The Central Bank of Ireland is set to remove the requirement that certain administration services for Irish funds must be carried out in Ireland, but proposes to use this as an opportunity to introduce a new and extensive range of rules relating to the use of external providers to carry out fund administration activities.
Background
The minimum activities rules that have applied to Irish funds (both UCITS and non-UCITS) since 1995 require that key fund administration functions are carried out by the fund's administrator in Ireland. The Central Bank has, until now, considered this necessary to effectively supervise these functions. However, the pending introduction of EU cross-jurisdictional servicing capability (through the management company passport under UCITS IV) has compelled the Central Bank to reconsider this position. In addition, having dealt with many industry requests in this area, the Central Bank is cognisant of the fact that technology has advanced significantly in this area in recent years. The technical means are now available to effectively outsource fund administration services on an international scope, while retaining supervision and control.
Minimum Activities Rules Out, Outsourcing Rules In
The Central Bank's consultation paper (CP48) refers in its title to minimum activities and contains the proposal to remove the minimum activities rules which currently require that certain key fund administration activities are carried out in Ireland. A more significant element of the consultation paper however is the proposal to introduce outsourcing requirements for fund administrators (the "Outsourcing Requirements").
While the link seems quite tenuous, the Central Bank considers that the removal of the minimum activities rules and the introduction of the Outsourcing Requirements are connected by the need to ensure that the Central Bank can effectively supervise the functions of the fund administration firms. Firms that carry out non-Irish fund business only may query this logic as they were not caught by the minimum activities rules but will be subject to the new outsourcing regime.
Draft Outsourcing Requirements – Overview
The key areas covered by the Outsourcing Requirements are summarised below and considered in more detail in the table.
- Scope - The Outsourcing Requirements are very broad in scope covering Irish and non-Irish funds and making no provision for non-material services to be exempt.
- Operational - A range of operational measures be put in place where outsourcing is proposed.
- Documents - A range of documents will need to be prepared and maintained.
- Outsource Provider - Requirements will apply to outsource providers engaged.
- Central Bank's Role - There will be an initial authorisation procedure and an ongoing supervisory role.
- Client Disclosure - Outsourcing arrangements
must be disclosed to new and existing clients.
|
Area |
Summary |
Analysis |
|
Scope |
Covers all fund administration firms (including non-Irish funds business) |
The Outsourcing Requirements relate to outsourcing of services provided to funds by Irish authorised fund administration firms. They therefore apply to all funds administered so include UCITS and Irish authorised non-UCITS but also, importantly, cover administration of non-Irish funds. |
|
Scope |
Non-material services not exempt |
The Outsourcing Requirements cover outsourcing of any part of the administration services carried out for funds. There is no provision for non-material services to be exempt from the scope of the rules, nor do they account for once-off or short-term arrangements specifically. |
|
Scope |
Intra-group arrangements |
Intra-group outsourcing arrangements are also captured by the Outsourcing Requirements. The Central Bank may take into account specific circumstances (such as group controls) when considering these arrangements. |
|
Operational |
Regulatory responsibility to be retained |
The fund administration firm must retain regulatory responsibility for outsourced services. |
|
Operational |
Core management Functions |
Senior management must retain core management functions. These include risk strategy, risk policy and risk-bearing capacity. |
|
Operational |
Core administration functions |
Final net asset value determination and the maintenance of shareholder register may not be outsourced. If a NAV is released by an outsource provider, the fund administration firm must verify the next day. |
|
Operational |
Core competence must be retained |
The fund administration firm must retain adequate resources at senior operational level to ensure it can resume the performance of the outsourced functions in exceptional circumstances. |
|
Operational |
Senior management oversight |
Senior management must take necessary measures to ensure outsourced services meet necessary performance and quality standards, including:
|
|
Documents |
Outsource policy Procedures |
Fund administration firms that operate outsourcing will be required to draw up a detailed document on outsourcing policy and procedures addressing matters including:
|
|
Documents |
Service level agreement (SLA) |
A detailed, legally binding SLA must be entered into in respect of every outsourcing arrangement. The Central Bank sets out specific elements to be covered in such an SLA. The scope of services and responsibility of each party must be clearly outlined. There must be clear termination provisions including a provision to terminate at the instance of the Central Bank. The SLA must contain confidentiality provisions. It must provide for the fund administration firm, its auditors and the Central Bank to gain direct access to the outsource provider's data and premises. |
|
Documents |
Internal audit and compliance report |
The fund administration firm's internal auditors must examine and report on outsourcing arrangements within the first twelve months and a copy of their report must be sent to the Central Bank. The fund administration firm's compliance department must also prepare a first year report and file it with the Central Bank. |
|
Documents |
Compliance confirmation statement |
A written confirmation of compliance with the Outsourcing Requirements from senior management (compliance confirmation statement) must be submitted to the Central Bank as part of an outsourcing advance notification submission (referred to in more detail below). |
|
Outsource Provider |
Appropriate party |
The outsource provider must be appropriately regulated to carry out the services. The outsource provider must also have the ability and capacity to perform the services reliably and professionally. |
|
Outsource Provider |
Material changes |
Material developments that may affect the outsource provider's service must be notified by the fund administration firm to the Central Bank. |
|
Outsource provider |
Access |
The fund administration firm must ensure it, its auditors and the Central Bank are all entitled to gain direct access to the outsource provider's data and premises. |
|
Central Bank role |
Advance notification submission |
Advance notification of any proposed outsourcing must be made to the Central Bank. It should be noted the draft Requirements do not make any concession for non-critical services or once-off or short-term arrangements as opposed to long-term arrangements. Such advance notification must be supported by the compliance confirmation statement. It is not specifically stated in the Outsourcing Requirements that the outsourcing policy procedures, referred to above, or relevant SLA must be submitted. The Central Bank will approve an outsourcing application within one month, unless it requests further information regarding the proposal. Any permission to carry out outsourcing activity may be granted subject to specific conditions (in addition to the Outsourcing Requirements) as the Central Bank considers appropriate. |
|
Central Bank role |
Ongoing |
Material developments that may affect the outsource provider's service must be notified by the fund administration firm to the Central Bank. |
|
Central Bank role |
Ongoing |
The first year internal audit report and first year compliance report (referred to above) must each be submitted to the Central Bank. |
|
Client Disclosure |
New and existing client requirements |
Fund administration firms must disclose outsourcing arrangements to affected clients and disclosure of such arrangements must be made to new clients in advance of formal engagement. The absence of a carve-out for non-material services outsourcing presumably means existing outsourcing arrangements that may not currently be disclosed to clients as a matter of course will be affected and subject to this disclosure requirement. This could be very commercially sensitive. |
Outsourcing Rules – In Context
The draft outsourcing rules are based on the 2006 Guidelines on Outsourcing issued by the Committee of European Banking Supervisors (CEBS). The CEBS Guidelines were designed for EU authorised banks/credit institutions based on supervisory requirements relative to banks and market practices in that area. The purpose of the CEBS Guidelines was to produce a best practice guide to outsourcing in order to produce a consistent and appropriate standard at EU level. The CEBS Guidelines focussed on material obligations that impacted on regulatory obligations of banks.
The Outsourcing Requirements are rules based. No elements are included on a guidance only basis. It is arguable that a set of industry guidelines to be adopted as a matter of best practice would be more appropriate in this area. This is particularly the case given that there is no specific requirement within the Investment Intermediaries Act (IIA) to regulate outsourcing procedures in this manner (as is the case for MiFID firms) and given the fact that the regime has operated for fifteen years without such a prescribed regime. (The Central Bank relies on the authority granted to it under section 14 of the IIA to impose conditions or requirements on authorised firms as it sees fit to ensure proper and orderly regulation and supervision of their business.)
The Outsourcing Requirements make no accommodation for the outsourcing of nonmaterial services. Some accommodation for the outsourcing of non-material functions would seem sensible. It is also doubtful whether an advance notification and a one month timeline for regulatory clearance is practicable for once-off or short-term outsourcing arrangements.
Consultation Process
CP48 is open to responses from interested industry participants. Responses on the proposals (and the specific questions set out within CP48) are invited to be received up to 31 December, 2010 with finalised measures proposed to be introduced in the first quarter of 2011.
Consultation responses may be made directly to the Central Bank. If you wish to discuss the CP48 measures further in advance of making such a response, please refer to the contacts below.
Conclusion
The Outsourcing Requirements, once finalised and in effect, will have a significant impact on the Irish fund administration industry, particularly given that they apply to the administration of non-Irish funds as well as Irish funds.
The Outsourcing Requirements are not framed as an industry code or best practice set of guidelines but a range of regulatory rules that must be complied with. The impact of this new prescriptive regulatory regime should not be underestimated. It will be interesting to see if there is any concerted resistance to the introduction of these rules given their potential impact on the operations of the fund administration firms that outsource services.
Some of the requirements are sensible and useful. However, some are arguably too far-reaching and represent an unjustifiably large operational and administrative burden in an industry already deluged by regulation.
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