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指导essay The Regulation of financial markets
‘Financial markets do not work well when left to market forces alone’ ( La Porta, Lopez-de Silanes and Shleif, 2005; Journal of Finance)
The importance of the role of financial markets
• Financial markets and financial institutions are responsible for enormous amounts of money
• They run the payments system upon which a modern economy is crucially dependent.
• Allocate financial capital to its most productive use
Objectives of regulating financial markets
• To promote financial stability
• Transparency
• Investor protection against fraud or dissemination of misleading information
• To promote fair and healthy competition
Rationale for government intervention
• To correct ‘market failure’ and unfair distribution of the resources
• To ensure equity in the distribution of resources
• To ensure efficient use of those resources
Examples of market failure
1. The externalities problem- the financial system provides a payments mechanism for the entire economy, and financial institutions play a pivotal role of linking both users and lenders of funds, therefore failure in this sector can lead to disastrous effects.
2. The problem of asymmetric information- the directors of managers as well as financial institutions have available to them superior information about the prospects of the company than an outsider. This could lead to insider dealing, hence countries have passed laws prohibiting insider trading. Some regulations impose disclosure requirements to make public a great deal of financial information to potential and actual investors
3. The moral hazard problem- by moral hazard we mean that insurance against an event occurring will make the event more likely to occur than if the event was not insured against. For example, a deposit insurance protection scheme will guarantee investors their funds should a deposit taking institution get into difficulty.
4. The principal agent problem- the directors and managers of financial institutions act as agents for the shareholders and investors in the institution (the principals).
Types of government regulation
1. Structural regulation- covers the different types of activities, products and geographical boundaries within which a financial institution can operate
2. Prudential regulation- this covers internal management of a financial institution, e.g. setting ratios to ensure that the institution has sufficient capital to absorb possible losses and sufficient liquidity to meet its obligations
3. Investor protection- measures to protect investors from mismanagement of funds, malpractice and fraud
Some key measures
Licensing regulations- financial institutions must be licensed
Disclosure requirements- large public companies are required to disclose a large amount of information relating to their financial performance#p#分页标题#e#
Deposit insurance- forestalls runs on deposits should a financial institution get into trouble
Restriction on activities- many governments restrict the range of activities that can be undertaken by a financial institution.
Exposure limits- most authorities expect banks to have a diversified portfolio to control risk to exposure
Liquidity ratios- certain reserve ratios should be maintained
Capital adequacy- revolves around the idea that shareholders in a bank should make up for the losses not depositors
Regulation of exchanges- rules to ensure fair play
Costs associated with financial regulation
i) compliance costs-the providers of financial services will add these to their charges
ii) institutional costs- enforcement institutions will have to be created and the costs passed on to the consumer
iii) structural costs- the complexity of the environment within which business is transacted (increases costs of providing financial services)
Models of financial regulation
Integrated approached by a single regulator- where a single body regulates all institutions in the financial services industry
The UK, Norway, Iceland, Luxembourg, Japan, Korea adopted this model
Advantages-
• A fragmented regulatory structure might generate inconsistencies in approach, insufficient communication or an inadequate overview of regulated firms as more financial conglomerates emerge.
• There are economies of scale in monitoring financial institutions (i.e. the average cost of monitoring falls as the amount of institutions to be supervised increases).
• Consumers cannot undertake supervision activities by themselves
• Consistence and coherence in the design and enforcement of the regulatory framework ( avoids duplications, contradictions, gaps etc)
Examples
In 1986 Norway established a single regulatory authority called Kredittilsgnet
In 1987 the Canadian authorities merged banking and insurance in the Office of the Superintendent of Financial Institutions (OSFI)
1988 Denmark set up the Finanstilsynet
In 1988 Japan introduced a single regulator –the Financial Supervisory Authority
In 1988 Korea established the Financial Supervisory Service
In 1999- Iceland launched the Fjarmalaesfirlit
In 1999- Luxembourg introduced a single regulator for banking and securities
Specialized approach
The USA is the main leading case of the specialised approach of financial regulation. For instance, the regulator of banks is not the same as the regulator of pensions, who in turn is different from the regulator of securities
Advantages
• Power is not centralised in a single entity
• Regulation of banks is kept within the realm of the Federal Reserve Bank (central bank)
• Not easy for the regulator to be ‘captured’ by vested interests
Examples
Australia has two cross-sectional bodies#p#分页标题#e#
Prudential supervision of the banks, insurance and pensions funds falls under the Australian Prudential Regulation Authority
The Australian Securities and Investment Commission oversees the regulation of securities and the conduct of business
Financial regulation in the UK
History
The Big Bang, 1986
Some key changes- prior to the Big Bang membership of the Stock Exchange was restricted to private partnerships.
There was separation between jobbers that quoted share prices and brokers that advised clients
Charges to clients involved minimum fixed commissions based on the size of the share trade
Reforms
1. Admission to the Stock Exchange was opened up to corporations
2. The broker-jobber divide was ended and firms were permitted to be both market –makers in shares and advisers/brokers (led to the building of ‘Chinese walls’)
3. Fixed minimum commissions were abolished
In 1986 the Financial Services Act (FSA) was enacted but came into force on April 29, 1988. Before the FSA 1986, a system of self-regulation was in place
The FSA 1986 brought a new system of ‘self-regulation within a statutory framework, within financial services firms authorised by Self-Regulatory Organisations (SROs).
Reasons why the government established the FSA 1986 regime were:
a) The need to internationalise the City
b) The desire to attract investment from the US
c) The programme of privatising state-run industries
d) The introduction of personal pensions
The Financial Services Authority (FSA) was created as a single statutory regulator in 1997. It is not a government agency but is a private company limited by guarantee, with the HM Treasury as the guarantor. It is financed by the financial services industry. The board of the FSA is appointed by the Treasury.
The activities of the FSA
a) It is the authorising body for the carrying on regulated activities
b) Is the regulator of exchanges and clearing houses operating in the UK
c) Approves companies for stock market listing in the UK
d) Is a rule making body
e) Undertakes supervision
f) Has wide powers of enforcement
In June 1998 responsibility for banking supervision was transferred to the FSA from the Bank of England
The Financial Services and Markets Act (FSMA 2000) was implemented as from the 1st of December 2001 and has responsibility for:
• Prudential supervision of all firms, which involves monitoring the adequacy of their management, financial resources and internal systems and controls, and
• Conduct of business regulations of those firms doing investment business. This includes overseeing firm’s dealings with investors to ensure that the information provided is not misleading.
Statutory objectives of the FSA
a) to maintain confidence in the UK financial system
b) To promote public understanding of the financial system, including awareness of the benefits and risks associated with different kinds of investment or other financial dealing, and providing appropriate information and advice#p#分页标题#e#
c) To secure the appropriate level of protection for consumers, bearing in mind:
i) the different level of risk that come with different kinds of investment or other transaction
ii) The differing experience and expertise of consumers
iii) Consumers’ needs for accurate advice and information,
iv) The principle that consumers should take responsibility for their decisions (caveat emptor)
d) To continue to reduce financial crime
Market abuse
The FSA’s Code of Market Conduct applies to any person dealing in certain investments on recognised exchanges and does not require proof of intent to abuse a market
S 123 of the FSMA 2000 gives statutory powers to impose unlimited fines for the offence of market abuse
Market abuse could consist of:
a) Knowingly buying shares in a takeover target before a general disclosure of the proposed takeover
b) Market distortion: dealing on an exchange just prior to the exchange closing with the purpose of positioning the share price at a distorted level in order to avoid having to pay out on a derivatives transaction
c) Posting an inaccurate story on an internet bulletin board in order to give a false or misleading impression
These regulations refer particularly to participation in equity markets
Managing investments
The following are prohibited when conducting a business with or for a customer
Churning and switching
a) For investments generally- churning-i.e. dealing too frequently in the circumstances
b) For packaged products: switching between packaged products, unless the dealing or switching is in the client’s best interest. For example, recommending the surrender of a life policy in order to switch into a new one could be against a client’s interest because the surrender value could be relatively low compared with the expected maturity value, and there will also be charges on the new policy.
Churning refers to dealing or switching excessively, with the objective of increasing commissions earned.
Seminar questions
a. Put a case for self-regulation in the financial markets as opposed to statutory regulation
b. Critically evaluate the merits and demerits of adopting an integrated regulatory model as against the specialised approach.
c. 指导essayFind out by financial regulation in the US and compare the system with that of the UK
Seminar questions
d. Put a case for self-regulation in the financial markets as opposed to statutory regulation
e. Critically evaluate the merits and demerits of adopting an integrated regulatory model as against the specialised approach.
f. Find out by financial regulation in the US and compare the system with that of the UK
g. The regulation of financial has not been effective, hence the crisis in the markets today. Discuss
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