Our Insights

Safeguarding operational integrity through robust oversight

Management and monitoring of outsourcing arrangements is key

As asset managers pursue cost efficiencies and scalability, they are increasingly outsourcing operational processes to third parties such as fund administrators and technology companies. Ben Pumfrett, Head of Product and Profitability, Middle Office, at RBC Investor & Treasury Services (RBC I&TS) recently moderated an engaging panel discussion with prominent institutional asset managers, who shared their unique insights on how best to monitor outsourced providers.

Key insights

  • Regulators continue to reiterate the importance of robust service provider oversight
  • Technology is playing a growing role in helping managers monitor their service providers in areas such as NAV oversight, thereby mitigating risk
  • Advances in technology are encouraging vendors to develop more innovative products for their clients
  • Inadequate monitoring of third-party vendors could make it more challenging for asset managers to win investor mandates
  • Maintaining in-house experience and knowledge is vital when overseeing outsourcing arrangements, which can be achieved through regular staff training

Regulators demand proper oversight of outsourced providers

In the UK, for example, regulators have made it abundantly clear that asset managers need to have proper oversight arrangements in place to monitor external providers. The UK Financial Conduct Authority (FCA) has spent years warning asset managers about oversight deficiencies in regards to outsourcing.1 A missive issued by the FCA to fund managers in 2020, informed them that “inadequate governance and oversight, risk management and clear contractual arrangements with third-party outsourcers raises operational resilience risks to your firm and customers.”2 This FCA letter, which was drafted pre-COVID-19, also reminded managers that accountability for outsourced functions resided squarely at their firms and among senior prescribed employees as mandated under the Senior Managers & Certification Regime.Furthermore, in December 2019, the FCA published a consultation paper on new requirements to strengthen operational resilience in the financial services sector.4    

Global regulators have also stepped up their scrutiny of outsourcing practices. The Financial Stability Board produced a consultation analyzing potential systemic risks that could emerge as a result of the financial services industry's reliance on third party providers, while the International Organization of Securities Commissions has also published its own guidance on outsourcing.

Asset managers embrace oversight responsibilities

Maintaining oversight
of providers can have
a direct influence
on helping fund
managers win

Asset managers have largely embraced regulators' comments and guidance, and recognize the value in establishing efficient oversight protocols that can help minimize reputational risk. For example, if a fund manager were to incur a financial loss resulting from a service provider incident, it could lead to potential client withdrawals. End investors are also conducting thorough operational due diligence on prospective fund managers and scrutinizing their service provider oversight arrangements. Should issues be flagged, allocators may choose to invest elsewhere. Maintaining oversight of providers can have a direct influence on helping fund managers win mandates.

“We outsource to three separate providers and we adopt a consistent approach when overseeing them all. This takes into account what the FCA has said in its various 'Dear CEO letters' together with the principles outlined in the Investment Association's (IA) Outsourcing Working Group (OWG),” said Stephen Lowe, Head of Outsource Operations at Royal London Asset Management (RLAM).

Lowe explained that RLAM has a well-defined governance framework whereby dedicated teams – which report into members of the Executive – monitor outsourced providers and verify they are meeting all of their performance KPIs and that risks are being managed appropriately. “We adopt a policy of KYO (Know-Your-Outsourcer), in that we keep a check on all of the changes happening at our external providers," he added.

It is vital that
in-house staff
continue to build
their knowledge
base through 
regular training

If operational risks are to be effectively managed – both internally and externally – then it is vital that in-house staff continue to build their knowledge base through regular training. “We spend a lot of our time upskilling our teams in areas such as risk management so that they become a value add rather than just an operational processing unit,” said Fiona Coughlan, Head of Operations, Comgest Asset Management International Limited. Others concurred, including Dinesh Pindoria, Head, Middle Office, Vontobel Asset Management, who said staff at his firm are often moved into different roles to broaden their understanding about the business. “One of the biggest challenges we face is the volume of information we receive from our providers,” continued Pindoria. In order to mitigate this problem, firms need to ensure that their employees have the knowledge and understanding to identify the relevant pieces of information to prevent any data overload.

Leveraging technology in the oversight process

Technology plays an integral role in facilitating third-party oversight, in particular the use of tools that can readily filter and flag exceptions for review and remediation. “It's important for asset managers to establish a risk-based approach that is repeatable and can navigate the vast amount of data available,” noted Pumfrett. “Sophisticated exception-based management facilitates operational efficiency,” he added.

Technology plays an integral role in facilitating third-party oversight

Lowe said RLAM is reviewing the usage of a net asset value (NAV) oversight tool, effectively monitoring the work of the company's administrator on a near real-time basis. NAV oversight, while not a new activity, is gaining more interest and higher levels of adoption among firms as service providers use technology to provide solutions to clients. During the RBC I&TS discussion, 50 percent of respondents to an audience poll said NAV oversight was an area of focus. In addition, 38 percent of respondents said they leveraged tools provided by their custodians and asset servicers to perform oversight, while 12 percent said they would develop tools in-house or partner with a technology vendor.

By using technology intelligently, asset managers can oversee their outsourced partners more efficiently. Longer-term, this could have an impact for service providers and encourage development of further digital solutions. “Service providers recognize that automation is taking away some of their historic value-add in areas such as striking NAVs. In response, we are seeing more providers develop their own USPs (unique selling propositions). For instance, providers are starting to offer clients advisory services rather than simply acting on instructions,” said Coughlan.

Regulatory pressures – in addition to the pandemic – are driving asset managers to monitor external providers more diligently. Demonstrating enhanced vendor oversight can help minimize risk and potentially attract investment mandates.

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