On the other hand, the market and regulators are broadening their focus from solely shareholder returns to considering stakeholders’ interests, managing risks, and implementing good practices. This is evident with FCA’s 2024 revision of the Corporate Governance Code which in particular makes clear the board’s accountability for effective internal controls1.
Based on a survey of 200 asset management industry leaders performed by BNY Mellon in 2024, 53% of asset managers engage in outsourcing various functions, with a notable inclination towards expanding these efforts2. The recent data indicates there is a robust trend towards heightened reliance on outsourcing as firms strive for enhanced efficiency and specialised expertise in an increasingly competitive landscape.
While the reliance on service organisations is increasing, we have yet to see tangible improvements in the quality of outsourcing governance. This is highlighted from a very recent incident that came to media attention in April 2024 when a prominent fund manager received a warning notice from the financial regulatory authority following the collapse of their flagship fund strategies nearly five years ago. The authority criticised the fund administration company for failing to manage the fund with due diligence, particularly regarding liquidity risks, and also pointed out the manager’s inadequate understanding of their responsibilities in this area. The fund manager plans to challenge these findings, asserting that the criticisms primarily relate to the administration company’s responsibilities. This situation highlights the complexities and accountability issues involved in fund administration outsourcing.
As highlighted by the above real-life incident, from a governance standpoint, it is essential to recognise and address three critical risks that can significantly impact the effectiveness of outsourcing arrangements. These risks encompass the following:
In order to identify and appoint service providers which can meet the operational needs as well as contribute to long-term success of your organisation, it is crucial to perform thorough due diligence and evaluation of potential service providers. Moreover, it is essential not only to select the appropriate service providers but also to engage in ongoing evaluations to determine their continued relevance. This process should include a thorough assessment to decide whether to retain or replace the service provider as circumstances evolve. According to FCA guidance, asset managers must ensure that their service providers can deliver quality services without compromising customer interests3. When identifying relevant service providers in the asset management industry, key factors to consider include their expertise, financial stability, technological capabilities, and compliance with regulatory standards. Additionally, evaluating their risk management practices, client support, and cultural fit is essential for establishing a successful and collaborative partnership. To offer practical solutions for readers of this article, we have curated a detailed checklist of essential factors to consider when selecting service providers in the asset management industry. Download this infographic checklist by clicking the link below.
Once suitable providers are identified, it is vital to articulate precise performance metrics and service level agreements (SLAs). The FCA’s operational resilience framework stresses the need for clear communication regarding responsibilities and deliverables to minimize misunderstandings and ensure accountability4.
Outsourcing can falter significantly when clear expectations are not established. For instance, the introduction of third-party managers may result in a disconnect between management principles and portfolio of investments selected. In recent years, there has been considerable backlash as investors have uncovered that their funds are allocated to companies whose practices starkly contrast with the environmental, social, and governance (ESG) principles to which they profess commitment. Clearly articulated contractual provisions and Key Performance Indicators (KPIs) would go a long way to mitigate such misunderstandings and ensure that third parties remain aligned with the expectations of the management.
Assigning the management of outsourcing risk to an accountable person, such as a board member or senior executive, is also advised. Furthermore, an example of good practice is reviewing and updating the SLA with service providers on an annual basis, to cope with the changes in the business needs and regulatory environment.
Effective governance requires ongoing oversight of the outsourced functions. The high stakes are evident when we revisit that a major financial institution faced a $440 million trading loss in 2012 due to inadequate oversight of its outsourced trading operations, which resulted in significant lapses in risk management. This incident highlighted the critical need for robust monitoring and risk assessment practices when engaging outsourcing in asset management.
The FCA and the Prudential Regulation Authority (PRA) have specified the necessity for firms to maintain robust risk management systems to monitor provider performance and compliance continuously. This is particularly relevant under the new regulations concerning CTPs, which mandate that firms ensure their critical service providers operate in a resilient manner to mitigate systemic risks5.
To effectively implement continuous monitoring and risk management for outsourced functions in the asset management industry, organisations should establish a robust governance framework that clearly defines roles and responsibilities. Regular risk assessments and dynamic risk profiling are essential to adapt to changing conditions. Utilising key performance indicators (KPIs) and automated monitoring tools can provide real-time insights into vendor performance, while ongoing due diligence ensures compliance with contractual obligations and regulatory requirements. Maintaining open communication with vendors and providing training for internal teams further enhances oversight. The FCA also highlighted a good practice example where a firm could take “a leading role in the oversight of the service provider by carrying out extensive, in-depth on-site visits and reviews at the service provider and produced detailed six-monthly reports.3”
The realm of outsourcing in asset management is experiencing a remarkable surge, with over half of asset managers now embracing diverse outsourced functions to drive efficiency and tap into specialised expertise. To navigate this complex landscape successfully, firms must proactively address critical risks by meticulously selecting service providers, articulating clear performance expectations, and instituting a culture of continuous monitoring and risk management.
Effective governance hinges on thorough due diligence in identifying capable service providers, ensuring they align with organisational values and regulatory standards. Clear communication of performance metrics and service level agreements (SLAs) is vital to prevent misunderstandings and foster accountability. Moreover, ongoing oversight—bolstered by regular risk assessments and advanced monitoring tools—ensures that outsourced functions not only comply with evolving regulations but also contribute meaningfully to your organisation’s strategic objectives.
If you have any questions or simply want to discuss this topic in more detail then please contact us and a member of our asset management team will be in touch.
The asset management industry is responding to an exponential amount of change, ranging from changes in a complex regulatory environment, advances in digital capabilities, and economic, societal and governance (ESG) developments. Against this backdrop, asset managers are seeking solutions that can help them thrive and remain competitive in a dynamic market.
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