Webinar: The regulator says it is time for fund managers to measure, mitigate, manage and monitor outsourced operational risk
AUDIO: An audio replay of the Webinar. Click on the 'Play' button to listen.
The Financial Conduct Authority (FCA), the United Kingdom regulator, is concerned that fund managers are not prepared for the failure of a global custodian bank to which they have outsourced operational functions such as custody, fund accounting, transfer agency and middle office processing.
In two documents, published in December 2012 and October 2013, and at an in-house asset management conference in October, the FCA has effectively instructed fund managers to obtain a full understanding of their operational exposure, identify any outsourced activities that are essential to maintain services to investors, and mitigate the risk by reintegrating expert staff and formulating detailed exit plans.
Custodians and fund managers, loosely organised as the Outsourcing Working Group, have published a paper offering managers advice on how to monitor their global custodians, standardise their interactions with their global custodian to make it easier to change provider, and plan a successful exit from the relationship in the event of disaster.
This could lead to a massive shake-up in the relationship between fund managers and custodians, with managers insourcing some functions, and dividing their operational support across multiple providers, with unpredictable consequences for pricing and efficiency.
Here are some of the key findings from a webinar held by COOConnect’s on these issues:
•At present,80% of assets are serviced by four providers and the regulator believes there re unconvincing recovery and resolution plans in place at fund managers to deal with a bank failure, not to mention inadequate monitoring of those service providers. The FCA has said that there have been improvements in fund managers’ contingency planning for a service provider failure although oversight remains a weak point, namely because of the lack of internal staff with the necessary skill-sets. Some firms – notably Bridgewater whereby Northern Trust shadows the work of BNY Mellon AIS – are spreading their back and middle office risk across multiple providers. However, this is costly.
• There needs to be some form of industry standardisation on operational outsourcing. There is scepticism in the industry about the FCA’s resolve in pushing this issue. Very few fund managers are taking the FCA seriously while many are simply trying to do the bare minimum to ensure they satisfy the regulators.
• In terms of ensuring effective resolution of data, fund managers can have a shadow books and records, or a data isolation or warehouse platform. There is a debate about whether ny data utility should be a user-owned or commercial venture. However, fund managers must have the necessarily experience and skills to be able to manage this data in-house.
• Shadowing appears to be more prevalent in the US than Europe. Some also argue the upside for collecting this data is limited and just adds cost. One panellist said hedge funds do collect data as it brings benefits – namely the data is timely and can provide value add for the front office.
• Most panellists doubt in-sourcing will occur as it will be prohibitively expensive due to the hiring costs and technology overheads.
• Investors have remained fairly muted on the OWG findings. This is something pensions or any beneficial owner should be taking seriously. There appears to be variable degrees of awareness at pension plans about these issues.
• Who will pay for the change? Firms are adopting a short-term approach. There needs to be a standardised approach to the challenges laid forth by the OWG.