Investment firms need to review their outsourcing arrangements in order to ensure compliance with the new regulatory regime which takes effect next year. This article considers the background to the new regime and outlines some of the steps which firms may consider in order to achieve compliance.

When MiFID is implemented next year, it will entail a new regime for investment firms, including retail banks and investment banks. Outsourcing is one of the areas on which the directive focuses and any investment firm involved in this activity must be ‘au fait’ with the new requirements if it is to remain compliant.

MiFID, otherwise known as the Markets in Financial Instruments Directive 2004/39/EC, is a key element of the European Union’s Financial Services Action Plan. By creating a level playing field, the Directive’s aim is to increase competition as well as consumer protection.

MiFID’s high-level regulations are fleshed out by Level 2 measures ("L2M"). These set out the technical steps to be adopted by Member States in order to implement the directive.

MiFID And Outsourcing

Outsourcing falls within the remit of MiFID. Article 13(5) of the Directive focuses on the outsourcing of "critical operational functions" which are defined by L2M as defects or failures that "would materially impair the continuing compliance of an investment firm with the conditions and obligations of its authorisation, or its financial performance, or the soundness or the continuity of its investment services and activities." Such outsourcing "may not be undertaken in such a way as to impair materially the quality of its internal control" or monitoring of its compliance by the FSA.

Any investment firm outsourcing critical operational functions, must take "reasonable steps to avoid undue additional operational risk". "Reasonable steps" are expressed by L2M as 11 conditions with which the firm must comply.

MiFID And The FSA

The FSA is proposing a new regime for "common platform" firms. Basically, this provides a single standard for firms subject either to MiFID, or to the Capital Requirements Directive, or both. Common platform outsourcing requirements will constitute SYSC Chapter 8 and will apply to existing, as well as new, outsourcing arrangements.

Common platform proposals extend the MiFID requirements for critical operational functions to all of a firm’s "material outsourcing" with regard to:

  • regulated activities whether MiFID business or not;

  • listed activities under the Banking Consolidation Directive (e.g. lending activities); and

  • ancillary services under MiFID (e.g. the provision of investment research).

Apart from rules for material outsourcing, the FSA also provides guidance for nonmaterial outsourcing. In this case, "a firm should take the material outsourcing rules into account, as appropriate and proportionate."

While common platform firms may opt to comply with the new FSA regulations from January 2007, compliance will be mandatory from 1 November 2007.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.