Outsourced But Not Out of Mind

Over the past decade, financial firms have grown accustomed to outsourcing a wide range of operational functions. Since the financial crisis, this situation has become a cause for concern among regulators, who want to ensure that if an external service provider experiences financial or operational difficulties, financial firms can continue operating and end-investors do not suffer losses.

The UK's Financial Conduct Authority (FCA) is one of the supervisory bodies taking steps to ensure firms effectively manage the risk associated with outsourcing. At the end of last year, the FCA's predecessor (the Financial Services Authority) highlighted its concerns in a letter to the CEOs of asset managers.

The asset management industry has been quick to respond, particularly through the formation of the Outsourcing Working Group, which comprises asset managers, service providers and the Investment Management Association and which this month published a series of principles to help asset managers address the FCA's concerns.

The FCA has praised the industry for its level of engagement, but its recently published review of the use of outsourcing by asset managers highlights a number of areas of concern, including the management of pricing and valuations, and corporate actions.

The FCA's report says research it undertook last year found that mainstream asset managers usually outsource the daily valuation of funds and, due to time constraints, do not carry out detailed checks on all valuations before they are published. Instead, they run overnight checks on valuations.

Overall, the report says there is "considerable variation" in the extent of valuation checking and testing of potential pricing anomalies. At the high-risk end of the scale, it gives the example of an asset manager that applied price investigation triggers on equities and bond movements away from the chosen pricing data sources of 10% and 3% respectively.

The report also highlights differences in the size and expertise of the internal teams retained to carry out pricing checks. "It is not acceptable for firms to fail to retain the necessary in-house valuation expertise post outsourcing," notes the report.

When it comes to the management of corporate actions, the FCA discovered a variety of different oversight practices. It says the processes used for voluntary corporate actions are more vulnerable to mistakes because they require a degree of manual processing. As a result, the report says it is particularly important that controls and oversight are in place for these practices.

The UK's asset management industry has responded well to regulators' concerns. However, tightening controls around outsourcing is a big project that is likely to remain a major theme at financial firms of every type over the years to come.