US banks’ reliance on third-party outsourcing is about to collide headfirst with the wide-reaching compliance requirements of the Fatca anti-tax evasion law. Banks focusing on their own compliance shortfalls need to start looking at their suppliers too – or risk falling foul of the new law When US Congress enacted the Foreign Account Tax Compliance Act (Fatca) in 2010, it may not have anticipated the compliance obligations this would impose on the large number of financial institutions around the globe that have found themselves caught in this complex web. Foreign financial institutions (FFIs) and US withholding agents have invested heavily in programmes to comply with the anti-tax evasion regulation, which, in many cases, is likely to involve reliance on third-party suppliers for various aspects – including the core elements of identifying US accounts, reporting their details to local or US authorities, and withholding the 30% charge on transactions with non-compliant institutions. Key areas include client onboarding and know your customer (KYC) processes, which are traditional areas of outsourcing for financial institutions, and also withholding – the key to Fatca. There are concerns because many third-party contracts for these areas will have been in place for some time, possibly pre-dating Fatca, along with various service-level agreements (SLAs), meaning that many aspects may be missing that were irrelevant before Fatca, but are now crucial to ensure compliance with it. On top of this, the task of amending such contracts or SLAs – to make sure they highlight the clear responsibilities of third-party providers in order to ensure Fatca compliance – has been hindered by the late issue of some of Fatca's vital forms, especially for withholding agents in the US. This has left financial institutions scrambling to prepare, from a compliance perspective, and their third-party contracts may be leaving them exposed either because the contracts are out of date, being worked upon post-deadline, or perhaps they have just not been placed high on the list of priorities where Fatca compliance is concerned. For long-standing third-party relationships, contracts may have been in place for years before Fatca was enacted or even thought of, and the same applies to SLAs. With FFIs and withholding agents concentrating on their internal Fatca compliance, many in the industry are concerned that not enough attention is being given to their third-parties' compliance. Jeff Trent, a New York-based partner at PwC, says that identifying third-party relationships and where they may have responsibilities related to Fatca compliance is a key part of the overall governance and compliance programme required under Fatca. He is concerned it might not have been happening as much as it should. "If you think about the fact that a lot of service providers to both banks and asset managers, for example, have been doing that for a number of years, even prior to the existence of Fatca, it would be rare if many of those contracts explicitly covered those responsibilities, because they likely didn't exist when the contract began," says Trent. The issue is "pervasive", according to Trent. To give an example of where it might manifest itself, he says the current Fatca onboarding and withholding programmes underway need to be mapped out in detail to see who is responsible for which element. "If an institution that is putting together a programme around Fatca compliance has not mapped out entirely the pieces they own internally on their side and the pieces that are outsourced, they may have a gap in control that could lead to a potential non-compliance issue," he says. Examples might be the withholding agent not having specifically said it expects its third party to do its withholding, or the agent not having shared the information required by the third party to identify the amount that should be withheld from customers. Trent says that without mapping out the entire process these issues may arise. "They might have missed some of those connection points, and where the data might be relevant and needed – perhaps they didn't communicate on time to their service provider how they would get new fields and new information. Withholding is a very automated process, so if you don't have the right fields and the right classification data in those fields, you can miss those little things." On the agenda There are several possible explanations. One is simply that third-party compliance has not been top of the priority list for institutions trying to implement their Fatca programmes. "Internally, the banks have their own challenges," says Karen Rossouw, London-based manager and business consultant at Sapient Global Markets. "Thinking of third parties is almost lost on their radar because internally they're still trying to figure all this out. They have different structures in the group and divisional challenges, group challenges, who is reporting, who is the client, who owns the client, and so on. So, third party is almost lost on the radar. In some cases they almost expect the third party to be compliant and they'll later find out ‘we should have probably done more work on this'." Karen Rossouw, Sapient Global Markets A further issue is that even recently written or updated third-party contracts may still be out of date or lacking vital components of compliance, as the regulations implementing Fatca have been uncertain and fluid right up until the last minute. When compliance with the act became a requirement on July 1, withholding agents in the US were still waiting for the ‘instructions for the requester' for the W-8 forms, which are used to identify non-US people and non-US entities. On June 26 – five days before Fatca compliance was due to start – Operational Risk & Regulation reported that withholding agents were growing very concerned about the absence of instructions for the W-8BEN-E form. "The lack of instructions was, and is, a major obstacle to fully complying with Fatca," Jonathan Jackel, Washington, DC-based senior counsel at law firm Burt, Staples & Maner, said at the time. "Withholding agents are responsible for making sure the forms they receive from customers are valid. There is no way to be sure a form is valid unless the instructions are out." This has made life very difficult for withholding agents and for the third-party suppliers who might have been administering the W-8 forms for them. This lack of clarity meant that whoever was issuing the form – the withholder or third-party – may have been leaving themselves open to being non-compliant. "It was nearly impossible to provide a W-8BEN-E with any confidence prior to the instructions being released within the last couple of months," points out Craig Cohen, New York-based senior counsel at Allen & Overy. The instruction for requester forms for the W-8s finally materialised on July 16 – more than two weeks after Fatca compliance started for FFIs and withholding agents. This has contributed to the difficulties experienced by financial institutions on both sides of the equation in trying to clarify third-party responsibilities under their Fatca compliance programmes. PwC's Trent says service providers involved in the delivery of those aspects of Fatca compliance that are provided for in forms such as the W-8BEN-E or in the instructions for the requester may have had to retrofit the requirements into their application, which means there may still be a lack of clarity as to who is responsible for what. "With those forms that didn't come out until very, very late there is still this kind of window right now that's operating where perhaps some people are doing more by themselves and looking to implement more third-party controls later on, which means they continue to operate in a window where they are still working out the details of who owns what part of the control." IGA day On top of this, the lack of clarity around the intergovernmental agreements (IGAs) meant US withholding agents did not know which jurisdictions were in or out until the very last minute in some cases. "In the run-up to July 1, you had to check the IRS website almost every hour to see what countries they had reached IGAs in substance with," points out Deborah Pflieger, the Washington, DC-based principal of tax information reporting and withholding services at EY. For withholding agents in the US using third parties for any part of their onboarding, KYC or withholding processes, this has added to the issue of having to retrofit aspects into an application that may have been serving a withholding agent; once again, meaning contracts or SLAs would either have to be amended or else continue to function inaccurately. Ultimately, financial institutions – whatever side of Fatca they fall on – need to ensure their third-party relationships do not leave them open to gaps in their compliance programmes, regardless of the reason for it happening. As Sapient's Rossouw says, institutions across the spectrum cannot sit back and assume their third parties are Fatca compliant; they need to work with their providers to make sure they clearly define the roles and responsibilities of each party, and put in trackable measurements. "You have to have some form of paper performance measurement in place – tangible stuff you can relate back to," Rossouw adds. "Trust is not a control." An earlier version of this article wrongly gave the withholding rate as 20%, not 30%. This has been corrected. Apologies....
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