The FCA’s Outsourcing in the Asset Management Industry thematic review is therefore a sobering read. The oversight and resilience mechanisms that financial firms will need when outsourcing major critical functions, should this become law, are far-reaching.
In November 2013 the FCA published its Thematic Project Findings Report on outsourcing in the asset management industry. This followed the ‘Dear CEO’ letter issued by the FSA to 125 asset managers in December 2012.
The letter raised the concern that “if an outsource provider were to face financial distress or severe operational disruption, UK asset managers would not be able to perform critical and important regulated activities, thereby causing detriment to customers.”
The FSA letter discounted a number of potential solutions the industry had been relying on in response to similar concerns following the collapse of Lehman in 2008, namely:
* Public rescue of financial institutions – too big to fail;
* Taking activities back in-house;
* Transfer to another External Service Provider (ESP);
* Exercising step-in rights.
The thematic report focuses on assessing two key areas of risk relating to the outsourcing of critical activities:
* Asset managers having inadequate contingency plans in place to deal with a failure of their service provider (‘resilience risk’);
* Asset managers applying inadequate oversight of their service provider (‘oversight risk’).
In response to the FCA’s concerns, the IMA, together with a number of asset managers and outsource providers, formed the Outsourcing Working Group (OWG) to provide an industry response.
The OWG is producing proposed guidelines in respect of oversight, standardisation and exit planning.
In its November report, the FCA stated that it was pleased with the level of engagement from asset managers in response to the FSA’s letter, and during 2013 it reported improvements in asset managers’ planning for the failure of a service provider.
It also praised the industry-led work intended to help firms with contingency planning – the OWG principles aim to guide the industry, with a key aim of improving portability between providers.
In addition to helping mitigate the resilience risk, there could be wider benefits to the industry and its customers if asset managers were able to move between service providers more readily.
The report does, however, bring more focus and demands on oversight risk. Here the FCA concludes that the effectiveness of oversight arrangements varies from firm to firm, and many are unable to demonstrate high standards across all outsourced activities.
The report states: “Where oversight of an activity was lacking, we found the main cause was insufficient internal expertise.”
How does an asset manager even begin to determine whether a service provider is in a position where it might fail?
