Securities and Exchange Board of India (SEBI) has released a circular on ‘Guidelines on outsourcing of activities by intermediaries’. In the document, it has defined outsourcing as ‘the use of one or more than one third party - either within or outside the group - by a registered intermediary to perform the activities associated with services which the intermediary offers.’
The regulator had highlighted various risks associated with the outsourcing of activities, viz, operational risk, reputational risk, legal risk, country risk, strategic risk, exit-strategy risk, counter party risk, concentration and systemic risk. Present regulations require intermediaries to render high standards of service and exercise due diligence and ensure proper care in their operations, and under this light, SEBI had issued a concept paper on outsourcing. Now, post discussions with various intermediaries, it has issued principles for the same.
The paper clearly states that intermediaries cannot outsource their core business activities and compliance functions like investment related activities in case of Mutual Funds and Portfolio Managers. Intermediaries have been asked to form a comprehensive policy which will cover those activities that can be outsourced, the authorities who can approve outsourcing of such activities and the selection of third party to whom it can be outsourced.
SEBI has emphasized on a comprehensive risk management process for outsourced activities and the relationship with the third party. Intermediaries will have to put systems in place to have an arm’s length distance between the intermediary and the third party in terms of infrastructure, manpower, decision-making, record keeping, among others, for avoiding potential conflict of interests.
The intermediary will be required to review the financial and operational capabilities of the third party in order to assess its ability to continue meeting its obligations. Importantly, the regulator has made the intermediary fully liable and accountable for the activities that are being outsourced, for the loss incurred by them due to the failure of the third party and for redressal of the investor grievances arising out of activities rendered by the third party.
Outsourcing relationships will have to be governed by ‘written contracts/ agreements/ terms and conditions that clearly describe the rights, responsibilities and expectations of the parties under contract, client confidentiality issues, termination procedures, among other material aspects of the arrangement.
The full document, which discusses all pertinent issues in detail, is available on the regulator’s website.