As firms look to outsourced solutions to deal with the costs of new legislation, UK market regulator the Financial Services Authority (FSA) has warned buy-side firms to improve safeguards should service providers fail.
The regulator fears end-clients would pick up the bill if an outsourcing partner were to fail, and has called for stronger contingency plans across the industry, in a letter sent to CEOs of asset management firms this week.
“If an outsource provider were to face financial distress or severe operational disruption, UK asset managers would not be able to performance critical and important regulated activities,” the letter reads.
Based on its investigation, the FSA is not confident that effective recovery and resolution plans are in place for the asset management sector as a whole.
The watchdog’s findings, based on discussions with asset managers, suggest some firms rely on partners such as banks that may be supported with public money if they face serious problems, a strategy the FSA described as “lacking prudence”.
Moving operations in-house would likely take months, and moving directly to another provider would also pose significant operational challenges. This would potentially breach regulation SYSC 8.1.7R of the FSA Handbook, in which firms should exercise “due skill and care and diligence” in managing outsourcing operations, according to the UK watchdog.
“It is the responsibility of firms’ boards to ensure they have in place an adequate resilience plan which enables the firm to carry out regulated activity if a service provider fails,” the letter reads, adding that the FSA will host an industry event in early 2013 to establish a clearer industry consensus on appropriate exit strategies to protect clients.
The FSA concerns pre-empt an expected expansion of outsourcing activities from buy-side firms, with recent research suggesting the amount of operations managed externally will rise as firms try to cut costs while growing their business.
New regulation in Europe and the US has also been identified as a major factor in outsourcing operations, as asset managers look to cut down reliance on in-house systems in favour of external solutions that offer scalability and cost efficiencies. Reforms to the OTC derivatives market will impose new collateral requirements on the buy-side that will be expensive to build themselves, while dwindling equity volumes and increased market complexity have also led more investment managers to outsource trading, to firms such as BNP Paribas' FIN'AMS.