A recent European Banking Authority (EBA) consultation paper sets out draft recommendations for credit institutions and investment firms considering ‘material’ cloud outsourcing. We review 5 key areas that feature in the recommendations.
The new recommendations supplement existing outsourcing requirements and detail the supervisory requirements, processes and expectations that apply when credit institutions and investment firms outsource to the cloud. They aim to achieve greater supervisory convergence and clarity on what is required when a financial institution wishes to adopt cloud computing and reduce the cost of complying with regulatory obligations in this area.
Notable changes in the new recommendations include the ability of financial institutions to participate in ‘pooled audits’ with other customers of the same cloud provider, potentially resulting in sizable cost savings. Other requirements place obligations on the financial institution to ensure contractual rights of access and audit of the cloud service provider and particular contractual requirements with respect to chain outsourcing. The 2017 recommendations focus on the following five key areas:
1.Proportionality and Materiality Assessment
The overriding principle of the 2017 recommendations is proportionality, based on the materiality of the activities being outsourced. Where the outsourcing is material, the financial institution needs to notify its regulator before that outsourcing can take place. The Committee of European Banking Supervisors (CEBS) guidelines already require a financial institution to undertake a ‘materiality assessment’ prior to outsourcing activities. If the outsourcing involves cloud services and is assessed as material, then the 2017 recommendations on information, access to data and auditing will apply.
The 2017 recommendations provide guidance on what a financial institution should consider when undertaking a materiality assessment and cover areas such as:
- criticality and inherent risk profile of the activities to be outsourced;
- complexity of the financial institution’s activities;
- size, structure and operational environment of the financial institutions; and
- potential impact of a confidentiality breach on the institution and its customers.
2.Access and Audit Rights
On access and auditing of outsourced data, the recommendations seek to ensure an equivalent level of access to data as if the activity had not been outsourced by the financial institution. They recommend that both the outsourcing institution and the competent authority have an unrestricted right to audit the cloud services, in addition to access rights to the cloud service provider’s business premises. The premises access rights also include a right to access all devices, systems, networks and data used for providing the outsourced services.
Where an outsourcing institution does not employ its own audit resources the recommendations provide for ‘pooled audits’ performed jointly with other customers of the cloud service provider. This could result in significant savings for financial institutions outsourcing to the cloud.
Alternatively, financial institutions may be able to rely on third-party certification and third party (or internal) audit reports made available by the cloud service provider. This aligns to a degree with the Irish Data Protection Commissioner’s general guidance on data security, which indicates that to ensure data security in a multi-tenanted cloud arrangement “third party certification to approved national standards, rather than a direct outright audit, will often be most appropriate”.
3.Data Protection Controls
Outsourcing institutions are expected to ensure adequate systems and controls to protect the confidentiality, integrity and availability of data when it is being processed, transferred and stored.
Particular care is advised if outsourcing institutions are considering entering into agreements outside the EEA. In these circumstances, the 2017 recommendations list additional considerations for risk assessment, such as the political and security stability of the jurisdiction and the law enforcement provisions in the event of a cloud service provider failing.
The 2017 recommendations also address the security of data for ‘chain’ outsourcing. Chain outsourcing arises where the outsourcing service provider sub-contracts some or all of the elements of the service to other providers. The 2017 recommendations set out guidance on the contents of such sub-contracting agreements.
They also reiterate the importance of each outsourcing institution retaining the right to terminate a contract where the cloud service provider plans to change subcontractor or the sub-contracted services in a way which would have an ‘adverse effect’ on the risk assessment of the agreed services.
Although there is a requirement for a cloud service provider to notify the outsourcing institution of a proposed significant change of subcontractor, a requirement that must be provided for by contract, the outsourcing institution’s consent is not required if no risk of an adverse effect arises.
5.Termination and exit management
The recommendations also provide guidance on contingency plans and exit strategies for cloud outsourcing. They advise that outsourcing contracts should include termination and exit management clauses. These clauses would allow the transfer of the outsourced activities to an alternative service provider or to be taken back in-house by the outsourcing institution.
Where to from here?
The EBA hosted a public hearing on the recommendations on 20 June 2017. Concerns were raised about:
- the extent of the audit and access rights and the disruptive impact they may have on cloud service providers;
- the need for more particular guidance regarding the use of pooled audits; and
- the lack of clarity on what constituted a significant change, which triggers the requirement of cloud service providers to inform outsourcing financial institutions of a change of subcontractor.
However, the 2017 recommendations serve to re-emphasise the duty to ensure that audit and access rights and change of subcontractor notification rights, where chain outsourcing is envisaged, are expressly provided for in the contract with the service provider.
It is worth nothing that the EBA will consider the applicability of the 2017 recommendations to other types of regulated financial services providers in the future. Meanwhile, credit institutions and investment firms can be certain that they will now have to prepare contingency plans and exit strategies to ensure business continuity in the event of the failure of a cloud service provider. It is still unclear whether the contingency plans and exit strategies have to be incorporated into contracts with service providers or if an internal plan and strategy is sufficient. In light of these and other issues raised at the EBA public hearing, it is clear that challenges and uncertainties still remain for financial institutions to ensure that they are fully compliant with regulatory obligations in the area of outsourcing to the cloud.
The deadline for the submission of comments to the consultation is 18 August 2017, after which it is hoped that further clarity will be reached on this topic.