There are few FSA rules governing outsourcing and arrangements with third parties. But those that do exist relate to high-level standards and to be in breach would be viewed as indicative of serious compliance shortcomings within a firm. Instead, FSA have issued a plethora of guidance (which firms ignore at their peril). This guidance is indicative of the FSA attaching greater importance to these arrangements and the reliance that firm’s place on them. FSA expect firms to apply guidance in a way that is proportionate to the size and complexity of their business and the materiality of the relationship.
FSA refuse to be drawn on what constitutes ‘material’ – it is for the firm’s senior management to decide. Whilst it may be acceptable to kick the tyres of one third party, another will warrant a detailed inspection. Although contractual arrangements are important, pre-contractual due diligence is of equal importance.
FSA expect to see clear evidence of adequate pre-contractual due diligence having been carried out prior to a firm entering into an agreement with an insurer or other third party. Neither intra-group agreements or agreements with other FSA authorised firms are exempted (although firms can take some comfort from the product manufacturer or service provider being an FSA authorised firm).
For example, in relation to an insurance intermediary’s selection of an insurer, there is very little guidance from FSA. However, it is reasonable to assume that the FSA would expect an authorised firm to have research methodologies and processes similar to those for selecting outsource partners and other third parties. In fact, the selection process is likely to be broadly similar to that a national independent financial adviser (IFA) would use to select a panel member. Here, FSA state, ‘So long as the panel [member] is selected against definite criteria which are applied equally, and [is] reviewed regularly (and whenever significant market changes require it) we consider the practice acceptable.’ Benchmark criteria might include:
Typically the process might begin with the issue of an invitation to tender (ITT) type document arranged in such a way as to collect sufficient information to enable an initial filter of potential product manufacturers to be carried out. Remaining candidates would be considered more carefully, gaining a deeper understanding of their culture, people, procedures, systems and controls (e.g. capacity planning, business continuity etc.). FSA would expect to see documented rationale supporting the selection of the product manufacturer. Depending on the size and complexity of a firm, and the reliance placed on insurers, outsourcers and other third parties, they would also expect to see the entire process (including objective defined criteria, research methodologies and procedures relating to the ongoing maintenance of the relationships) to be well defined and clearly and fully documented from end-to-end.
Ideally, fee negotiations should be carried out at arm’s length from operational due diligence to avoid this particular factor unduly influencing the outcome. Frequent changes of insurer, outsource partner of other third parties may cast doubt on the original due diligence.
In their paper ‘The firm risk assessment framework’, FSA set out the risks arising from the use of outsourcing or third party providers. These include the reliance on, and the controls over, the third party or outsourcer.
To find out more about outsourcing and arrangements with other third parties, contact us.
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