Regulatory risk is the risk that a business or investment may be adversely affected by changes in the regulations of a particular industry. It is a form of policy risk and is also a type of systemic risk, meaning that when changes to regulations occur, entire industries can be affected, simultaneously affecting all companies within the industry.

Regulatory risk is sometimes referred to as “regulatory uncertainty” because it is inherent to the ever-changing laws and regulations that govern a sector. Regulations can change suddenly and with little warning, making it difficult to predict the impacts of the new rules in advance. Regulations can also change gradually, though they still pose a risk.

The most significant regulatory risk comes when a government introduces a new law to restrict or prohibit certain activities or introduce limits on the number of participants in a field. For example, a government may increase taxes or impose tariffs on imported goods, limit the number of new entrants into a market, or require firms to comply with additional reporting and regulatory standards. These changes can result in significantly higher operating costs for businesses or lower rates of return for investments.

Financial service providers are particularly susceptible to regulatory risk as this sector requires a thorough understanding of the applicable regulations. Compliance with the regulations is key to protecting a firm’s license and its customers’ assets. Regulators often conduct regular audits to ensure firms are following the regulations and can impose fines for non-compliance.

There is no simple way to avoid regulatory risk. Companies must proactively monitor the sector and government developments that may affect the industry, as well as implement internal systems and controls in order to reduce their exposure. Companies should also understand their customers’ needs and expectations to make sound business decisions in line with industry regulations.

Overall, regulatory risk is a compounding factor for businesses and investors, given that it carries the potential for major changes that cannot be easily anticipated. Companies must stay informed and implement robust internal controls in order to minimize their regulatory risk exposure.