers - death in service, sickness benefits

• Reinsurance
oLarge risk assessed and accepted by financial institution
oPassed to reinsurance company for proportion of premium
oLloyd’s of London specialist insurer / reinsurance market


Longer-Term Investments and Capital Markets

•Capital markets developed to meet 2 key objectives:
o Need for investors to invest in assets to provide real growth
o Need for companies to raise money without borrowing from bank

o Allow investors (private and corporate) to buy/own percentage of company
o Benefit from any increase in value of company
o Receive dividends (distributed profits)
o Able to vote at meetings

•Bonds (fixed interest)
o Allow investors (private and corporate) to lend a company money
o Interest will be higher than that available from a bank (due to higher risk)

• Vast majority access shares and bonds through collectives - not individually


UK Financial Services Structure

•Four key components:
o Financial Infrastructure: payment, settlement, clearing and trading systems
o Financial Markets - on exchange and over the counter (OTC)
o Financial Firms - including banks, pension funds and insurance firms
o Financial Sector Authorities - Bank of England, the FCA, the PRA and HM Treasury

•Financial Infrastructure:
o Payment systems deal with high values/widely used by customers
o Widely used systems integral to wider economy
o Failure could impact substantially on normal economic activity
o Bank of England is overseer of UK payment systems

•Payments Systems Regulator (PSR) economic regulator

•Clearing houses and settlement systems provide infrastructure for securities/derivatives
o FCA regulates recognised investment exchanges
o BoE supervises recognised clearing houses under European Market Infrastructure Regulation (EMIR)

•Financial Markets
o On exchange markets:
- To trade equities and derivatives via trading floor
- Electronic or physical
o Over the counter markets:
- No physical exchange
- Users of the markets have formed committees that examine how markets function


Financial Firms

Operate within wider markets:

Market / company - Purpose
Money markets = Commercial borrowers and lenders transact business (wholesale market)

Capital markets = Primary and secondary markets for issuing and trading shares and bonds

Commodity markets = Hard and soft commodities (metals, grains, etc.) are traded

Foreign exchange (FX) markets = Foreign currency is traded

Insurance companies = Invest premiums not required to meet
immediate claims for long-term profit

Life and pension, investment houses
companies = As above, but also invest policyholder’s
contributions for their own benefit

Reinsurance companies = Enable large risks to be more widely spread


Banks/Building Societies

• Retail banks/building societies have significantly increased range of financial services to capitalise on brand awareness

•Core services:
o Current account: flexible, secure, easy access, little/no interest paid
o Deposit account: less accessibility, generally higher (tiered) interest rates
o Mortgages and loans: traditionally banks = loans, building societies = mortgages, but now similar services
o Demutualisation - when building societies change from mutual company to a PLC often resulting in windfall for shareholders

•Indirect services:
o Portfolio management: specialist investment managers establish and manage a suitable portfolio on advisory (make suggestions) or discretionary (take trading decisions) or execution only (carry out instructions) basis
o Unit trusts/OEICs: offers wide spread of investments without day to day control, more cost effective for smaller portfolios
o Stockbroking services
o Wills and executorship: based on experience, expertise and continuity of service
o Insurance and pensions

•Basis of advice - for life and pension business must be made clear:
o Independent – firm must assess a sufficient range of relevant products that are sufficiently diverse in type and issuer to ensure clients’ investment objectives suitably met
o Restricted - limited in terms of product range, provider, or both, cannot say they’re independent
o Bancassurer: bank/building societies own life assurance company which forms basis of restricted offering

• Life assurance companies:
o Products distributed via intermediaries (as above) or own sales team

•Friendly societies
o Established as mutual self-help groups with no shareholders taking profits
o Granted exemption from taxation so able to offer tax efficient savings
o Legislation restricts business by imposing limits

•Multi-distribution organisations
o Diverse organisations e.g. Sainsbury’s, M&S and Virgin, capitalising on established client base to offer limited range of financial products/life assurance, ISAs, unit trusts/OEICs, sometimes Stakeholder pensions
o Restricted fact-finding and advice requirements allowed in-roads without need for fully qualified sales team


Role and structure of International Markets

•Three European Supervisory Authorities (ESAs):
o European Banking Authority (EBA)
o European Securities and Markets Authority (ESMA)
o European Insurance and Occupational Pensions Authority (EIOPA)
o European Central Bank (ECB)
o European Systemic Risk Board (ESRB)
o European System of Financial Supervision (ESFS)

•Financial Stability Board
•Financial Action Task Force (FATF)
•International Organisation of Securities Commissioners (IOSCO)
•International Association of Insurance Supervisors (IAIS)
•Basel Committee on Banking Supervision (BCBS)
•International Swaps and Derivatives Association (ISDA)
•The Bond Market Association (TBMA)
•International Securities Market Association (ISMA)


Role of EU

• EU law applies during transition period
•Financial Services Industry subject to EU regulations as condition of membership
•Financial Services Action Plan - package of measures to improve:
o Single market for wholesale financial services
o Open and secure retail markets
o State of the art prudential rules and supervision

•EC rules relate to (amongst others):
o capital requirements
o conduct of business
o anti-money laundering and terrorist financing
o suitability of new controllers / large shareholders
o market abuse
o disclosure when seeking new capital


UK Regulation

• Regulation of financial services market is responsibility of Treasury
• Treasury is under authority of Chancellor of Exchequer
• 2000 Financial Services and Markets Act - established the FSA

• 2012 Financial Services Act: since April 2013 three regulatory bodies
o The Financial Policy Committee (FPC)
o The Financial Conduct Authority (FCA)
o Prudential Regulation Authority (PRA)
o PRA and FCA act together = dual regulation
o FCA only = sole regulation

•2016 Bank of England and Financial Services Act
o Ended subsidiary status of PRA
o Created Prudential Regulation Committee (PRC) to govern PRA



•To raise revenue for government and to redistribute wealth
•High taxation reduces ability to spend and slows down economy
•Low taxation means more money available to spend so stimulates economy
•Government encourages savings/investments through concessions:
o Pensions
o ISAs
o Qualifying life policies
o Friendly Society plans
o Capital gains on gilts
o Certain National Savings and Investment products
•Removal of tax concessions can decrease attractiveness of products


Economic Policy

•Set of actions a government can take on expenditure, borrowing and setting of interest rates to control the economy
•Fiscal policy = control of taxation, government borrowing and spending
•Monetary policy = control of interest rates and money supply
o The government spends money on goods and services provided by UK companies within the UK
o Government expenditure has more significant effect on economy than tax cuts

o When government borrows money, it reduces money in circulation so reducing economic activity
o Conversely, repaying loans injects money into economy
o Quantitative easing involves BoE buying gilts and corporate bonds, flooding economy with cash

•Interest rates
o Since 1997 interest rate decisions are responsibility of Monetary Policy Committee (MPC) within Bank of England
o Gilt repo market is primarily used to influence short-term interest rates
o Repo = sale and repurchase agreement
o MPC’s responsibility to set interest rates to meet Chancellor‘s inflation target (CPI 2%)
o MPC consists of both internal and external members

•Controlling economy without using interest rates
o Key method of controlling economy is interest rates, but taxation, spending and borrowing measures also used
o Quantitative Easing is alternative method for stimulating economy e.g. buying loan stock to increase money supply

•Provision of welfare and benefits
o Provides final safety net - NHS, State pension and tax credits etc
o Increasing burden being placed on (depleting) resources
o If there was no system, would be greater need for private insurance
o State’s level of provision is decreasing - issues such as increasing longevity, underfunded and overburdened NHS, and pension crisis
o Unable to rely solely on State for standard of living

•Actions the government could take:
o Compulsory pension provision (auto-enrolment goes some way towards this)
o Compulsory private medical insurance
o Tax breaks e.g. health insurance, medical insurance or long-term care