Claritas Curriculum Review: Regulation and Supervision

Chapter 3, Regulation and Supervision concludes module 2 in the Claritas Curriculum. The module will be worth approximately 10% of your overall grade.

Objectives of Regulation

The section is basically a short list and lends itself to memorization. As with many of the important lists, it might be easier to remember one word for each idea and what it represents.
Protection – protect consumers from manipulative practices and fraud
Growth – fair financial markets help to allocate capital to its best use and foster economic growth
Stability – I think we all know what happens when the financial system fails, often as a result of inadequate regulation
Transparency – Markets that are unfair or asymmetric are inefficient and only the most risk tolerant or insiders will participate. Regulations help to make sure full and fair disclosure benefits everyone.
Efficiency – setting rules by which everyone must follow helps the markets to run more smoothly
There’s a lot of overlap in the broad objectives and the Institute includes a ‘catch-all’ with the last; social objectives.

Basic Regulatory Process

The ten-step regulatory process looks a little daunting to memorize. Start with the basic idea for each step in the process then just try to memorize a one-word reminder.
Need for regulation –> legal authority –> analysis of costs and benefits to regulation –> public consultation –> adoption of regulation –> implementation–> monitoring –> enforcement –> dispute resolution –> review
The rest of the reading focuses on types of regulatory regimes. The Institute makes the distinction between Rules-based and Principles-based regimes. The rules-based regime is more complex and less flexible but provides less uncertainty while the principles-based regime is more like a code to follow.

Specific Types of Regulation

Gatekeeping – Involves screening of personnel and products to ensure integrity of markets
Operational – Net capital rules prevent excessive risk taking that could undermine the markets while regulations for handling customer assets protects client assets from risks in institutional assets
Disclosure – disclosure is an important concept for the Institute so understand the two general disclosure rules:
Corporate Issuer Rules – financial statements, risk factors, size of offering, etc
Market Transparency Rules- includes pre and post-trade disclosures
Sales Practices – help to protect consumers against manipulation and include rules on advertising, fees, information barriers, suitability and self-dealing
Trading – Includes rules for market standards, abusive practices, insider trading, front running and brokerage practices
Proxy voting – Rules to make sure the vote is carried out fairly and in shareholders’ interests
Anti-money laundering – Ensures record-keeping and reporting for tax and identity purposes
Business continuity – Includes maintaining a back-up of customer records and establishing system recovery plans

Corporate Policies and Procedures

Here the impetus switches from governmental oversight to corporate self-regulation to ensure that the company is adhering to regulation. Policies should be in place to guide: hiring and training; continuing education; supervisory duties and systems; and rules for documentation.
Having a detailed set of policies, along with procedures for handling violations, helps the company operate more efficiently and within the law.

Consequences of Regulatory Failure

This section is more obvious and you probably don’t need to memorize the list of examples given. Remember the general consequences to employees, co-workers, the firm and the overall economy.
Legal costs and sanctions are the principal consequences to the firm
The loss of trust in the system is an important consequence, especially for the financial industry
While failure of a small firm may not impact the economy, the most recent market collapse is the best example of how regulatory failure can affect the nation
Chapter 4, Financial Statements, begins the module on tools and inputs and is arguably one of the most important for financial professionals.
‘til next time, happy studyin’
Joseph Hogue, CFA

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