The Financial Stability Board (FSB) has kicked off a consultation on regulatory and supervisory issues related to the outsourcing of different functions, particularly technology, in financial services.
The Switzerland-headquartered FSB, which monitors and makes recommendations about the global financial system, has called for feedback on a discussion paper in which it highlights concern about the possibility of systemic risk arising from ‘concentration’ in the provision of some outsourced and third-party services to financial institutions.
Financial institutions have relied on outsourcing and other third-party relationships for decades but, in recent years, the ‘extent and nature’ of interactions with third parties has ‘evolved’, particularly in the area of technology, the FSB says.
The financial sector’s response to Covid-19 highlights the benefits as well as the challenges of managing the risks of financial institutions’ interactions with third parties, the FSB notes, adding that the pandemic may have ‘accelerated the trend’ towards greater reliance on certain third-party technologies.
Financial services is typical of how many industries have adapted during the pandemic, with a greater emphasis on remote working and increased reliance on digital services – all the time increasing the use of technology.
‘Major outage’ could have major impact
The 33-page consultation paper, ‘Regulatory and Supervisory Issues Relating to Outsourcing and Third-Party Relationships’, follows a 30-page report entitled ‘Third-Party Dependencies in Cloud Services’, as well as an FSB member survey.
The earlier report, published in December 2019, flagged the ‘small number’ of globally dominant players providing cloud services – the use of a network of remote servers hosted on the internet to store, manage and process data, rather than a ‘local’ server. ‘Cloud’ has continued to grow in popularity with Google and Amazon Web Services (AWS) among the big companies that have large banks using their cloud infrastructure.
In its new paper, the FSB is looking more broadly, albeit that cloud is an important part of the picture.
‘Where there is no appropriate mitigant in place, a major disruption, outage or failure at one of these third parties could create a single point of failure with potential adverse consequences for financial stability and/or the safety and soundness of multiple financial institutions,’ the FSB warns. ‘Given the cross-border nature of this dependency, supervisory authorities and third parties could particularly benefit from enhanced dialogue on this issue’.
Four questions for respondents to tackle
In its paper the FSB is careful to point out that link-ups between financial institutions and third parties can have ‘undeniable’ benefits for financial institutions, including the ability to improve their resilience (and reduce some risks), innovate and reduce costs. But, it emphasises that, at the same time, they can also amplify or transform other risks and possibly create new ones, if managed ineffectively.
Respondents to the consultation, which closes on 8 January 2021, are asked to tackle four questions relating to outsourcing and third-party relationships.
Those questions are: what respondents consider the key challenges in identifying, managing and mitigating the risks of outsourcing; how best to address them; how to identify ways in which financial institutions, third-party service providers and supervisory authorities could collaborate to address challenges on a cross-border basis; and what lessons have been learned from the pandemic.
From 31 December 2021, European Union (EU) banks will be expected to maintain a register of all their outsourcing arrangements on the European Banking Authority’s Outsourcing Register, the FSB points out. EU banks are already expected to maintain a register of all their cloud outsourcing arrangements and make it (or parts thereof) available to supervisory authorities upon request.
The FSB brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. Its secretariat is hosted by the Bank for International Settlements (BIS) in the city of Basel.