Regulatory risk is the risk that a change in laws and regulations will materially impact a security, business, sector, or market. A change in laws or regulations made by the government or a regulatory body can increase the costs of operating a business, reduce the attractiveness of an investment, or change the competitive landscape.
Breaking Down Regulatory Risk
Financial institutions face regulatory risk with respect to capital requirements, services, and products they are allowed to engage in, and disclosure practices. Salient to investors that brokers serve would be a change in the amount of margin that investment accounts can possess. If margin requirements are tightened, the impact on the stock market could be material, as this would force investors to either meet the new margin requirements or sell off their margined positions.
Example of Regulatory Risk
For example, the utilities are heavily regulated in the way they operate, including the quality of infrastructure and the amount that can be charged to customers. For this reason, these companies face a regulatory risk that can arise from events—such as a change in the rates they can charge—that may make operating the business more difficult.
A plethora of regulatory risk examples exist. One of the best places to directly learn about this type of risk to a particular company is its annual filing (or 10-K). Each 10-K filing contains a section on material risks to company operations. Regulatory risks customarily are mentioned—and sometimes discussed in great detail, as is the case for the drug industry, for example.