THE UH OH MOMENT. Financial Services Enterprises Focus on Governance, Transparency and Supply Chain Risk

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1 THE UH OH MOMENT Financial Services Enterprises Focus on Governance, Transparency and Supply Chain Risk By Lois Coatney, Chuck Walker and Joseph Yacura, ISG Directors

2 INTRODUCTION A top priority for financial services enterprises today is assessing, monitoring and mitigating operational risk. This emphasis largely reflects growing general concerns about natural disasters, political instability, economic uncertainty and a changing supplier landscape. In addition, having outsourced significant portions of core functions, organizations are increasingly dependent on third parties for critical operations, and are therefore potentially vulnerable to disruptions at any point along the service delivery chain. Coupled with this heightened sense of exposure, regulators are subjecting financial services businesses to more intense scrutiny, partly in response to new legislative and regulatory requirements, but also as a result of more rigorous adherence to existing rules and standards. To address these challenges, firms are focusing on improving governance and risk management mechanisms to enhance accountability and ensure oversight of operations and processes throughout the supply chain. It s a tall order, as many enterprises lack even rudimentary tools and capabilities to monitor supply chain risks. This ISG white paper examines the emerging regulatory environment in the financial services sector, challenges facing many organizations and their causes and characteristics, and keys to implementing effective governance and supply chain risk programs. THE UH OH MOMENT LOIS COATNEY, CHUCK WALKER & JOSEPH YACURA 1

3 GLOBAL SERVICE DELIVERY Outsourcing, offshoring and multisourcing are integral to the global operational models of financial services organizations. According to ISG data, in 2011 the financial services sector accounted for 35 percent of the total value of outsourcing contracts, and generated 29 percent of the outsourcing industry s revenue. In recent years, moreover, ISG research shows a clear trend of decreasing contract sizes, while total contract value has remained relatively constant. Put simply, the critical operations and sensitive data of today s financial services organizations are increasingly managed by a growing number of third parties, often including layers upon layers of sub-contractors (often termed first-, second-, third-, etc., tier suppliers). Involving multiple external suppliers in the delivery chain poses the obvious potential risk of the weakest link. More specifically, multisourcing can make it difficult to define end-to-end service accountability and process owners, as well as open the door for finger-pointing when something goes wrong. Global delivery service models increasingly deploy both third-party vendors and captive service centers in India, China, Eastern Europe and Latin America. Concentrating suppliers in any one region exposes businesses to risk from natural disasters or political upheaval. While dispersing providers geographically diffuses such risk, it also expands the range of potential fail points in service delivery. In addition to being increasingly complex, global delivery models are also highly volatile. For one thing, fluctuations in offshore labor rates result in frequent relocations of offshore delivery centers as businesses seek the next low-cost hot spot. Concerns around productivity, access to skilled resources, foreign exchange rate fluctuations, data security, quality and political fall-out, moreover, are causing many clients to rethink their offshore strategy and move operations back onshore. CLOSER SCRUTINY In response to broader economic trends as well as the specific potential threats posed by sourcing trends, regulatory bodies are undertaking a more aggressive approach to evaluating how financial services organizations are managing service delivery. The Dodd-Frank legislation is the most prominent and visible regulatory initiative affecting the industry. Although confusion remains regarding the particular implications of specific rules, and while litigation and lobbying efforts continue, in 2013 the industry will move from a wait-and-see attitude of what the rules will mean to one of taking action to comply. Accordingly, banks are hiring compliance officers and technology experts to enhance their oversight capabilities, and are stepping up efforts to communicate the implications of Dodd-Frank to clients. Regulatory compliance concerns are not confined to Dodd-Frank. ISG has observed more rigorous audits of banks by the Office of the Comptroller of the Currency (OCC). Bulletin of the Consumer Finance Protection Bureau (CFPB) specifically directs banks to ensure that third-party providers who touch customers are compliant with consumer protection laws. Recent audits of insurance firms by the Federal Reserve have focused on transparency of outsourced services, while the Securities and Exchange Commission (SEC) has emphasized the protection of service delivery continuity as more and more providers become involved in the supply chain. The combination of new regulations and legislation, together with a stricter enforcement of existing risk management standards, has significantly raised the bar. Previous levels of compliance are no longer sufficient, as auditors increasingly demand specifics in terms of understanding how services are being monitored (in real time), what processes are being used and how service provider performance is reported over time. THE UH OH MOMENT LOIS COATNEY, CHUCK WALKER & JOSEPH YACURA 2

4 CHARACTERISTICS OF THE PROBLEM In an environment characterized by the increased potential for supplier risk exposure, coupled with more rigorous oversight by regulators, enhanced transparency and improved governance processes and supply chain risk management are becoming more urgent requirements for financial services organizations. Evidence suggests that many financial services organizations today lack adequate governance processes and supply chain risk management tools to effectively assess, evaluate and mitigate risk in their outsourced service delivery chains. One fundamental problem is that many banks and insurers simply don t conduct adequate due diligence. Those that do, moreover, tend to focus on pre-contract due diligence, rather than monitoring contract performance and risk during contract execution and beyond. In many cases, extensive financial and capability analyses are conducted up front to qualify providers and make award decisions. However, with shorter contract terms and one-year options, all the data collected early on has a limited shelf life, so that three to six months into a contract the assessments made and data collected are outdated. Indeed, ISG has observed many financial services organizations where extensive documentation exists but has little application to reality and provides no decision-making support. A front-loaded approach to governance also frequently results in a lack of available resources for ongoing oversight. In other words, the business not only lacks access to real time actionable data and documentation, it lacks the bandwidth and expertise needed to interpret the data in real time and take corrective action. If the governance and supply chain risk management frameworks are inadequate from the outset, they will typically be unable to address the complexity of the service delivery chain specifically, the multiple stakeholders involved, the hand-off points between clients and suppliers, and between suppliers and other suppliers. Without a target operating model in place, outsourcing becomes a tactical rather than a strategic exercise, with different sets of roles and responsibilities for each supplier. The result is a hodgepodge of standards and multiple fractures in the service delivery process. Rather than ensuring coordination between the myriad entities and touch points involved, governance and supply chain risk management efforts are often limited to addressing discrete risks or solving isolated problems. In this fragmented environment, it s impossible to aggregate information across the delivery chain, as individual suppliers focus on collecting their own data, using their own tools and managing their own fixes and changes. As a result, the business struggles to understand the causes and effects of risks at different states of the sourcing lifecycle, to ensure visibility into critical processes, and to assign accountability for problems that occur. THE UH OH MOMENT For many banks and financial institutions, the key problem is that they simply don t know what they don t know. While processes may be in place, and data may be collected, analyses quickly reveal a gap between what the rules are and the ability to verify that the rules are being followed. As a first step in analyzing a governance and supply chain risk management framework and processes, ISG often assesses the data, reports and processes a client uses to make decisions. The review involves detailed questioning around how service providers are managed, what processes are used, and how those processes would be demonstrated during a regulatory audit. In many cases, clients struggle to provide substantive answers, and it quickly becomes apparent that significant gaps exist between the theory of process oversight and the reality of day-to-day management decision-making. This harsh epiphany convinces clients that immediate and urgent action is imperative. The challenge then becomes where to begin. As a first step, ISG recommends an initial risk assessment profile. This profile is a prioritization exercise to identify the areas of both internal and external risk that have the most impact on the business. Subsequently, for each critical area identified, service levels, issue and change management processes, ITIL frameworks and other criteria are assessed to identify specific problems and high-priority corrective actions. THE UH OH MOMENT LOIS COATNEY, CHUCK WALKER & JOSEPH YACURA 3

5 The initial analysis that focuses on critical trouble areas should be followed by a broader collaborative exercise between the client and supplier teams, one designed to facilitate discussion aimed at identifying problem areas and outlining means of monitoring and opportunities for improvement. By bringing all parties to the table, a holistic view of service delivery and the interrelationships along the service delivery chain begin to emerge. Moreover, it becomes possible to calculate the value of specific changes (limiting re-work or catching billing errors, assuring continuity of supply, etc.), define standard roles and responsibilities, and make contractual changes to re-define problematic supplier touch points. STANDARD VS. CUSTOM As the client and service provider teams build a holistic view of service delivery, it s critical to define a standard set of taxonomies, roles and responsibilities, process owners, sources of real time data, etc., for all strategic (first-tier) suppliers and their critical (second-, third-, fourth-, etc., tier) suppliers. This is necessary to address the fractures in service delivery described earlier, and to ensure continuity and visibility into the multiple touch points along the total supply chain. Perhaps most important, standardization is essential to addressing the compliance challenge, as it enhances transparency and the ability to design to expectations. ISG sees an opportunity for service providers to add value to client relationships by proactively pushing for and defining standard processes. In many cases, suppliers bear the burden of defining mandates; while this practice could be seen as accommodating client preferences, in reality it prevents providers from leveraging standard practices across multiple clients if the supplier gives every client a unique set of processes, no single client can benefit from the supplier s economies of scale. While standard processes are essential, clients must at the same time categorize different types of suppliers according to risk. This involves tiering different suppliers based on the level of risk they are exposed to. In other words, suppliers that regularly handle sensitive data will require a high level of scrutiny of oversight, while those that are less exposed will fall into a category requiring fewer resources. In addition to evaluating suppliers individually, clients must understand where different layers of sub-contractors might be exposed to risk, and address those entities in an appropriate manner. By prioritizing the risk exposure posed by different suppliers, clients can assign the necessary resources to monitoring different suppliers as appropriate. Clearly defined categories, based on clearly defined rules and standards, are also important to addressing regulatory inquiries. Over the long term, organizational discipline and commitment of resources is essential to the successful mitigation of supply chain risk. The best intentions of governance and supply chain risk management efforts in early stages of a relationship yield only temporary value if not built into the fabric of the enterprise to assure a sustained focus. THE UH OH MOMENT LOIS COATNEY, CHUCK WALKER & JOSEPH YACURA 4

6 LOOKING FOR A STRATEGIC PARTNER? Your operational excellence is our business. CONTACT US Visit the AccessISG Sourcing Portal for more sourcing information, insight and tools. Click the envelope to contact us or go to Information Services Group (ISG) (NASDAQ: III) is a leading technology insights, market intelligence and advisory services company, serving more than 500 clients around the world to help them achieve operational excellence. ISG supports private and public sector organizations to transform and optimize their operational environments through research, benchmarking, consulting and managed services, with a focus on information technology, business process transformation, program management services and enterprise resource planning. Clients look to ISG for unique insights and innovative solutions for leveraging technology, the deepest data source in the industry, and more than five decades of experience and global leadership in information and advisory services. Based in Stamford, Conn., the company has more than 850 employees and operates in 21 countries. For additional information, visit Copyright 2013 Information Services Group All Rights Reserved

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