100 Key Financial Terms: Master Financial Regulations and Compliance

Finance isn’t just about managing money — it’s about understanding the rules that keep our global economy running smoothly. Financial regulations and compliance are the backbone that keeps the global economic world in order. From students to business leaders, this intricate system impacts everyone.

Why are these financial regulations so crucial? 

They keep us all protected.  

Knowledge of financial regulations and compliance terms isn’t just beneficial — it’s essential.

Over the years, new regulations have been introduced to address changing financial practices and crises. Have you heard of the infamous Harshad Mehta scam in 1992 or the stock market crash of 1929? Such incidents caused dramatic drops in stock prices and shook investor confidence.

These 100 financial regulations and compliance terms are vital to protect all of us from such scams! 

Why is this list of 100 financial regulations and compliance terms a must-read?

Here’s how you can benefit from these financial regulations and rules:

1. Business leaders and executives can gain a clear understanding of financial rules to protect their businesses from legal issues.
2. Financial professionals and auditors will find valuable insights into the regulations and compliance terms needed to ensure accurate financial reporting.
3. Investors and market experts can evaluate how well companies adhere to financial industry compliance requirements.
4. Entrepreneurs and innovators can learn the financial compliance standards and basic principles to avoid legal complications.
5. Educators, students, and curious minds can explore how clear rules and practices build trust and honesty in business.

100 Must-Know Financial Regulations and Compliance Terms| Safeguard Your Future Now! 

Financial regulation and compliance terms can be divided into five key categories.

1. Regulatory Frameworks
2. Operational and Reporting Standards
3. Financial Instruments and Markets
4. Compliance and Ethics
5. Risk Management

Regulatory Frameworks

Financial regulations and compliance are crucial as they protect everyone involved in the functioning of the financial ecosystem!

In the US, the Securities and Exchange Commission (SEC) regulates the financial markets. In India, the Companies Act 2013, the Income Tax Act 1961, and the Reserve Bank of India (RBI) are a few important regulations acts.

Here’s a quick overview of key financial regulations and rules around the world!

1. Sarbanes-Oxley Act (SOX)

The Sarbanes-Oxley Act was passed on July 30, 2002. It aims to protect investors from corporate fraud. Known as the SOX Act, it introduced strict reforms and tough penalties.

This financial regulation focuses on four main areas:

• Corporate Responsibility: Enhanced duties for corporate leaders.
• Increased Criminal Punishment: Tougher penalties for financial frauds.
• Accounting Regulation: New financial rules for accounting practices.
• New Protections: Added safeguards for investors and whistleblowers

2. Securities and Exchange Commission (SEC)

The U.S. Securities and Exchange Commission (SEC) is a key regulatory body. It was established to oversee financial markets and protect investors.

When the stock market crashed in October 1929, people lost trust in financial markets.

To address this, Congress investigated and then passed the Securities Act of 1933. The following year, Congress created the SEC with the Securities Exchange Act of 1934.

The SEC has three main goals:

1. Protect Investors: The SEC works to ensure investors are safe from fraud and unfair practices.
2. Maintain Fair Markets: It keeps markets fair, orderly, and efficient for everyone.
3. Facilitate Capital Formation: The SEC helps businesses raise money to grow.

How Does the SEC Maintain Fair Markets?

U.S. capital markets are large and complex, trading over $100 trillion annually. The SEC keeps up with market changes and technology.

3. Securities Act of 1933

The Securities Act of 1933 is a U.S. law designed to ensure transparency in financial markets. It requires companies to provide accurate and complete information to investors. They must do it when selling securities, helping to prevent fraud and protect investors.

The Securities Act of 1933, one of the most powerful financial regulations act, was created after the 1929 stock market crash.

What does it aim at?

1. Improve clarity in financial statements for investors.
2. It ensures that companies follow the financial industry compliance requirements.
3. It set laws against misleading and fraudulent market activities.

4. Securities Exchange Act of 1934

The Securities Exchange Act of 1934 regulates the secondary trading of securities in the U.S.

This financial regulations act gives the SEC broad authority over the securities industry.

The SEC regulates the working of brokerage firms, transfer agents, and clearing agencies. It identifies and prohibits certain types of market conduct and can discipline regulated entities.

5. SEBI- Securities Exchange Board of India Act, 1992

This act established the Securities and Exchange Board of India (SEBI).

SEBI is India’s primary regulatory authority for financial markets.

It was first set up as a non-statutory body on April 12, 1988. This initial step was a resolution by the Government of India. However, to strengthen its regulatory powers, SEBI was officially established as a statutory body in 1992.

• SEBI aims to safeguard the interests of investors in the securities market.
• It works to encourage the development of the securities market.
• SEBI oversees and regulates the market to ensure it operates fairly and transparently.

How Does the SEBI Maintain Fair Markets?

It plays a crucial role in ensuring the smooth operation of India’s financial markets.

1. SEBI supervises brokers, dealers, and other market participants to ensure they follow fair practices.
2. It implements financial regulations to prevent fraud and market manipulation.
3. SEBI also provides resources and mechanisms for investors to lodge complaints and seek redressal.

6. Reserve Bank of India Act, 1934

The Reserve Bank of India (RBI) Act of 1934 established the RBI as the country’s central bank and established its role and powers.

The RBI manages India’s monetary policy, which includes controlling inflation and ensuring economic stability. It also handles the nation’s foreign exchange reserves and oversees the banking sector.

Explore the top 10 private banks in India!

RBI makes rules and regulations for banks to follow, ensuring the financial system operates smoothly.

7. Banking Regulation Act, 1949

The Banking Regulation Act of 1949 is a key law for managing banks in India. It gives the RBI the authority to regulate and supervise banks, making sure they follow proper practices. This financial act protects banks from fraud and mismanagement.

What’s more?

It also sets guidelines for how public banks and private banks should operate.

Initially, this financial regulations act was applicable only to banking companies. However, in 1965, it was amended to make it applicable to cooperative banks and introduce other changes.

8. Insurance Regulatory and Development Authority Act, 1999

This financial services regulatory compliance body manages the insurance sector in India. The Insurance Regulatory and Development Authority of India (IRDAI) protects insurance policyholders’ interests.

1. The IRDAI works to safeguard the interests of people holding insurance policies.
2. It regulates and promotes the growth of the insurance sector, ensuring its orderly development.

The act aims to develop the insurance sector, increase consumer confidence, and ensure that insurance products meet high standards.

9. Companies Act, 2013

Are you investing in multiple companies’ stocks? Have you ever wondered who manages each company and how they operate? 

Are they self-regulated?

Nah!

The Companies Act of 2013 lays the most powerful financial regulations and rules for companies in India. It sets rules for company formation, management, and dissolution. This act ensures that companies follow proper accounting practices, corporate governance, and transparency.

10. Foreign Exchange Management Act, 1999

The Foreign Exchange Management Act of 1999 regulates foreign exchange transactions in India.

FEMA replaced the Foreign Exchange Regulation Act (FERA).

The Foreign Exchange Regulation Act was passed in 1973 and came into effect on January 1, 1974. This legislation aimed to regulate financial transactions related to foreign exchange and securities. It was introduced during a time when India’s foreign exchange reserves were very low.

However, FERA was replaced because it did not fit with the post-liberalization policies of the Indian government.

Why was it formed?

It monitors external trade and payments and promotes the orderly development of the foreign exchange market. The act controls how foreign currencies are bought, sold, and exchanged.

Thus, the aim is to maintain a stable exchange rate and manage the country’s foreign reserves effectively.

11. Markets in Financial Instruments Directive (MiFID II)

The Markets in Financial Instruments Directive II (MiFID II) is EU legislation. It regulates firms providing services linked to financial instruments.

Its aim?

Increase transparency across the EU’s financial markets and standardise regulatory disclosures.

MiFID was introduced in 2004 and came into effect in 2007. In 2018, MiFID was replaced by MiFID II.

What did it bring?

More stringent rules enhance the scope of covering additional financial instruments beyond stocks.

Recent amendments published in March 2024 aim to enhance market transparency further.

12. General Data Protection Regulation (GDPR)

GDPR is a European Union law. It is considered to be the toughest financial law worldwide. The GDPR affects organisations worldwide that handle EU residents’ data. It became effective on May 25, 2018.

It applies to any organisation targeting EU data. Fines for non-compliance can reach millions of euros.

It provides individuals with rights over their data and imposes strict rules on organizations to ensure privacy and security.

13. Bank Secrecy Act (BSA)

The Bank Secrecy Act (BSA), also known as the Currency and Foreign Transactions Reporting Act, was created in 1970. It aims to prevent criminals from using banks to hide or launder money.

This financial regulation act requires banks and financial institutions to document certain transactions. They must file reports for suspicious cash transactions over $10,000. This helps regulators track and reconstruct these transactions.

Initially, it was used to fight funding for criminal organisations. It later also addressed funding for terrorist groups. The BSA plays a crucial role in monitoring financial transactions to prevent misuse.

14. Patriot Act

The USA PATRIOT Act was passed after the September 11, 2001, terrorist attacks. It gives law enforcement more power to investigate and prosecute terrorists. The act also increased penalties for terrorism-related crimes.

• USA PATRIOT” stands for “Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism.”
• It requires financial institutions to report suspicious behaviours that might indicate terrorism-related money laundering.

15. Consumer Financial Protection Bureau (CFPB)

The Consumer Financial Protection Bureau (CFPB) is a U.S. agency that protects consumers in the financial sector. It oversees financial products and services. The CFPB also handles consumer complaints and enforces regulations.

The CFPB works to ensure that consumer financial markets benefit:

• Consumers
• Responsible providers
• The overall economy

16. Consumer Protection Act

The Consumer Protection Act is a law aimed at safeguarding consumers from unfair, deceptive, or fraudulent practices in the marketplace. Almost every nation has a consumer protection Act.

The Consumer Protection Act 2019 is a significant update to the 1986 Consumer Protection Act in India. This new law was enacted to address modern consumer issues in the digital age.

With the rise of digital commerce, consumer expectations and challenges have changed. This financial regulation act safeguards against defective products and unfair trade practices.

17. Electronic Fund Transfer Act (EFTA)

EFTA regulates electronic payments and transfers. In the U.S., it protects consumers against errors and unauthorized transactions.

These transfers include:

• ATM transactions
• Debit card purchases
• Direct deposits
• Point-of-sale (POS) transactions
• Transfers initiated by phone
• Automated Clearing House (ACH) systems
• Pre-authorized withdrawals from checking or savings accounts

The EFTA ensures consumer protection by providing a way to correct transaction errors and limiting liability for lost or stolen cards.

18. Investment Advisers Act of 1940

This financial act regulates investment advisers in the U.S. It requires them to register with the SEC and adhere to fiduciary standards. Additionally, they must provide transparency about their fees and conflicts of interest. 

19. Credit CARD Act of 2009

The Credit Card Accountability Responsibility and Disclosure Act of 2009 is commonly known as the CARD Act. It is a U.S. law that protects consumers from unfair credit card practices. It includes provisions for clear disclosure of terms, limits on fees, and fair billing practices.

Before the CARD Act, credit card companies could raise interest rates without advance notice. They could increase rates on both existing balances and future purchases at will. 

The CARD Act changed this by instituting the following protections:

1. Credit card issuers must generally wait until your account is at least 12 months old before raising your interest rate.
2. If a rate increase is planned, issuers must notify you 45 days in advance.
3. You have the right to cancel your card before the new rate takes effect. The new rate will apply only to new purchases made at least 14 days after the notice. Existing balances remain at the original rate.
4. If you cancel due to a rate increase, you have five years to repay the outstanding balance at the original rate. However, your minimum payment may increase up to twice the previous amount.

20. Federal Reserve System (Fed)

The Federal Reserve System, is often referred to as the Fed. It is the central banking system of the U.S. This financial regulation system manages monetary policy, regulates banks, and ensures financial stability. The Fed influences interest rates and controls the money supply to promote economic stability.

Operational and Reporting Standards

These compliance standards ensure companies’ smooth financial and operational activities. For organisations, these standards help maintain reliable records, simplify audits, etc.

Let’s take a look at some important operational and reporting standards that are part of key financial regulation and compliance terms!

These internal procedures and practices are essential for organisations to implement:

1. International Financial Reporting Standards (IFRS)

International Financial Reporting Standards are a global accounting rule for preparing financial statements. They keep financial reporting clear and consistent worldwide. This helps investors compare company performances easily.

Companies must follow IFRS rules for accurate reporting. Ignoring these rules can lead to legal problems and lost trust. IFRS are regularly updated to handle new financial issues.

Recent IFRS Updates

• IFRS 17: Starts January 1, 2023. Covers insurance contracts.
• Amendments to IAS 12 – 23rd May 2023 – International Tax Reform
• IFRS S1 and S2: New standards for sustainability and climate information.
• Amendments to IFRS 16- Lease Liability in a Sale and Leaseback

2. Generally Accepted Accounting Principles (GAAP)

These are standard accounting rules widely followed around the world, though specific local regulations may vary by country.

GAAP includes:

• Basic accounting principles and guidelines
• Accounting standards
• Industry-specific practices

In India, financial statements follow accounting standards from the Institute of Chartered Accountants of India (ICAI) and laws like Schedule III of the Companies Act 2013.

Some of the key financial regulations and rules include:

• Business Entity Assumption: This means you need to treat the business as separate from its owners or other businesses.
• Monetary Unit Assumption: The records of all financial transactions should be done in consistent currency.
• Accounting Period: The business must follow regular intervals for reporting, e.g., quarterly or yearly.
• Full Disclosure Principle: The organisation must disclose all the relevant financial information in financial statements.

GAAP undergoes periodic updates to incorporate changes in accounting practice.

3. Payment Services Directive (PSD2)

It is a European regulation for electronic payment services. PSD2 aims to make payments secure and help banking services adapt to new technologies. It became effective on January 13, 2018, in Europe. PSD2 requires strong customer authentication (SCA) to make online payments safer. It ensures greater transparency in fees and improves dispute resolution mechanisms.

Consumers can benefit from increased security. Banks must upgrade their systems to meet new security standards and facilitate third-party access.

4. FATCA (Foreign Account Tax Compliance Act)

The Foreign Account Tax Compliance Act (FATCA) is a U.S. federal law enacted in 2010 to control tax evasion by U.S. taxpayers holding accounts and other financial assets outside the United States. 

FATCA requires foreign financial institutions (FFIs) to report information about financial accounts held by U.S. taxpayers or by foreign entities.

U.S. citizens and residents, including those living abroad, must report their foreign financial accounts and assets annually.

As per this financial regulation act, if you fail to comply, you can face significant penalties. 

• For U.S. taxpayers, this includes fines for not reporting foreign assets. 
• For FFIs, non-compliance can lead to a 30% withholding tax on certain U.S. source payments.

FATCA has a global reach, affecting financial institutions worldwide. 

5. EMIR (European Market Infrastructure Regulation)

This financial regulation aims at increasing the stability and transparency of the over-the-counter (OTC) derivatives market. It was introduced in response to the 2008 financial crisis.

The aim of these financial regulation standards is to reduce counterparty credit and operational risks.

• It covers all derivative transactions: equity, interest rate, currency, commodity, credit, and others.
• Standardised OTC derivatives contracts must be cleared through central counterparties (CCPs). 
• For non-centrally cleared derivatives, EMIR requires the implementation of risk mitigation techniques. 
• The regulation ensures that all parties involved in derivatives trading are protected through stick risk management.

6. Payment Card Industry Data Security Standard (PCI DSS)

It is a set of rules to protect credit, debit, and cash card transactions. PCI DSS helps prevent data breaches and fraud by securing cardholders’ personal information. It aims to safeguard sensitive data and reduce risks for organisations handling payment card details.

Although PCI DSS is not a legal requirement, many businesses must follow it as part of their contracts. 

It was created in 2004 by Visa, Mastercard, Discover, JCB, and American Express. While officially established in 2004, PCI DSS’s framework began in the 1990s.

The financial services regulatory compliance, PCI DSS, ensures that businesses follow best practices for handling credit card data.

7. Business Continuity Plan (BCP)

BCP is a strategy that helps businesses prevent and recover from potential threats. It involves identifying risks that could disrupt a company’s operations. These risks can include natural disasters, pandemics, terrorism, or cyber-attacks.

A BCP ensures that a business can continue to operate and protect its personnel and assets during and after a disaster. They protect against losses, higher costs, and difficulties restarting operations. Regular testing of BCPs is crucial to identify and fix any weaknesses.

You must know that insurance alone is not enough, as it doesn’t cover all costs or prevent customers from moving to competitors. A BCP is typically planned in advance with input from key stakeholders and staff.

8. Data Breach Protocols

These are the procedures and actions taken by an organization when it experiences a data breach. They involve identifying and containing the breach and assessing its impact. Not only this, organisations must notify the affected parties and take steps to prevent future breaches. The aim is to minimise damage and protect sensitive information.

If your business experiences a data breach—whether due to hacking, insider theft, or accidental exposure—you need a clear plan of action.

• You must fix any vulnerabilities that led to the breach to prevent future incidents.
• It is important to secure any affected areas by locking them and changing access codes if needed.
• You must change all passwords and credentials to prevent further unauthorised access. 

Even if hackers have been removed, your system remains vulnerable until credentials are updated.

9. Incident Reporting

It is the process of recording any event that could impact the operation, data security, or compliance of an organisation. It includes detailing the nature of the incident, the affected systems or data, and the steps that you take to resolve it. Incident reporting helps organisations track, manage, and learn from incidents.

A good reporting system should be easy for everyone to use, from contractors to management.

Accidents are inevitable, but how they’re handled is key. A strong reporting process and effective management system enhance safety across the organisation.

10. Tax Evasion

Tax evasion is the illegal act of not paying the full amount of taxes owed or deliberately underreporting income. It occurs when an individual or organisation hides or fakes income. Or they make false claims for deductions or fail to declare cash transactions.

Tax evasion is a serious offence that can result in legal penalties, fines, and imprisonment. Governments worldwide implement strict laws to detect and prevent tax evasion. This illegal practice undermines the tax system and results in substantial penalties.

Common methods of tax evasion include:

1. Smuggling to Avoid Taxes
2. Filing Incorrect Tax Returns
3. Maintaining Fake Financial Statements
4. Using Fake Documents for Tax Deductions
5. Not Reporting Income:
6. Not Paying Taxes
7. Offering Bribes to Officials

Tax evasion not only harms the economy but also undermines the integrity of the tax system.

11. Audit Report

It is a formal document issued by an independent auditor after examining a company’s financial statements. In an audit report, he provides an opinion on whether the financial statements are accurate and comply with accounting standards. The report typically includes the auditor’s opinion, the basis for that opinion, and any significant findings.

Types of audit opinions include:

• Unqualified (Clean): Indicates that the financial statements are fairly presented.
• Qualified: Suggest some issues.
• Adverse: This means the financial statements are misleading.
• Disclaimer: Indicates the auditor could not form an opinion.

Audit reports are essential for stakeholders such as investors, regulators, and management.

12. Financial Reporting

It involves creating statements that disclose an organisation’s financial status to management, investors, and the government. These reports include:

• Balance Sheet
• Income Statement
• Cash Flow Statement
• Statement of Changes in Equity

The purpose is to provide a clear picture of a company’s financial health, performance, and cash flows over a specific period. Standards like the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP) guide this process.

13. Ind AS (Indian Accounting Standards)

Ind AS are accounting standards notified by India’s Ministry of Corporate Affairs. They are largely aligned with International Financial Reporting Standards (IFRS). 

Ind AS covers various aspects of financial reporting, including:

• Recognition
• Measurement
• Presentation
• Disclosure

These standards aim to improve the quality of financial reporting. They also facilitate cross-border comparisons of financial information.

14. CARO (Companies Auditor’s Report Order)

It is a regulatory requirement in India that auditors include specific information in their audit reports. It is issued by the Ministry of Corporate Affairs. CARO aims to improve the transparency and reliability of financial statements.

It requires auditors to report on:

• Maintenance of Proper Records
• Physical Verification of Assets
• Compliance with Statutory Dues

15. Audit Trail

It refers to the detailed chronological record of the steps taken to complete a financial transaction or any other business activity. The audit trail includes documentation of the source of data, the processes used to manage it, and the final outcomes. This helps ensure transparency, accuracy, and accountability in business operations.

You can confirm the validity of transactions and compliance with regulations.  

In accounting, an audit trail might include each entry, the date and time it was made, and the user who made it. This helps auditors verify the accuracy of financial statements and detect any fraudulent activities.

16. Quality Assurance Standards

These are the policies and procedures that are used to ensure that an organisation’s products and services meet customer expectations. The purpose of adopting quality assurance standards is to ensure that you can achieve customer satisfaction. Additionally, you can ensure financial services compliance.

Management creates these processes to evaluate and improve performance.

These help meet regulatory requirements related to environmental safety, intellectual property, and more.

This helps speed up time to market and supports business growth.

17. Operational Resilience

It basically includes the company’s ability to continue delivering products and services and protect its workforce despite facing adverse events or disruptions. These events might include cyberattacks, natural disasters, pandemics, or system failures.

In today’s volatile environment, organisations face various risks. Operational resilience ensures that a company can handle these challenges. It helps companies to continue functioning during and after adverse events. Thus minimising downtime and maintaining customer trust. 

The Four-Stage Resilience Lifecycle generally includes the following:

1. Anticipation: The company must recognise potential risks and prepare for them.
2. Prevention: The organisation must implement measures to avoid or reduce the impact of identified risks.
3. Recovery: If any organisation faces some disruption, it is a must to develop and execute plans to restore operations after an incident.
4. Adaptation: Learn from disruptions and adjust strategies regularly to improve resilience.

18. Compliance Management Systems

It is an integrated framework designed to help organisations meet regulatory requirements, internal policies, and industry standards. Its purpose is to prevent non-compliance issues and ensure ongoing adherence to regulations. 

A CMS comprises various tools, business processes, and internal controls. It can include risk assessments, compliance training, and other measures. Modern CMS often use automation to identify potential risks and address financial services compliance issues in real-time.

It helps organisations explore complex and industry-specific regulations like HIPAA (for healthcare) or GDPR (for the EU). Non-compliance can lead to significant fines and legal issues. For example, in May 2023, Meta faced a $1.3 billion fine for GDPR violations.

Benefits of a CMS

• Risk Reduction
• Efficiency
• Adaptability

19. Transfer Pricing

It is a critical operational standard within multinational corporations. It involves setting the prices for transactions between different divisions or subsidiaries of the same company. This practice ensures that each part of the company is fairly compensated for the goods or services it provides to other parts. Companies typically set transfer prices based on market prices for comparable goods or services. Transfer pricing helps allocate costs and revenues among different divisions or subsidiaries. This allocation is crucial for internal financial reporting and performance evaluation.

By setting appropriate transfer prices, companies can manage profit margins across various divisions.

While transfer pricing can offer tax advantages to corporations, it is often scrutinised by tax authorities.

This practice applies to both domestic and international transactions.

20. Anti-Tax Avoidance Directive (ATAD)

It is a set of European Union rules designed to control multinational companies’ tax avoidance practices. The directive was proposed by the European Commission on January 28, 2016, but adopted by the Council on June 20, 2016. 

It prevents profit shifting to countries with low or no taxes. It also addresses the issue of double non-taxation of certain income.

This ensures companies pay taxes when relocating assets across borders.

Financial Instruments and Markets: A World of Regulation

How do the financial markets stay in check?

From Market Abuse Regulation (MAR) to Cryptocurrency Regulations, the financial rules are complex.

However, each of these financial regulations and compliance terms is important!

Explore how every regulation in the world of financial instruments and markets has a story and a purpose. 

Let’s see how these rules not only shape the markets but also protect investors and ensure fairness.

1. Market Abuse Regulation (MAR)

Market Abuse Regulation (MAR) is a set of rules designed to keep financial markets fair and transparent. It aims to prevent insider trading and market manipulation.

What exactly is insider trading?

It occurs when someone buys or sells stocks based on secret, non-public information about a company. This could involve a company director who has inside information and trades company shares based on that information.

Market manipulation, on the other hand, involves tricks to falsely influence stock prices.

MAR makes it illegal to trade on inside information or to try and artificially affect market prices.

The goal is to ensure that everyone has equal access to crucial market data and that no one has an unfair advantage.

2. Commodity Exchange Act (CEA)

The Commodity Exchange Act (CEA) is a 1936 law that regulates the trading of commodities and futures contracts. It created the Commodity Futures Trading Commission (CFTC).

This financial regulation also protects the investor’s interest!

Before the CEA, there were issues with market manipulation and unfair practices. These peaked, especially during the Great Depression.

It is said that speculation caused major problems in crop prices. After the 2008 financial crisis, the CFTC’s role has expanded.

3. Volcker Rule

The Volcker Rule is a federal regulation that generally prohibits banks from engaging in certain investment activities with their own accounts. It also limits their dealings with hedge funds and private equity funds. Named after former Federal Reserve Chair Paul Volcker, the rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

1. Banks are restricted from using their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures.
2. The rule aims to reduce the risk of speculative investments that do not benefit customers. Thus, avoiding the factors that contributed to the 2007-2008 financial crisis.

Despite its intentions, the Volcker Rule has faced criticism. Some argue that it may reduce market liquidity, making it harder for banks to buy and sell assets quickly.

4. Credit Default Swaps (CDS)

These are financial contracts that help manage risk. CDS is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor. They allow investors to protect themselves against the chance of a borrower defaulting on a loan.

• Parties Involved: There are two main parties in a CDS contract: the buyer and the seller.
• Buyer: The buyer of the CDS makes periodic payments to the seller.
• Seller: In return, the seller agrees to compensate the buyer if the underlying financial instrument (like a bond) defaults.

Let us say you are an investor who is worried about a borrower possibly defaulting. What can you do?

You buy a CDS from another investor. In return, the seller agrees to compensate you if the company defaults.

CDSs can serve different purposes. 

• Investors use CDS to hedge against the risk of default on bonds they own.
• Traders can also use CDS to speculate on a company’s creditworthiness.
• CDS can be used to exploit price differences between markets.

The CDS market was valued at over $4.3 trillion in 2023, highlighting its major impact on the global financial market.

5. Over-the-Counter Derivatives

OTC derivative is a type of financial contract that’s not traded on a formal exchange. These financial contracts are traded directly between two parties. OTC derivatives can be tailored to meet the specific needs of the parties involved, unlike standardized exchange-traded derivatives.

1. The most common types of OTC derivatives are forwards, swaps, and exotic options.
2. These contracts are subject to minimal regulation compared to exchange-traded derivatives, which can increase counterparty risk.

OTC derivatives derive their value from underlying assets. These could be stocks, bonds, commodities, currencies, interest rates, or market indexes.

6. Private Equity Regulations

Private equity in India is governed by a comprehensive regulatory framework designed to ensure transparency, protect investors, and promote fair practices. 

These financial regulations regulate how private equity firms raise and manage funds.

In India, private equity transactions are governed by a comprehensive legal framework. 

These include the following:

Companies Act, 2013:

This financial regulation governs all private equity transactions, including the private placement of securities.

Securities and Exchange Board of India (SEBI) Regulations

It regulates private equity funds, requiring them to register as AIFs.

SEBI Act, 1992

It provides the overall regulatory framework for securities markets in India.

Foreign Exchange Management Act (FEMA), 1999

This financial regulatory authority regulates foreign investments in India, including private equity investments.

Income Tax Act, 1961

This financial regulations act governs the taxation of private equity transactions.

• Insurance Regulatory and Development Authority Act, 1999

Governs private equity investments in the insurance sector.

7. Venture Capital Regulations

These financial regulations and compliance rules oversee investments in startups and early-stage companies. They aim to protect investors while promoting innovation and entrepreneurial growth. Collectively, these regulations ensure that venture capital investments are conducted in a transparent, fair, and compliant manner. Thus promoting the growth of startups and innovative businesses.

8. Green Bonds

These debt instruments raise funds for projects that have positive environmental impacts. You may have heard about renewable energy or energy efficiency projects. If you’re an investor who supports environmental sustainability, these bonds are for you!

So, what are these energy efficiency projects?

They include solar and wind power, energy efficiency improvements, clean transportation solutions, and sustainable water management.

Green bonds often come with added benefits, such as tax incentives, making them even more attractive. They are part of a growing trend in sustainable and socially responsible investing!

9. Social Bonds

These are similar to green bonds but focus on funding projects that have positive social impacts. Social bonds can include projects aimed at improving education, healthcare, or affordable housing. These bonds are issued by governments, companies, or organisations.

When you invest in a social bond, your money supports projects aimed at improving social welfare.

If you have been looking for such stock market investments, you could explore these!

Social bonds typically come with transparency requirements. Thus ensuring that funds are used as promised and that the social impact is measurable and reported.

10. Sustainability-Linked Bonds

SLBs are financial instruments that encourage companies to adopt sustainable practices. This happens by tying the bond’s financial terms to its performance on specific sustainability targets. Thus, the issuer commits to achieving specific sustainability targets. The bond’s interest rate can vary based on whether these targets are met. This incentivises issuers to meet their sustainability goals. Unlike green bonds, which fund specific environmental projects, SLBs can be used for general corporate purposes. However, they have conditions related to sustainability goals.

SLBs are part of the growing trend in sustainable finance!

11. Cryptocurrency Regulations

Digital assets are becoming an attraction. However, handling them presents many challenges. Thus, Cryptocurrency regulations are evolving rapidly as governments worldwide address these.

• United States: The U.S. is gradually developing a regulatory framework for cryptocurrencies. The recent financial industry regulatory authority efforts include the Financial Innovation and Technology (FIT).
• European Union: The EU has introduced the Markets in Crypto-Assets Regulation (MiCA), the world’s first comprehensive cryptocurrency regulation.
• India: India is working on developing its cryptocurrency regulations. The government has proposed a bill to create a framework for digital assets.
• Global Trends: International bodies like the International Organization of Securities Commissions (IOSCO) are working on global standards for cryptocurrency regulation.

12. Blockchain Technology

It is a decentralised, distributed digital ledger that records transactions across multiple computers in a secure, transparent, and unchangeable way. 

Unlike traditional databases controlled by a single entity, blockchain is maintained by a network of computers (nodes). This makes it more resilient to failures and attacks.

Once data is recorded in a block, it cannot be altered without changing all subsequent blocks. All participants in the network have access to the same data, promoting transparency and trust.

1. Cryptocurrencies: Blockchain is the underlying technology for cryptocurrencies like Bitcoin and Ethereum.
2. Smart Contracts: These are self-executing contracts with the terms directly written into code. 
3. Supply Chain Management: Blockchain can track the movement of goods, ensuring transparency and reducing fraud.

13. Smart Contracts

Smart contracts are self-executing contracts where the terms of the agreement are directly written into code. These contracts run on blockchain technology. This ensures that once the conditions are met, the contract is automatically executed without the need for intermediaries.

1. Automation: Smart contracts automatically execute actions when predefined conditions are met.
2. Transparency: All participants can see the terms and outcomes, ensuring trust and reducing disputes.
3. Security: Transactions are encrypted and recorded on the blockchain, making them tamper-proof.

Imagine you put a coin into a vending machine, and it automatically gives you a snack. Similarly, a smart contract automatically carries out actions when certain conditions are met without needing a middleman.

Applications:

• Financial Services: Automating payments and settlements.
• Supply Chain: Tracking goods and ensuring compliance.
• Real Estate: Facilitating property transfers without intermediaries.

Smart contracts are programmed with “if/when…then…” rules. For example, “If payment is made, then release the product.” When these conditions are fulfilled, the contract automatically performs actions. The blockchain updates to show that the transaction is complete.

14. Regulation Crowdfunding

Regulation Crowdfunding (Reg CF) is a set of rules by the U.S. Securities and Exchange Commission (SEC) that allows eligible companies to raise capital through crowdfunding.

1. Companies can raise up to $5 million in a 12-month period through crowdfunding.
2. All transactions must occur online through an SEC-registered intermediary, either a broker-dealer or a funding portal.
3. There are limits on how much individual non-accredited investors can invest across all crowdfunding offerings in a 12-month period.
4. Companies must disclose certain information in filings with the SEC, to investors, and to the intermediary facilitating the offering.

Reg CF is a way for small businesses to raise money by inviting people to invest through online platforms. It’s a great alternative to traditional funding methods like banks or wealthy investors.

Unlike traditional investments that often require a lot of money, Reg CF allows anyone to invest small amounts. This means ordinary people can support and benefit from new startups and small businesses.

15. Derivatives Regulation

This involves financial rules that govern the trading and use of derivatives.

Derivatives are financial contracts whose value depends on the performance of an underlying asset. These assets could be stocks, bonds, or commodities. Common derivatives include futures, options, and swaps.

Here are some of the important regulations!

For instance, the financial industry regulatory authority requires that all derivative transactions be reported in detail. Many derivatives need to be cleared through central counterparties (CCPs). This reduces the risk of one party defaulting on their contract.

Objectives of Derivatives Regulation:

• Transparency: It ensures that all transactions are conducted transparently.
• Market Integrity: It promotes fair trading practices and prevents market abuse.

In India, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) offer trading in various derivative products. These exchanges operate under the regulatory oversight of SEBI, ensuring that all trading activities adhere to the prescribed rules and guidelines.

Traders must maintain a minimum amount of funds, known as margin, in their accounts. This acts as a safety net to cover potential losses and helps prevent excessive risk-taking.

These financial regulations are in place to ensure that derivatives are used responsibly.

16. High-Frequency Trading Regulations (HFT Regulations)

High-Frequency Trading (HFT) uses powerful trading systems and algorithms to execute a large number of trades. While it can improve market liquidity and efficiency, it also introduces risks like market manipulation and increased volatility. HFT firms must register with regulatory bodies such as the Securities and Exchange Commission (SEC) in the U.S. or the Financial Conduct Authority (FCA) in the UK.

Regulators require detailed reporting of HFT activities to monitor and prevent manipulative practices. Continuous monitoring of HFT ensures the detection of any unusual trading patterns.

17. Equity

Equity represents ownership in a company. When you purchase stock, you become a shareholder and own a part of the company. Stocks are traded on stock exchanges, and their value fluctuates based on the company’s performance and market conditions.

You can earn money by selling shares at a higher price than you bought them. Equity investments can be volatile, and their value can change due to various factors.

18. Debt Securities

These are financial instruments representing a loan from an investor to a borrower. The most common types of debt instruments include bonds, treasury bills, and certificates of deposit (CDs).

Debt securities provide regular interest payments to investors. The borrower repays the principal amount at the end of the maturity period. Generally considered lower risk than equities because they offer fixed returns.

• Types: Includes government bonds, corporate bonds, and municipal bonds.

19. Regulation A

It offers a way for companies to avoid the full SEC registration process when they want to publicly offer securities. This rule, part of the Securities Act of 1933, allows companies to raise capital more easily.

Updated in 2015, Regulation A has two tiers:

• Tier 1 allows for offerings up to $20 million and requires fewer ongoing reporting obligations.
• Tier 2 permits offerings up to $75 million but requires audited financial statements and continuous reports.

Under Regulation A, companies must still file an offering statement with the SEC and provide buyers with documentation similar to a prospectus.

20. Regulation S

It exempts securities sold exclusively outside the U.S. from SEC registration. It applies to both U.S. and foreign issuers who want to sell securities to non-U.S. investors. Securities sold under Reg S are considered restricted and cannot be resold in the U.S. for a specified period, which can be up to a year.

Compliance and Ethics in the Financial Industry

In today’s digital world, there are multiple challenges that every individual has to face! This means there’s a greater need for strict financial rules and compliance.

Let’s discuss ethics and compliance today. They are crucial aspects of financial regulation and compliance worldwide!

Ethics is about moral principles; compliance is about following the rules.

Ethics

Ethics, rooted in the Greek word ethos, meaning “character,” is about doing what’s right.

It’s more than just following financial laws; it’s about acting with integrity and making morally sound choices.

Compliance

Compliance means sticking to financial laws and regulations, as well as internal company rules. It involves everything from security procedures to anti-fraud measures. Thus ensuring that companies operate within legal and ethical boundaries.

Here are some of the real-world examples that have led to the need for stronger financial regulations and compliance!

The Tyco Fraud Case

Tyco’s CEO, Dennis Kozlowski, was caught misusing company funds for personal luxuries. This led to charges of securities fraud.

Was he given a second chance?

No, Kozlowski was sentenced to 8 to 25 years in prison in 2005.

The Sahara Case

In 2011, SEBI charged the Sahara Group for failing to return over 200 billion rupees to investors.

The Satyam Scam

India’s largest corporate fraud, the Satyam Computer Services scandal, involved falsified accounts. The company’s founder and directors were involved in inflating share prices.

Scandals like these have pushed companies to focus more on financial compliance standards!

So, what are some key ethics and compliance terms you should know?

Let’s explore!

1. Anti-Money Laundering (AML)

Did you know it’s tough to turn black money into white money without getting caught?

That’s what Anti-Money Laundering (AML) is all about.

AML is a system designed to catch people trying to hide illegally earned money and turn it into clean cash (white money).

Various organisations or individuals indulge in this activity! They try to use unethical ways to make their earnings look as if earned from a legitimate source.

AML protects the financial system from criminals abusing it. New technologies are being integrated to make AML efforts even more effective.

2. Know Your Customer (KYC)

When you go to a bank to open an account, get a loan, or even open a demat account, the first step is KYC.

Know Your Customer (KYC) is the process of verifying the identity of clients to prevent fraud. The purpose of KYC is to ensure that financial institutions know who their customers are.

This involves collecting and verifying customer information.

Why is it needed?

KYC helps prevent money laundering, fraud, and other financial crimes. It plays a key role in maintaining the integrity of financial systems.

3. Fair Credit Reporting Act (FCRA)- US

The Fair Credit Reporting Act (FCRA) is a U.S. law that promotes fairness and accuracy in credit reporting. It ensures that credit reports are accurate and that consumers have the right to dispute incorrect information.

The act also regulates how lenders and employers can use credit information.

4. Foreign Contribution (Regulation) Act, 2010 (FCRA, 2010)

This is an e-governance initiative by the Ministry of Home Affairs in India. It aims to provide a smart, citizen-centric, and transparent system for accessing services related to foreign hospitality.

The FCRA, 2010, was created to:

• Regulate how individuals, groups, or companies accept and use foreign donations or hospitality.
• It ensures that foreign contributions and hospitality are not used for activities that might harm national interests.

5. Financial Crimes Enforcement Network (FinCEN)

The Financial Crimes Enforcement Network (FinCEN) is a U.S. agency.

FinCEN aims to fight money laundering and related crimes, including terrorism. It includes collecting, analyzing, and sharing financial intelligence.

6. Anti-Bribery and Corruption (ABC)

Anti-Bribery and Corruption (ABC) is another key financial regulation and compliance term. It aims to prevent bribery and corruption within businesses.

Ethics and compliance are ongoing processes!

They aim to avoid practices that could lead to legal and reputational damage.

7. Economic Sanctions

Economic sanctions are restrictions imposed by countries or international bodies to influence the behaviour of other nations. These can include trade restrictions, financial penalties, or asset freezes. They are often used to address issues like human rights violations or illegal activities.

8. Data Privacy

Data privacy refers to the protection of personal information collected by businesses. Financial industry compliance requirements ensure that companies handle data responsibly.

You must keep it secure and use it only for the intended purposes.

9. Cybersecurity Measures

Cybersecurity measures are used to protect computer systems and data from cyber-attacks. These include measures like firewalls, encryption, and regular security audits. The aim is to safeguard sensitive information from unauthorized access.

10. Environmental, Social, and Governance (ESG)

Every company aims to contribute to society in one way or another.

Environmental, Social, and Governance (ESG) criteria are used to evaluate a company’s sustainability and ethical impact.

ESG focuses on how businesses manage environmental responsibility, social relationships, and governance practices. This helps investors make the right decisions about the long-term impact of their investments.

11. Whistleblower Protections

Have you ever heard about someone who complained about their manager and ended up getting suspended instead of receiving help?

Unfortunately, this happens in about 76% of companies.

To tackle this issue, there are financial compliance standards like Whistleblower Protections!

These protect people who report illegal or unethical behaviour in organisations. These make sure that whistleblowers don’t face retaliation or harm for revealing wrongdoing.

12. Ethics and Compliance Program

Every organisation has an ethics and financial compliance system to ensure smooth functioning!

Here’s why:

• Employees want to work for companies that uphold strong values.
• Consumers expect businesses to be transparent and fair.
• Shareholders invest when they trust that a company is not only profitable but also follows the law and maintains good governance.

It is a framework designed to ensure that employees adhere to legal and ethical standards. It includes policies, training, and monitoring to prevent misconduct and promote integrity.

13. Foreign Corrupt Practices Act (FCPA)

The Foreign Corrupt Practices Act (FCPA) is a U.S. law. It prohibits companies from bribing foreign officials to gain business advantages. It also requires accurate record-keeping and internal controls to prevent corruption.

14. Compliance Audit

A Compliance Audit is an independent evaluation of an organisation. It helps ensure that the company follows financial regulations and rules.

The primary aim is to confirm that the organisation complies with both external legal requirements and internal policies.

Now, conducting a compliance audit involves several steps.

These includes:

• Reviewing documents
• Interviewing employees
• Evaluating internal controls.

A part of the audit involves checking that financial practices are ethical and transparent.

This includes reviewing financial statements and transactions.

15. Compliance Training

Compliance training is all about teaching your team the rules and policies they need to follow. The main goal of compliance training is to educate employees about legal and financial regulatory requirements. This helps prevent violations and promotes ethical conduct within the organisation.

For example, you might train them to create strong passwords and practice safe internet habits. The training can also cover basics like first aid, fire safety, and any specific safety procedures.

However, they must be relevant to their job!

When done right, compliance training helps create a positive, respectful workplace!

16. Insider Trading Laws

Insider trading laws help prevent buying or selling stocks based on secret, non-public information. The goal is to keep trading in the financial markets fair for all.

Insider trading happens when someone trades a company’s stock.

Sound simple?

However, this would be insider trading if he does it based on confidential information that isn’t available to the public.

This kind of trading is illegal if the insider uses the information to make a profit or avoid a loss!

Regulatory bodies like SEBI and the SEC keep an eye on such trading practices.

17. Ethical Investing Guidelines

Ethical investing guidelines involve choosing investments based on ethical criteria, such as social responsibility and environmental impact.

There is no strict compliance standard for this; it entirely depends on your personal decision.

However, you should consider the following:

• Know Your Values: These might include environmental protection, social justice, or adherence to religious principles.
• Do Your Research: Look for companies and funds that align with your values.
• Check Performance: You must ensure your investments not only align with your values but also perform well financially.

18. Privacy Impact Assessment (PIA)

A Privacy Impact Assessment (PIA) is one of the widely used compliance standards. It shows how a new project or system might affect people’s privacy.

The main aim of a PIA is to spot and fix privacy issues before they become problems. It makes sure privacy concerns are considered right from the start of any project.

19. Corporate Responsibility Standards

CSR are guidelines that define how businesses should operate ethically and sustainably. They cover areas like labour practices, environmental impact, and community engagement.

Have a look at these financial compliance standards:

1. ISO 26000 compliance standard guides organisations on how to act responsibly.
2. Global Reporting Initiative (GRI)- GRI provides a framework for sustainability reporting. It helps companies share their economic, environmental, social, and governance performance.
3. OECD Guidelines for Multinational Enterprises offer principles and standards for responsible business conduct.

20. Sustainable Accounting Standards (SAS)

Sustainable Accounting Standards (SAS) help companies disclose how sustainability issues affect their business and financial results.

SAS focuses on specific industry compliance requirements for sustainability reporting:

• Industry-Specific Standards

SASB creates standards for 77 different industries. These focus on sustainability issues that can affect a company’s financial performance.

• Materiality

SAS emphasises reporting on issues that could influence a company’s financial health or performance. This makes the information valuable for investors.

These compliance standards have global applicability.

Risk Management

It is the process of identifying, assessing, and controlling risks to minimise their negative impact. In financial regulation and compliance, risk management applies to individuals, organisations, and financial institutions.

The goal is to minimise the negative impact of these risks on operations and finances.

It involves several steps:

1. Identify risks: These could range from financial losses to operational disruptions.
2. Assess risks: Understand the potential impact of the risks and their chances of future occurrence.
3. Control or mitigate risks: Implement strategies or measures, such as insurance, safety protocols, or diversifying investments.

Effective risk management strategies may differ depending on the stakeholder.

Let’s take a look at the key risk management terms you must know to fulfill financial industry compliance requirements.

1. Risk Assessment

It is the process of identifying potential risks and evaluating their possible impact. It involves spotting what could go wrong—such as financial losses, operational issues, or legal problems—and analysing how these risks could affect the organisation.

During risk assessment, businesses consider the likelihood of each risk happening and the severity of its impact. This process helps prioritise which risks need immediate attention and which can be monitored over time.

2. Risk Tolerance

Risk tolerance refers to the amount of risk an individual or organisation is willing to accept in pursuit of their goals.

For individuals- It might relate to their comfort level with fluctuations in investment values or potential financial losses.

For organisations- It relates to their strategic objectives and financial stability.

If you have a high-risk tolerance, you might invest in volatile stocks. However, if you have a low-risk tolerance, you might prefer safer, more stable investments. 

Understanding risk tolerance is crucial because it helps you make smarter financial choices!

3. Risk Appetite

Risk appetite is the level of risk that an individual or organisation is prepared to take on to achieve its objectives. It reflects how much risk it is willing to assume based on its goals, resources, and overall strategy.

For example, a company looking to expand aggressively might have a high-risk appetite.

Conversely, a company focused on stability might have a low-risk appetite. Thus, they would favour safer investments and strategies.

4. Risk-Based Capital Guidelines

These are the financial rules and regulations for banks and insurance companies. The aim is to protect financial firms, their investors, their clients, and the economy as a whole.

These requirements ensure that each financial institution has enough capital on hand to sustain operating losses. The idea is that banks have enough money to cover potential losses from their investments and operations.

5. Risk Management Framework

It is a structured approach that helps organisations easily identify, assess, and manage risks. It includes financial policies and procedures designed to reduce the likelihood of negative events and their impact.

It’s like a roadmap for protecting an organization.

The framework involves multiple steps, such as identifying potential threats, evaluating their impact, etc. A strong RMF helps ensure business continuity and protects the organisation’s reputation.

6. Compliance Risk

It is the potential harm an organisation faces from not following financial rules and compliance standards.

This non-compliance can result in:

• Financial penalties: Fines, legal costs, and restitution
• Reputational damage: Loss of trust from customers, investors, and the public
• Legal issues: Lawsuits, criminal charges, and regulatory sanctions
• Operational disruptions: Business interruptions due to investigations or enforcement actions

The process involves ensuring that all business activities follow financial compliance requirements.

This helps avoid legal troubles and maintains the company’s reputation.

Financial institutions face strict compliance requirements. Some of these include anti-money laundering (AML) and know-your-customer (KYC) rules.

7. Operational Risk

It is the risk of loss resulting from failed internal processes, people, or systems or from external events. For example, a computer glitch causing a production halt or a small mistake in accounting could be operational risks. These risks can vary from company to company and can impact how well a business performs.

Examples of operational risks include:

• People: Employee fraud, misconduct
• Processes: System failures, breakdowns in internal controls, inadequate procedures
• Systems: Technology failures, cyberattacks, data breaches
• External events: Natural disasters, economic downturns, political instability

The company must have a strong risk management system to prevent and respond to such issues.

8. Credit Risk

It is the risk that a borrower will not repay their loan or meet their financial obligations. For example, if someone takes a loan and fails to make payments, the lender faces credit risk. To manage this credit risk, lenders must understand the borrower’s creditworthiness. However, this needs to be done before actually entering into the contract. They can also ask for collateral (assets pledged to secure the loan) to minimise potential losses.

Credit risk represents a significant concern for financial institutions. The potential for borrowers to default on loan repayments can lead to huge financial losses.

Effective credit risk management involves a comprehensive evaluation of a borrower’s creditworthiness through factors like income, repayment history, etc.

9. Market Risk

It represents the risk of losing money due to changes in market conditions, such as fluctuations in stock prices, interest rates, or exchange rates.

It conveys the chance that your investments might lose value due to broader economic changes. It’s not about a single company struggling; it’s about the entire market taking a hit. For example, if the stock market falls, your investments could lose value too.

This risk can come from changes in interest rates, wars, or even natural disasters. So, even if you invest in strong companies, you could still see losses if the overall market is down.

That’s why it’s important to understand market risk and look for ways to protect your investments

10. Interest Rate Risk

Interest Rate Risk is the risk of losing money due to changes in interest rates. It primarily affects financial institutions, investors, and businesses with significant debt or interest-bearing assets. 

For example, if a company has a loan with a variable interest rate and rates rise, its interest expenses could increase. It is important to manage the interest rate risk. Organisations can use strategies such as locking in fixed rates or using financial instruments to hedge against rate changes.

Let us say that if you buy a bond, it typically pays a fixed interest rate.

If interest rates rise after you buy the bond, new bonds will offer higher interest rates. This makes your older bond less attractive to investors, so its price goes down.

• Fixed-income securities

Bonds and other fixed-income investments are particularly exposed to interest rate risk.

• Floating-rate instruments

These securities offer some protection against interest rate risk. However, they are not entirely secure. Changes in interest rates can affect the timing and amount of cash flows.

• Financial institutions

Banks and other financial institutions may face interest rate risk on both their assets and liabilities.

11. Foreign Exchange Risk

It represents the financial uncertainty that arises from changes in currency exchange rates. In simpler terms, it’s the risk that the value of your money can change when you’re dealing with different currencies.

For instance, let us say that a company does business internationally and the value of the foreign currency it receives falls. In this case, it could lose money when converting that currency into its home currency.

Imagine you’re a U.S.-based company that exports products to Europe. You sell your goods for euros. If the euro weakens compared to the U.S. dollar, you’ll receive fewer dollars when you convert your euro earnings back to U.S. dollars. This is a foreign exchange risk.

Managing foreign exchange risk is highly important. The various types of foreign exchange risks include:

• Transaction risk: This is the risk of losses on foreign exchange transactions. 

For example, if you have to pay for imports in a foreign currency and the currency appreciates, it will cost you more in your own currency.

• Translation risk: This occurs when financial statements of foreign subsidiaries are converted into the parent company’s currency.
• Economic risk: This is the impact of exchange rate changes on a company’s overall business performance.

  12. Counterparty Risk Management

It is the risk that the other party involved in a financial transaction might fail to fulfil their obligations. This can lead to financial loss for the party expecting payment or delivery of goods.

When you engage in any financial transaction, such as trading stocks, entering into a derivative contract, or simply issuing a loan, you rely on the other party (the counterparty) to meet their end of the deal.

For instance:

• Companies: When a company sells goods on credit, it expects payment from the buyer. If the buyer defaults, the company faces counterparty risk.
• Financial Institutions: Banks and other financial institutions face counterparty risk when lending money. If the borrower cannot repay, the bank incurs a loss.
• Investors: When investors buy bonds, they expect the issuer to pay interest and return the principal at maturity. If the issuer defaults, the investors lose their money.

Managing counterparty risk is crucial. You must follow:

1. Creditworthiness Assessment
2. Collateral:
3. Diversification
4. Indulge in Contracts and Agreements

  13. Risk Management Tools and Techniques- Diversification

Diversification is a strategy that every investor must use. It means that you should spread investments across various assets to minimise risk. Instead of putting all your money into one type of investment, you must invest in a mix of assets. You could probably invest in mutual funds, stocks, bonds, and even commodities.

Now, invest in these assets at zero brokerage!

This way, if one investment performs poorly, others may perform better, balancing out potential losses.

Diversification ensures that you earn consistent returns.

This risk management strategy also applies to companies. For instance, they must not rely upon a single supplier of raw materials.

  14. Hedging

It is a strategy used to protect investments from potential losses due to market fluctuations. Companies, financial institutions, and individual investors use hedging to reduce the risk of losing money.

Let’s say a company relies on buying a certain raw material, like oil, and the price of oil fluctuates a lot. If the price suddenly rises, the company could face higher costs and lower profits. To protect against this risk, the company can enter into a hedging contract to lock in the current price of oil. This way, even if the market price of oil increases, the company pays the agreed-upon price.

Financial instruments like options, futures, and swaps are commonly used for hedging. For example, an investor who owns shares in a company can buy a “put option.” This option allows the investor to sell their shares at a specific price, even if the market price drops. If the shares lose value, the investor can still sell them at the higher, agreed-upon price, minimising losses.

Hedging doesn’t eliminate risk entirely but helps manage and reduce it.

15. Stress Testing

It is a financial analysis technique that is often used to assess an institution’s or investment portfolio’s soundness. Stress testing helps understand how well they can handle extreme economic situations. It involves simulating severe market downturns or other tough scenarios. The aim is to spot any weaknesses and see if current risk management strategies are effective.

In simple terms, stress testing means putting a financial system through challenging but realistic situations to see if it can endure. This helps both financial institutions and regulators make better decisions.

16. Leverage Ratio

It is a financial measurement that shows how a company or financial institution is using borrowed money (debt) to finance its assets. It helps assess whether the company can handle its financial responsibilities. Companies often use a mix of their own money and borrowed funds to run their operations. Thus, knowing the amount of debt they have is important for understanding their financial health.

• The leverage ratio indicates how much of a business’s operations are funded by debt rather than equity. 

A high leverage ratio means a company is heavily reliant on borrowed money.

• Banks and other financial institutions use leverage ratios to ensure they are not over-leveraged. 

Regulatory bodies, such as the Basel Committee on Banking Supervision, set minimum leverage ratio requirements to maintain financial stability.

• Investors use the leverage ratio to assess the risk level of a company or institution.

 17. Tier 1 Capital

It is the core capital of a bank that mainly consists of common equity and retained earnings. It may also include preferred stock. Tier 1 capital is used to absorb losses and ensure the bank’s stability. Banks are required to maintain a minimum amount of Tier 1 capital to ensure they can handle financial losses without risking their stability. 

As per Basel III Standards. a bank must have Tier 1 capital equal to at least 6% of its risk-weighted assets (the total assets adjusted for risk).

Tier 1 capital is vital for understanding a bank’s ability to remain stable and absorb losses.

18. Tier 2 Capital

Tier 2 Capital includes supplementary capital that can be used to absorb losses but is less permanent than Tier 1 Capital. It includes items like subordinated debt and hybrid instruments. While it provides additional financial support, Tier 2 Capital is considered less reliable than Tier 1 Capital.

This is because Tier 2 capital is harder to quickly convert into cash if needed.

Tier 2 capital includes revaluation reserves, general provisions, subordinated debt, and hybrid instruments (like preferred stock). It acts as a buffer to help banks cover losses and is part of the total capital they must maintain. 

Under international guidelines, Tier 2 capital should make up a smaller portion of a bank’s total capital compared to Tier 1.

19. Total Loss-Absorbing Capacity (TLAC)

TLAC represents the minimum amount of capital and debt a bank must hold to absorb losses during a financial crisis. This means that if a bank faces significant losses, it has enough financial resources to cover those losses and continue operating without collapsing. The goal is to prevent a domino effect that could destabilise the entire financial system. This concept emerged after the 2008 financial crisis. It aims to enhance the stability of the global banking system.

1. Capital includes common equity and retained earnings.
2. Debt includes long-term debt instruments that can be converted into equity during a crisis.

For banks, maintaining TLAC means having a mix of high-quality capital and debt that can be quickly converted to cover losses.

 20. Model Risk Management

It helps to assess and manage that financial models used for decisions are accurate and not misleading. For example, if a bank uses a model to predict credit risk and the model is flawed, it could lead to poor lending decisions. Model risk management ensures that models are regularly updated to reflect changing conditions.

These models are mathematical and statistical tools. They are used to predict financial outcomes, such as asset prices, interest rates, and credit risks.

1. It ensures that models provide reliable predictions, helping institutions make sound financial decisions.
2. This helps meet regulatory requirements.
3. Identifies and mitigates potential risks associated with model errors, preventing financial losses.

In summary, Model Risk Management is a crucial practice for ensuring that financial models are reliable and effective.

Conclusion 

No matter where you are in the world, understanding financial regulations and compliance terms is essential for protecting your assets and ensuring your financial security. Whether you’re managing personal finances or making business decisions, integrating these practices into your routine can help you stay compliant and safe! 

Take action today to strengthen your financial foundation and secure a better future.

FAQs| Financial Regulations and Compliance Terms

Source: Investopedia

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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.