OCC Issues New Risk Management Guidance For Third Party Relationships

by Sheppard Mullin Richter & Hampton LLP
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The Office of the Comptroller of the Currency published on October 30, 2013 a new Guidance relating to risk management for third party relationships. This Guidance rescinds OCC Bulletin 2001-47, “Third-Party Relationships: Risk Management Principles” and OCC Advisory Letter 2000-9, “Third-Party Risk.” Prior to the formation of the Consumer Financial Protection Bureau, OCC-regulated institutions were subject to the rescinded Guidance and Advisory Letter, and OTS-regulated institutions were subject to Thrift Bulletin 83 (since rescinded), “Interagency Guidance on Weblinking: Identifying Risks and Risk Management Techniques,” but non-bank lenders were not subject to similar requirements with respect to their relationships with third party vendors. The CFPB then published its vendor management guidance last year. The OCC’s new Guidance is the first published by a bank regulator since the CFPB published its guidance, and is therefore the first view we have of current regulatory thinking since that time. This new Guidance, which is considerably more detailed than the CFPB’s guidance, may therefore be useful to both banks and non-bank lenders as to the types of things they should consider in building a robust vendor management policy. Among the highlights of the Guidance:

A bank should adopt risk management processes that are commensurate with the level of risk and complexity of its third-party relationships.

A bank should engage in comprehensive risk management and oversight of third-party relationships involving critical activities (i.e., such significant bank functions as payments, clearing, settlements and custody) or significant shared services such as information technology, or other activities that (i) could cause a bank to face significant risk if the third party fails to meet expectations, (ii) could have significant customer impacts, (iii) require significant investment in resources to implement the third-party relationship and manage the risk, or (iv) could have a major impact on bank operations if the bank has to find an alternate third party or if the outsourced activity has to be brought in-house.

An effective third-party risk management process follows a continuous life cycle for all relationships and incorporates the following phases:

Planning: Developing a plan to manage the relationship is often the first step in the third-party risk management process. This step is helpful for many situations but is necessary when a bank is considering contracts with third parties that involve critical activities.

Due diligence and third-party selection: Conducting a review of a potential third party before signing a contract helps ensure that the bank selects an appropriate third party and understands and controls the risks posed by the relationship, consistent with the bank’s risk appetite.

Contract negotiation: Developing a contract that clearly defines expectations and responsibilities of the third party helps to ensure the contract’s enforceability, limit the bank’s liability, and mitigate disputes about performance.

Ongoing monitoring: Performing ongoing monitoring of the third-party relationship once the contract is in place is essential to the bank’s ability to manage risk of the third-party relationship.

Termination: Developing a contingency plan to ensure that the bank can transition the activities to another third party, bring the activities in-house, or discontinue the activities when a contract expires, the terms of the contract have been satisfied, in response to contract default, or in response to changes to the bank’s or third party’s business strategy.

In addition, a bank should perform the following throughout the life cycle of the relationship as part of its risk management process:

Oversight and accountability: Assigning clear roles and responsibilities for managing third-party relationships and integrating the bank’s third-party risk management process with its enterprise risk management framework.

Documentation and reporting: Proper documentation and reporting facilitates oversight, accountability, monitoring, and risk management associated with third-party relationships.

Independent reviews: Conducting periodic independent reviews of the risk management process enables management to assess whether the process aligns with the bank’s strategy and effectively manages risk posed by third-party relationships.

The Guidance contains specific details with respect to each of the above-referenced categories. For due diligence, the Guidance suggests that the bank review the third party’s strategies and goals, legal and regulatory compliance, financial condition, business experience and reputation, fee structure and incentives for the services to be provided, the qualifications, backgrounds, and reputations of the third party’s principals, the third party’s risk management and information security programs, its management of information systems, its ability to respond to service disruptions or degradations resulting from natural disasters, human error, or physical or cyber attacks, its incident-reporting and management programs, its physical security controls, its human resource management, the extent of its reliance on subcontractors, its insurance coverage and any conflicting contractual arrangements it might have with other parties.

The Guidance suggests that the contract between the parties should address the nature and scope of the arrangement, specific performance measures or benchmarks, responsibilities for providing, receiving, and retaining information, the bank’s right to audit and require remediation, the third party’s responsibility for compliance with applicable laws and regulations, the compensation arrangement, the ownership and license of information, technology and intellectual property, confidentiality and integrity, business resumption and contingency plans, indemnification, insurance, dispute resolution, limits on liability, default and termination, customer complaints, subcontracting, and the OCC’s supervision rights over the bank.

The Guidance also contains an extensive discussion of the extent to which the bank should oversee the third party’s performance, and the third party’s level of accountability.

This blog is a summary only. More detail can be found in the Guidance. This Guidance may prove to be important to financial institutions and lenders that are not subject to the OCC’s oversight, because the CFPB and other regulatory agencies may well follow the OCC’s lead in updating their third party management guidances. The Guidance may be found at http://www.occ.treas.gov/news-issuances/bulletins/2013/bulletin-2013-29.html.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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