The FCA has published “Outsourcing in the Asset Management Industry: Thematic Project Findings Report” (TR13/10) which is based upon a sample of 17 asset managers (including 3 hedge fund managers). You may recall that a ‘Dear CEO’ letter on this topic was issued in December 2012 following the completion of work on the sample.
Two key findings were (a) Oversight risk: inadequate oversight of the service provider [mainly due to insufficient internal expertise] and (b) Resilience risk: inadequate contingency plans to deal with a failure of a service provider.
The FCA concentrated on four specific areas where it was considered that there was a risk of errors or omissions potentially resulting in customer detriment (see also Chapter 5 of TR13/10):
- Reconciliations of assets held with the custodian
- Pricing and valuations of a portfolio or specific instruments
- Corporate actions such as payment of dividends, rights issues etc
- Trade processing
Oversight risk findings are within Chapter 5. Because of the possibility of reputational risk, asset managers in the sample accepted responsibility for outsourced critical activities even where the contracting party was the governing body of the fund rather than the manager. Whilst all of the asset managers did have written service level agreements in place, the quality – and hence usefulness – of MI reports received was variable.
Detailed comments upon resilience risk and exit planning can be found in Chapter 4, including the FCA not approving of the ‘too big to fail’ belief that some asset managers held in respect of their service providers.
Positive approaches to the mitigation of resilience risk experienced by the regulator include the use of different service providers to carry out different activities (although this does seem to assume that each of them would be able to carry out the other’s activities) and identifying a ‘stand-by’ service provider, which will have the advantage of reducing the time needed for due diligence in the event of a transfer to another provider, possibly formalising a relationship with them by way of a Memorandum of Understanding.
The Investment Management Association has formed the Outsourcing Working Group (OWG) which also includes various asset managers and key service providers. The intention is to establish ‘guiding principles’ for the industry on standardisation, exit planning and oversight models with a key aim of improving portability between providers; the link to OWG slides may be of interest.
We are advised that the regulator will continue to monitor the progress of asset managers in meeting their outsourcing obligations and possibly “also consider further policy action”.