Regulatory risk is key for asset managers. They need to be able to demonstrate to their regulators that any contractual arrangement for the provision of outsourced services minimises operation risk. There are various regulatory requirements which UK asset managers should bear in mind when outsourcing:
Asset managers must notify the Financial Services Authority (FSA) of proposed outsourcing and significant changes to outsourcing arrangements. (15.3.1R and 15.3.8G (1) (e), Supervision (SUP), FSA Handbook).
Systems and Controls
If an asset manger is outsourcing critical functions, it must take reasonable steps to avoid undue operational risk. It must also not outsource important operational factors in such a way to impair materially the quality of its internal control and the FSA’s ability to monitor the asset manager’s compliance with its obligations under the regulatory system (8.1.1R, Senior Management Arrangements, Systems and Controls (SYSC), FSA Handbook).Asset managers must also exercise due skill, care and diligence when entering into, managing or terminating any arrangements for the outsourcing of critical or important functions (SYSC 8.1.7R), and ensure compliance with a number of specific conditions set out in SYSC 8.1.8R.
Where an asset manager outsources critical or important functions, it remains fully responsible for discharging all of its regulatory obligations and must comply with a number of conditions set out in SYC 8.1.6R. It must have a written contract in place with the supplier which clearly allocates the rights and obligations of each party (SYSC 8.1.9R). It must also make available to the FSA on request all information necessary to enable the FSA to supervise the arrangements’ regulatory compliance.
Impact of the Directive on Alternative Investment Fund Managers (Directive)
Under the Directive the provisions governing delegation of alternative investment fund manager (AIFM) functions are highly restrictive. Before an AIFM can delegate any functions, it needs to notify its regulator and certain conditions need to be complied with. In particular, any delegate must be qualified, experienced, capable, have sufficient resources and be of sufficiently good repute. An AIFM’s own liability will be unaffected by delegation. These provisions of the Directive will impact directly on outsourcing arrangements. In particular, the AIFM will need to demonstrate the supplier has been selected with all due care, can be monitored effectively, that instructions may be given at any time and that the agreement can be terminated immediately when it is in the interests of investors. All this means that not only will any future outsourcing arrangements to which an AIFM is a party need to comply with the Directive, but all existing arrangements will need to be revisited to ensure compliance.