Every financial service institution needs the help of third-party providers to operate their company. From catering and cleaning services to physical security and technology, third parties are indeed responsible for many of the main facilities and processes that the company requires to deliver its core value propositions. Rather than being a privilege, they are now a requirement, but they do provide plenty of advantages to those capable of utilizing them.
As much as third parties are in demand in every financial transaction, the question of whether it is safe or not is still up for others. How will you know if your investment that a third party handles is safe? Here are some pieces of information you need to know before investing and trusting a third party to help you with this issue.
What is Third Party in Investment?
A third party will operate on behalf of one or more of the persons involved in the transaction. For example, in a real estate deal, an escrow company would protect all parties involved in a transaction.
Through outsourcing middle/back-office solutions, small businesses are taking advantage of technology/processes to improve productivity in the execution of projects, optimize operational efficiency, reduce operating costs, reduce manual processes, and reduce errors. Operational costs are decreased, enforcement is increased, and tax/investor reporting is improved.
Benefits of Using Third-Party In Investments
Not just a route for carrying out low-value activities, the primary factor of third-party involvement is the desire to gain advanced expertise and information. Those things can make a significant difference in the value of an enterprise’s end products and services. In some cases, poor relationships with a third party can lead to a substantial financial loss. If that happens with you, you can file an investment loss lawsuit through your trusted lawyer. However, with the right procedure and good governance, third parties with tailored offerings and cutting-edge capabilities can give companies a competitive advantage in their market, as their integrated value proposition can amount to something far superior to what they might build on their own.
Third parties may also provide geographic scope, scale, and flexibility that even global organizations cannot match. It can be especially helpful for institutions that aim to expand rapidly, are reluctant to invest in certain areas, or are willing to provide services in markets that would be unprofitable if they entered through their distribution networks, processing centers, and infrastructure.
The advantage of using third parties, if handled effectively, is that they will potentially reduce your exposure to operational risk. For example, an asset management firm’s core capabilities should be to invest in and manage funds, not merely to execute and manage trades. By outsourcing those elements to the appropriate provider, they utilize the expertise they may not have independently. Also, using acceptable service level agreements, effectively minimizing the probability of risk incidents happening and ensuring that, if they do, the third party is responsible for addressing and resolving them.
Risks of Using Third Parties in Investments
Contrary to the benefits of using a third party in investments, there are also several risks that you can encounter for trusting one. Intermediaries have made many facets of life simpler by offering the service of endowed assurance. However, their service certainly didn’t come without their own risk.
The first and most striking is the threat posed by fraudulent activity. Despite rules and financial regulations, trusted third parties appear to be run by people and are thus vulnerable to fraud and abuse. The economic crisis of 2009 is a prime example of trusted third parties making a profit from fraudulent activities when lending institutions made loans to borrowers bound for default and then marketed those loans to unsuspecting investors. These entities have neglected their obligation to be an agent of trust in a transaction. We can conclude that the effects of their incompetence are still felt to this day.
Know your third-party relationships.
A financial services regulation, known as “Know Your Customer,” allows financial institutions to verify their customers’ identity and assess possible risks. Ideally, organizations in all industries can do the same for their external partners since many organizations and individuals lack a good understanding of their third-party dependencies.
Determine their scope of work.
Typical organizations can use hundreds of third parties. These partners will require varying degrees of due diligence and supervision, depending on the value of the goods, services, or capabilities they provide. The more critical the third party, the more stringent the partner’s governance is likely to be.
Review contracts to bring them into line with the new legislation.
Have your contracts been revised and updated to reflect the new data protection and privacy regulations? With further data privacy legislation enacted over the last few years, some of your agreements are likely to need to be revised to identify the obligations between the parties better.
Analyze your third party risk.
Many third-party partnerships pose unintended, inherited threats that result in losses to an entity. Since it is not possible to transfer all risks to third parties by contractual or legal arrangements, a risk management process focused on guidelines and best practices will help the company determine, evaluate, handle and track these risks.
Make sure to monitor your third party.
Efficient third-party management doesn’t end when partners are on board and working—in reality, that’s just the beginning. Many aspects of third-party relationships may, and typically can, change. Third parties might, for example, implement new risks. Their financial conditions can change, and their workers may come and go, requiring changes in access. Therefore, it is essential to have the right processes and metrics in place to track third parties, their accessibility to your systems and information, and their total ability to support your company objectives.
Whatever the business case might be, it is evident that modern-day companies cannot operate effectively without cooperation with third parties. However, make sure that you have enough information about your third party before taking any action to avoid further complications and losses in the future. A business or an individual entity should have a systematic, risk-based mechanism to collaborate with third parties to ensure continuous monitoring. Risk reduction activities should be in place, including efficient contract management, appropriate cost management, regulatory enforcement, data privacy, online safety, performance indicators, and ongoing third party supervision.