Dear CEO: Oversight of Service Providers Still Needs Attention

December 12, 2013

ImageA month ago, the FCA distributed a follow up report to their ‘Dear CEO’ letter regarding concerns around UK asset managers’ outsourcing relationships (read the full report here). The report discusses progress made and work that still needs to be done to address the FCA’s concerns.

The FCA review focuses on two types of risk, defined by them as:

Resilience risk: if an asset manager’s service provider was to suddenly fail and therefore be unable to provide their outsource services for an indefinite period, the asset manager in turn would not be able to continue the service it is contracted to provide to its customers

Oversight risk:  if asset managers fail to oversee their service providers effectively, it could result in poor outcomes for their customers

The report shows some positive movement in addressing the FCA’s ‘resilience risk’ concerns, especially with the work being driven by the Outsourcing Working Group, made up of the Investment Management Associations, asset managers and key service providers.  The larger concern seems to be with “oversight risk”.

The report notes, “The effectiveness of oversight arrangements varies from firm to firm, with only some asset managers able to demonstrate high standards of oversight consistently across all outsourced activities. Where oversight of an activity was lacking, we found the main cause was insufficient internal expertise to carry out the oversight.”

The research looks at four specific areas of potential oversight risk:

  1. Reconciliations of assets held with the custodian
  2. Pricing and valuations of portfolio or specific instruments
  3. Corporate actions relating to instruments held and,
  4. Trade processing

While each area has its own issues and related risks, most of the issues revolve around the need for asset managers to have the expertise and functionality in-house to verify and challenge (if necessary) the information coming from their service provider.  Asset managers understand they need to accept the responsibility for activities that are outsourced but many have inadequate resources to verify and validate the data, leading to over reliance on the service provider.

To address the verification issue one noted solution is to maintain internal client account books to accurately reconcile against the service provider’s records and ensure the information they provide is accurate and complete.

Keeping a shadow book of records in-house, using a solution like SS&C PORTIA,  creates an extra level of assurance and confidence for the asset manager and their clients by allowing the asset manager to independently reconcile the accuracy of positions, valuations, pricing and corporate action events, using the data vendors they choose, thereby ensuring the integrity of their data.  In addition, this approach gives the asset management organization more control over their data should there be a failure of some sort on the part of the outsourcing provider, addressing some of the “resilience risk” also identified by the FCA.

 The review concluded by noting that the FCA will consider further policy action if the continued progress does not lead to “an acceptable increase in the level of preparedness for a service provider failure and effective oversight of all outsourced activities”.  The FCA is encouraging asset managers to continue evaluating risks and implement solutions that will mitigate these risks to avoid additional regulatory policies. 


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