Outsourcing by Intermediaries

In a recent and much welcome move, SEBI has formulated Guidelines for the Outsourcing of activities by the Intermediaries ["Guidelines" hereinafter]. In light of the fact that intermediaries were outsourcing their activities for cost efficiency, SEBI deemed it necessary to regulate the outsourcing of these activities, and hence Guidelines on Outsourcing of Activities by Intermediaries have been issued by SEBI on December 15, 2011. This was based almost entirely on the Discussion Paper on Outsourcing of Activities related to Intermediary Services. A copy of the DIscussion Paper can be found here.
These Guidelines are mandatory and have to be complied with by all intermediaries.

The Circular obligates the intermediaries to report to the Financial Intelligence Unit of any suspicious transactions/ reports in respect of activities carried out by third parties; and also to conduct a self-assessment of their outsourcing arrangements at a time not exceeding 6 months from the date of the issue of the Circular.

Under the Guidelines, the intermediary seeking to outsource activities needs to prepare a comprehensive policy in this regard covering activities or the nature of activities that can be outsourced, the authorities who can approve the outsourcing of such permitted activities and the selection of the third party to whom the activity is to be outsourced. Further, Core Business Functions and Compliance functions cannot not be outsourced strictly. The intermediary shall also have a outsourcing risk management programme which shall, among other things, cover the impact of a failure of the third party to carry out its operations, and the ability of the intermediary to perform the functions in the event of such failure.
There is no prohibition on the outsourcing of activities to related parties, as long as they are able to maintain an arm's length distance.

An important point to be noted is that the Guidelines lay down that the intermediary shall continue to be liable for the services, and the rights of the customer shall not be affected in any manner whatsoever. 
The outsourcing relationship shall be governed by a written contract, which shall include the liability of the third party to the intermediary for unsatisfactory performance or breach of contract. 
Confidentiality of information is given importance, and the third party must also have checks and balances to ensure the confidentiality of the same.