On December 11, the UK Financial Services Authority (FSA) published a “Dear CEO” letter which had been sent to the CEO’s of regulated asset managers outlining its concerns about asset managers’ outsourcing arrangements.

The FSA stated that as a result of discussions with asset managers it had identified that the asset management industry outsources a growing number of activities, and that the small number of outsource providers are usually part of complex international banking groups. Accordingly, the outsource providers generally have balance sheet exposure, at group level, to activities other than the provision of outsourcing activities. The FSA is concerned that if an outsource provider were to face financial distress or severe operational disruption, UK asset managers would not be able to perform critical and important regulated activities and that customers of the asset managers would be disadvantaged.

The FSA sets out concerns about the effectiveness of firms’ recovery and resolution plans, and highlights the following issues:

• Reliance on an outsource service provider being a large financial institution that regulators might look to rescue using public funds is inconsistent with the FSA’s policy of allowing such organizations to fail. The FSA states that “this approach lacks prudence and is inconsistent with the FSA’s policy of allowing such organizations to fail.”
• Bringing outsourced activities back in-house would take many months and firms would not immediately have the capacity and expertise required.
• The operational challenges arising from transferring outsourced activities to another provider are substantial. The FSA believes that there are considerable operational challenges involved and it is likely that a transfer could not be implemented swiftly enough to protect customers. It may also not be a realistic option due to concentration risk in the supply of certain activities.
• The FSA believes that “step in” rights in a stressed scenario might prove difficult to enforce, and there could be undue delay and/or operational risks arising which would be to the detriment of customers.

The FSA considers that it is the responsibility of firms’ boards of directors to consider the implications of outsourcing to external parties, and to ensure that they have in place an adequate resilience plan enabling the firm to carry out regulated activity if a service provider fails. It requests CEOs to review their firm’s’ contingency plans, taking into account the FSA’s observations in the letter and firms’ obligations under chapter 8 of the FSA’s SYSC (Systems & Controls) sourcebook.

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