As Compliance Outsourcing Increases Offshore, Do Nearshore Providers Stand a Chance?

The trend toward outsourcing compliance spells opportunity for nearshore providers, but experts say that this is a slow process requiring caution on all sides. The challenge is that …

Anupam Jain of Everest Group says banks are reluctant to outsource compliance functions

The trend toward outsourcing compliance spells opportunity for nearshore providers, but experts say that this is a slow process requiring caution on all sides. The challenge is that prudence needs to be exercised as the compliance requirements themselves become more onerous –and apply to businesses of all sizes.

“In general, compliance work largely continues to be done onshore, largely due to legacy reasons, and banks’ reluctance to offshore what is perceived as a ‘core and critical activity’,” says Anupam Jain, who leads Everest Group’s research program focusing on BFSI BPO.  “Having said that, cost pressures in recent years have led to banks offshoring more rules-based components within the compliance spectrum.”

The result, says Jain, is that leading adopters such as Citi, J P Morgan Chase, HSBC, and Deutsche Bank have pushed the envelope in terms of the scale and scope of compliance activities supported from select offshore locations.

“There is evidence that these banks are achieving ten to 12 percent offshore penetration in compliance from India and an additional two to three percentage points from Latin America.” Jain says that the offshore penetration ratio for compliance is much lower than with traditional functions such as ADM and transaction processing. Outside of cost containment, it is domain expertise that determines whether compliance is outsourced to a third party, particularly for smaller companies.

“If Latin America-based outsourcers can develop domain expertise in compliance issues, it will enable them to combine this with their existing unique selling points”

The Small & Big of Compliance

“Outsourcing compliance functions should benefit most companies; however, those that could get most from this strategy are the small ones,” says Luis Gimenez Zapiola, a director at BCS Business Compliance Solutions in Buenos Aires. “Smaller companies can access highly specialized knowledge and expertise that they could probably not afford otherwise.”

Gimenez Zapiola says that providers can transfer economies of scale to small companies and help them to maintain a highly effective compliance program for less than what they would spend internally, and often with better quality. However, larger companies can still benefit from outsourcing some very specific or temporary compliance jobs. “Today we are assisting a number of medium to large banks to implement FATCA, for example,” says Gimenez Zapiola.  “I believe there is still room to do more in this segment; for instance, in AML monitoring and testing, or enhanced due diligence for correspondent banking and MBSs.”

The reality, however, is that smaller companies are faced with the same legal requirements as larger organizations, but they often don’t have the expertise.

“Smaller companies find themselves challenged on the domain expertise standpoint when they are suddenly called to comply with new set of regulations,” says Jain, whose coverage includes banking, capital markets, and insurance BPO.  “And since most of the larger firms have large global In-house centers, or ‘GICs’, they look to leverage third parties more for transactional work.”

That then allows for the GIC staff to focus on more judgement-oriented work. The tougher question for nearshore providers is whether they have the ability to deliver these services.

Cost Savings, At What Cost?

One of outsourcing’s great appeals is its ability to reduce costs. But when it comes to compliance there is a chance that costs – and risk – could actually increase if a provider doesn’t have the in-house talent.

“If a U.S. company wants to ensure compliance with local U.S. laws, then it is ideal to have consultants or vendors who are well trained and can demonstrate proficiency in regard to U.S. regulatory expectations,” says Dr. Nitish Singh, Associate Professor at St Louis University, and president of compliance advisory IntegTree.

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The trick is for those outsourcing companies with global capabilities to deliver quality compliance services at affordable rates. Realistically, that remains a challenge for some nearshore providers. “At this point in time the outsourcers in Latin America do not seem to have an edge over others,” says Jain. “The reason is because in Latin America outsourcers’ unique selling points are time-zone, cultural, and linguistic affinity. These are not the principal anchor points to base a competitive compliance solution.”

Of course, some nearshore providers might beg to differ, pointing to their increasingly complex capabilities. As well, time-zone, culture, and language can be strong starting points when delivering compliance solutions to U.S.-based customers.

“If Latin America-based outsourcers can develop domain expertise in compliance issues, it will enable them to combine this with their existing unique selling points,” says Jain. “From there they could position themselves at an advantage for compliance offerings.”

And it may make sense for nearshore providers to dip their toes in the water with smaller customers, many of who are receiving advice to look to third parties to address compliance issues.

“My general suggestion for smaller companies would be to outsource complex compliance functions and focus on what they do best,” says Thomas Bussen, vice president of IntegTree. “Small, moderately or lightly regulated companies may find that their compliance needs do not justify maintaining a permanent and specialized compliance staff.”

Tracking the Value

One way in which third parties are being made accountable for the job is to enter into outcome-based commercial models, though that is not a something that has been widely embraced with nearshore providers.

“We know of instances where compliance work is constructed in a way that the third party is liable to pay in case of fines being levied on the buyer for the work being performed by the third party,” says Jain from Everest. “The third-party typically doesn’t have full liability to the actual fine from regulators, but there are penalty clauses to ensure that they build enough checks and balances.”

Then there is the audit function. If properly scoped and agreed upon, it can be an efficient way to ensure success. If done poorly, it can add another costly layer of bureaucracy. “The audit can be expensive or inexpensive depending upon the extent of the processes involved,” says Jain.“If the compliance work is complicated, and involves multiple asset classes, the audit process can be expensive.”

Which is to say, nearshore providers had better expect that they will undergo the kind of scrutiny familiar to global consultancies. Given the level of liability, this is not a function that any company will outsource lightly, no matter their size or sector.

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