Outsourcing to the Cloud: EIOPA’s Contribution to the European Commission FinTech Action Plan

In the European financial regulatory landscape, the purchase of cloud computing services falls within the broader scope of outsourcing.

The credit institutions, investment firms, payment institutions and the e-money institutions have multiple level 1 and level 2 regulations that discipline their use of outsourcing (e.g. MIFID II, PSD2, BRRD). There are also level 3 measures: CEBS Guidelines on Outsourcing, representing the current guiding framework for outsourcing activities within the European banking sector.

Additional “Recommendations on cloud outsourcing” were issued on December 20, 2017 by the European Banking Authority (EBA) and entered into force on July 1, 2018. They will be repealed by the new guidelines on Outsourcing Arrangements (level 3) which have absorbed the text of the Recommendations.

For the (re)insurance sector, the current Regulatory framework of Solvency II (level 1 and level 2) discipline outsourcing under Articles 38 and 49 of the Directive and Article 274 of the Delegated Regulations. The EIOPA guidelines 60-64 on System of Governance provide level 3 principle based guidance.

On the basis of a survey conducted by the National Supervisory Authorities (NSAs), cloud computing is not extensively used by (re)insurance undertakings: it is most extensively used by newcomers, within a few market niches and by larger undertakings mostly for non-critical functions.

Moreover, as part of their wider digital transformation strategies many European large (re)insurers are expanding their use of the cloud.

As to applicable regulation, cloud computing is considered as outsourcing and the current level of national guidance on cloud outsourcing for the (re)insurance sector is not homogenous. Nonetheless, most NSAs (banking and (re)insurance supervisors at the same time) declare that they are considering the EBA Recommendations as a reference for the management of cloud outsourcing.

Under the steering of its InsurTech TaskForce, EIOPA will develop its own Guidelines on Cloud Outsourcing. The intention is that the Guidelines on Cloud Outsourcing (the “guidelines”) will be drafted during the first half of 2019, issued then for consultation and finalised by the end of the year.

During the process of drafting the Guidelines, EIOPA will organize a public roundtable on the use of cloud computing by (re)insurance undertakings. During the roundtable, representative from the (re)insurance industry, cloud service providers and the supervisory community will discuss views and approaches to cloud outsourcing in a Solvency II and post-EBA Recommendations environment.

Furthermore, in order to guarantee a cross-industry harmonization within the European
financial sector, EIOPA has agreed with the other two ESAs:

  • to continue keeping the fruitful alignment kept so far; and
  • to start – in the second part of 2019 – a joint market monitoring activity aimed at developing policy views on how cloud outsourcing in the finance sector should be treated in the future.

This should take into account the increasing use of the cloud and the potential for large cloud service providers to be a single point of failure.

Overview of Cloud Computing

Cloud computing allows users to access on-demand, shared configurable computing resources (such as networks, servers, storage, applications and services) hosted by third parties on the internet, instead of building their own IT infrastructure.

According to the US National Institute of Standards and Technology (NIST), cloud computing is: “a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction”.

The ISO standard of 2014 defines cloud computing as a: “paradigm for enabling network access to a scalable and elastic pool of shareable physical or virtual resources with self-service provisioning and administration on-demand”. It is composed of

  • cloud computing roles and activities,
  • cloud capabilities types and cloud service categories,
  • cloud deployment models and
  • cloud computing cross cutting aspects”.

The European Banking Authority (EBA) Recommendations of 2017 – very close to NIST definition – defines the cloud services as: “Services provided using cloud computing, that is, a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g. networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.

Shared responsibility framework

The cloud provider and cloud customer share the control of resources in a cloud system. The cloud’s different service models affect their control over the computational resources and, thus, what can be done in a cloud system. Compared to traditional IT systems, where one organization has control over the whole stack of computing resources and the entire life-cycle of the systems, cloud providers and cloud customers collaboratively

  • design,
  • build,
  • deploy, and
  • operate

cloud based systems.

The split of control means that both parties share the responsibilities in providing adequate protections to the cloud-based systems. The picture below shows, as “conceptual model”, the different level of sharing responsibilities between the cloud provider and the cloud customer.

These responsibilities contribute to achieve a compliant and secure computing environment. It has to be noted that, regardless the service provided by the cloud provider:

  • Ensuring that the data and its classification are done correctly and that the solution is compliant with regulatory obligations is the responsibility of the customer (e.g. in case of data theft the cloud customer is responsible towards the damaged parties or the customer is responsible to ensure – e.g. with specific contractual obligations – that the provider observe certain compliance requirements such as give the competent authorities access and audit rights);
  • Physical security is the one responsibility that is wholly owned by cloud service providers when using cloud computing.

The remaining responsibilities and controls are shared between customers and cloud providers according to the outsourcing model. However, the responsibility (in a supervisory sense) remains with the customers. Some responsibilities require the cloud provider and customer to manage and administer the responsibility together including auditing of their domains. For example, identity & access management when using a cloud provider’s active directory services could require that the configuration of services such as multi-factor authentication is up to the customer, but ensuring effective functionality is the responsibility of the cloud provider.

EIOPA Outs

Summary of Key Takeaways and EIOPA’s Answer to the European Commission

The key takeaways of the analysis carried out and described within this document are the following:

  1. cloud computing is mostly used extensively by newcomers, by a niche of the market and by larger undertakings mostly for non-critical function. However, as part of their wider digital transformation strategies many European large (re)insurers are expanding their use of the cloud;
  2. the current Regulatory framework of Solvency II (level 1 and level 2) appears to be sound to discipline the outsourcing to the cloud by the current outsourcing provisions (Articles 38 and 49 of the Directive and Article 274 of the Delegated Regulations);
  3. cloud computing is a fast developing service so in order for its regulation to be efficient it should be principle-based rather than attempting at regulating all (re)insurance-related aspects of it;
  4. cloud computing services used by (re)insurance undertakings are aligned to the one used by banking sector. The risks arising from the usage of cloud computing by (re)insurance undertakings appear to be, generally, aligned to the risks bear by the banking players with few minor (re) insurance specificities;
  5. both banking and (re)insurance regulations discipline cloud computing by their current outsourcing provisions. Under these, banking and (re)insurance institutions are required to classify whether the cloud services they receive are „critical or important“. The most common approach is to classify cloud computing on a case-by-case approach – similarly to the other services – on the basis of the service / process / activity / data outsourced;
  6. the impact of cloud computing on the (re)insurance market is assessed differently among jurisdictions: due to the complexity and the high level of technicality of the subject, some jurisdictions have planned to issue (or already issued) national guidance directly applicable to the (re)insurance market on cloud outsourcing;
  7. from the gap analysis carried out, the EBA Recommendations are more specific on the subject (e.g. the specific requirements to build a register of all the cloud service providers) and, being built on shared common principles, can be applied to the wide Solvency II regulations on outsourcing, reflecting their status at level 3;
  8. to provide legal transparency to the market participants (i.e. regulated undertakings and service providers) and to avoid potential regulatory arbitrage, EIOPA should issue guidance on cloud outsourcing aligned with the EBA Recommendations and, where applicable, the EBA Guidelines on outsourcing arrangements with minor amendments.

Click here to access EIOPA’s detailed Contribution Paper

How to successfully mitigate your organization’s third-party risk

What Is Third-Party Risk Management & Third-Party Due Diligence?

Third-party risk management is the process of assessing and controlling reputational, financial and legal risks to your organization posed by parties outside your organization. Third-party due diligence is the investigative process by which a third party is reviewed to determine any potential concerns involving legal, financial or reputational risks. Due diligence is disciplined activity that includes reviewing, monitoring and managing communication over the entire vendor engagement life cycle.

The Risks Are Real

As we see in the news too often, lapses in leadership around managing third parties have damaged organizations by exposing them to massive fines and penalties. According to the 2016 Benchmark Report, one-third of respondent organizations have faced legal or regulatory issues that involved third parties, with 50 percent of these involving average costs per incident of $10,000 or more. Even if the financial penalty can be managed, the reputational impact can have far-reaching consequences for many years. Third-party risk management is a top concern of compliance leaders, but many organizations are still coming to terms with how best to manage their third parties to limit risk and develop programs based on organizational risk assessments. The 2016 NAVEX Global benchmark report found that many organizations think they could be doing a better job of third-party risk management. Only 58 percent reported that they do a good job of complying with laws and regulations, and less than 25 percent rate their overall program as Good. Organizations may be diligent with their ethics and compliance programs, but for many the risk their third parties represent is a Wild West over which they feel like they have little control.

Benefits of a Strong Third-Party Risk Management Program

Managing third-party risk can make a big difference inhow well your organization can identify, manage and limit the liability a third party can represent. Your third party’s risk is your risk. You should have confidence that your program is minimizing that risk for you and your organization.

TPRClick here to access NAVEX detailed guide