How to Ensure Vendor Compliance with Changing Regulations in the Financial Services Industry

Your financial institution faces stringent regulatory oversight to ensure it upholds the highest integrity, security, and operational excellence standards. However, as your institution increasingly relies on third-party vendors for critical services, ensuring these vendors comply with applicable regulations has become a complex yet vital task.

According to PwC, 52% of businesses say an increase in new regulations is a top scenario in their 2-year resilience plans.

Vendor compliance is not just about meeting contractual obligations; it is about safeguarding your financial institution from significant risks, including legal penalties, reputational damage, and operational disruptions.

This guide discusses key strategies to ensure your vendors’ compliance with changing regulations. It covers:

• Examples of Financial Services Regulations from Different Jurisdictions
• Types of Risk Vendors Can Bring to Your Financial Institution
• Determining Which Regulatory Changes Apply to Your Vendors
• Ensuring Your Vendors Understand Their Regulatory Compliance Obligations
• Implications of Changes to Your Financial Institution’s Risk Profile
• Leveraging Vendor And Contract Lifecycle Management (VCLM) Software to Ensure Vendor Compliance
• Getting Proof of Vendor Compliance with Applicable Regulatory Changes
• Frequency of Checking Vendor Compliance
• Responding to Vendor Non-Compliance with Regulatory Changes
• Contractual Safeguards for Vendor Compliance with Regulatory Changes
• Updating Your Vendor Compliance Policies and Handling Contractual Knock-On Effects

Examples of Financial Services Regulations from Different Jurisdictions

Financial services regulations vary significantly across jurisdictions, with each country or region imposing its own set of rules to govern the conduct of financial institutions and their vendors. Some of the most impactful regulations include:

• Anti-Money Laundering (AML) Regulations: AML laws enforced globally require your financial institution and its vendors to implement measures to detect and prevent money laundering activities. Vendors involved in transaction processing, identity verification, or customer onboarding are particularly affected.
• Dodd-Frank Act: In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act introduced comprehensive regulations aimed at increasing transparency and reducing risk in the financial system. Vendors providing services related to financial transactions, derivatives, or consumer protection are directly impacted by this regulation.
• Digital Operational Resilience Act (DORA): In the EU, DORA establishes a regulatory framework to ensure that financial institutions are capable of withstanding, responding to, and recovering from ICT-related disruptions and cyber threats. It also mandates that institutions effectively manage risks posed by third-party ICT service providers, promoting higher standards of cybersecurity and operational resilience across the sector.
• General Data Protection Regulation (GDPR): In the European Union, GDPR mandates strict data protection and privacy standards, affecting any vendor that processes or stores personal data of EU citizens. Vendors must ensure they have adequate safeguards in place to protect such data and respect individuals' privacy rights.
• Payment Services Directive 2 (PSD2): In the EU, PSD2 requires banks to open their payment services to third-party providers, subject to stringent security and transparency requirements. Vendors involved in payment processing must comply with these requirements to operate legally.

These examples underscore the importance of understanding the regulatory environment in which vendors operate. Vendors that provide services across multiple jurisdictions must navigate a complex web of regulations, making compliance a multifaceted challenge.

Types of Risk Vendors Can Bring to Your Financial Institution

Vendors can introduce various types of risks to your financial institution, each of which can have significant implications:

• Cybersecurity Risk: As your institution increasingly relies on digital services, vendors that handle sensitive data or access your systems can introduce cybersecurity risks. A breach in a vendor’s security could lead to unauthourised access to such sensitive data. Cyber is the number one business risk with 40% of all respondents listing more frequent and/or broader cyber attacks as a serious risk (and another 38% calling it a moderate risk).
• Financial Risk: Vendors that are financially unstable or poorly managed can pose a financial risk to your institution. If a key vendor goes bankrupt or fails to deliver on contractual obligations, you may incur additional costs to find and onboard a replacement.
• Legal and Compliance Risk: Non-compliant vendors can result in legal penalties for your financial institution. For example, a vendor that fails to comply with AML regulations could lead to hefty fines and regulatory sanctions against you.
• Operational Risk: Vendors that provide critical services, such as IT infrastructure or payment processing, can expose your financial institution to operational risks. A failure in the vendor’s systems can disrupt your business operations, leading to financial losses and customer dissatisfaction.
• Reputational Risk: Vendors that fail to comply with regulations or engage in unethical practices can damage your financial institution’s reputation. For example, a vendor involved in a data breach could tarnish your image, leading to a loss of customer trust.

Your financial institution must adopt a comprehensive approach to vendor risk management, ensuring that vendors are carefully vetted, monitored, and held accountable for their regulatory compliance obligations.

Determining Which Regulatory Changes Apply to Your Vendors

One of the most challenging aspects of vendor compliance is determining which regulatory changes apply to your financial institution’s vendors. This process involves several steps:

• Collaborating with Legal and Compliance Teams: The legal and compliance teams play a crucial role in interpreting regulatory changes and assessing their impact on your institution’s operations and vendor relationships. These teams should work closely with the vendor management team to identify applicable regulations and ensure compliance requirements are communicated effectively.
• Engaging with Vendors: You should engage with your vendors to discuss regulatory changes and understand how these changes will impact their services. Vendors may need to update their processes, policies, or systems to comply with new regulations.
• Monitoring Regulatory Bodies: You must stay informed about regulatory updates from relevant bodies such as the Securities and Exchange Commission (SEC) in the USA, the Financial Conduct Authority (FCA) in the UK, or the European Banking Authority (EBA) in the EU. Regularly reviewing publications, attending industry conferences, and subscribing to regulatory alerts can help your institution keep abreast of changes.
• Utilising Third-Party Risk Management (TPRM) Tools: TPRM tools can help automate the process of monitoring regulatory changes and assessing their impact on your vendors. These tools can provide real-time updates and generate reports to track compliance across the vendor portfolio.

By following these steps, your financial institution can ensure that it identifies and addresses regulatory changes that apply to its vendors, reducing the risk of non-compliance.

Ensuring Your Vendors Understand Their Regulatory Compliance Obligations

Effective communication and collaboration are key to ensuring your vendors understand and meet their regulatory compliance obligations. Your financial institution can take the following steps:

• Aligning Compliance Cultures: You should work to align your compliance culture with that of your vendors. This can be achieved through regular communication, joint compliance initiatives, and sharing of best practices. A strong compliance culture can help ensure that your vendors remain committed to meeting their regulatory obligations.
• Offering Compliance Training and Resources: You can offer training sessions, workshops, or webinars to help your vendors understand their regulatory obligations. Providing access to compliance resources, such as policy templates or industry best practices, can also support your vendors in meeting their obligations.
• Providing Clear Guidelines: You should provide your vendors with clear, detailed guidelines outlining their compliance obligations. These guidelines should be updated regularly to reflect changes in regulations and should be incorporated into each vendor’s contract.

By fostering a collaborative relationship with your vendors and providing the necessary support, you can enhance their ability to comply with regulations and reduce the risk of non-compliance.

Implications of Changes to Your Financial Institution’s Risk Profile

Changes to your institution’s risk profile, whether due to internal shifts like expanding business operations or external pressures like new regulations, can significantly impact its regulatory obligations and risk exposure.

In such cases, it may be necessary to adjust your vendor management practices accordingly. Key actions include:

• Conduct Additional Audits: Significant shifts in risk may necessitate more frequent, or more targeted, audits of your vendors to ensure they continue to meet compliance standards, particularly in newly regulated areas.
• Enhance Vendor Communication: Proactive communication with your vendors is crucial when your institution’s risk profile changes. Clear, timely communication helps vendors understand new compliance expectations and align their practices accordingly.
• Monitor Regulatory Developments More Closely: With an evolving risk profile, your institution should intensify its monitoring of regulatory changes to anticipate how vendor compliance requirements might be impacted.
• Reassess Vendor Risk: When your institution’s risk profile changes, a thorough reassessment of existing vendors is necessary. This reassessment should consider whether vendors previously deemed low-risk have become higher-risk or vice versa due to your new circumstances.
• Review and Amend Contracts: Contracts with vendors should be reviewed and amended as needed to reflect your institution's updated risk profile. This may include adding new clauses to address emerging risks, removing redundant clauses, or adjusting penalties for non-compliance.
• Update Compliance Requirements: Changes in your institution’s risk profile may require updating the compliance requirements imposed on vendors. This could involve increasing or decreasing audit rigor, or reporting frequency, or imposing stricter or milder regulatory requirements.

By integrating these practices into your vendor management strategy, your institution can effectively respond to changes in its risk profile.

Using Vendor and Contract Lifecycle Management (VCLM) Software to Ensure Compliance

Trying to ensure its vendors’ compliance with regulatory changes manually is likely to be an extraordinarily tedious and uncertain undertaking for any financial institution.

Since such compliance should be defined contractually in your institution’s contracts with the relevant vendors, the use of modern software like Gatekeeper’s Vendor and Contract Lifecycle Management system can help to reduce the checking burden and maximise the compliance outcomes through the following capabilities:

• Audit Trails: Automatically record every action related to a contract, ensuring a complete audit trail for compliance verification purposes, which is crucial during regulatory inspections to provide proof of compliance efforts.
• Automated Alerts: Advise the relevant stakeholders when renewals, document expiries, or risk-related changes occur or actions need to be taken by them.
• Balanced Scorecards: Build up an auditable record of vendor performance over time, giving stakeholders a voice with customisable surveys and tracking remedial action to drive accountability.
• Centralised Contract Repository: Securely store electronic versions of all vendor records and contracts, with controlled access and a global search capability to help locate exactly what is needed.
• Vendor and Contract Dashboards: Present selectable current snapshot details about vendors and contracts for an at-a-glance status review of items of interest - this can be from a risk, spend, or other perspective.
• Generative AI Contract Analysis: Automating contract metadata extraction and clause analysis helps ensure vendors meet compliance requirements by quickly identifying key terms and risks. This reduces manual errors and saves time, making compliance management more efficient.
• Integration with Third-party Data Intelligence: View aggregated data from thousands of data points across multiple vetted financial, cybersecurity, industry, and news sources for instant awareness of concerns about specific vendors.
• Risk Management Module: Capture and report on risks related to vendors and contracts, automatically calculate risk scores, and drill down on risk types to drive prioritisation of attention.
• Workflow Engine: Develop custom automated processes based on best practice principles when relevant, triggered by dates or the occurrence of specified events to standardise activities, provide visibility of process progress, and allow touch-free handover from one process step to the next.

Getting Proof of Vendor Compliance with Applicable Regulatory Changes

Obtaining proof of your vendors’ compliance is crucial for demonstrating that they have fulfilled their regulatory obligations. This can be achieved through the following methods:

• Conducting On-Site Audits: Your institution can visit its vendors to assess compliance with regulatory requirements. These on-site audits should be conducted by qualified personnel and should include a review of the vendors’ policies, procedures, and controls.
• Requesting Certifications and Audit Reports: You should require vendors to provide certifications or audit reports that verify their compliance with applicable regulations. For example, vendors may provide SOC 2 reports, ISO 27001 certifications, or GDPR compliance attestations.
• Reviewing Documentation: You should review all relevant documentation provided by vendors, including policies, procedures, and training materials, to ensure they meet regulatory requirements.
• Utilising Third-Party Audits: In some cases, your institution may engage third-party auditors to assess vendor compliance. Third-party audits can provide an independent assessment of a vendor’s compliance status and identify any areas of concern.

By obtaining proof of compliance, your financial institution can demonstrate to regulators that you have taken the necessary steps to ensure your vendors are meeting their obligations. Any gaps identified during these reviews should be addressed promptly.

Frequency of Checking Vendor Compliance

How often to check vendor compliance should be determined based on the risk profile of each vendor and the nature of the services provided, which could be one or more of the following:

• Cloud Services: Supply of data storage, computing power, and software platforms essential for day-to-day operations, such as processing transactions or hosting critical applications. Many financial institutions rely heavily on cloud infrastructure for scalability, data redundancy, and cost-effectiveness. Any disruption to cloud services could halt operations, affecting customer services and business continuity.
• Cybersecurity Services: Provision of cybersecurity tools and monitoring systems, including firewalls, threat detection, encryption, and vulnerability assessments. Financial institutions are prime targets for cyberattacks. A security failure could lead to data breaches, financial losses, and regulatory fines. Vendors that protect digital infrastructure are critical to preventing these risks.
• Data Centres and Hosting Providers: Data centres house servers and networking equipment that manage and store critical financial data, providing remote hosting services. A disruption at the data centre level could result in significant downtime or data loss, severely affecting operational resilience and regulatory compliance.
• IT Infrastructure Management: IT maintenance, system upgrades, network management, and disaster recovery services. Proper management of IT infrastructure is vital for ensuring business continuity, particularly when hardware or software systems are compromised or need recovery after disruptions.
• Outsourced IT Development and Support: Many financial institutions outsource their IT development or support for maintaining banking software, mobile apps, and other digital interfaces. If IT support or development is disrupted, core systems that facilitate banking services may fail, leading to service outages and customer dissatisfaction.
• Payment Processing: Provision of payment gateways and processing services for card transactions, electronic transfers, and digital payments. Disruptions in payment processing can halt financial transactions, impacting cash flow, customer satisfaction, and overall financial stability.
• Transaction Settlement Services: Provision of solutions handling the finalisation of trade and investment transactions. The failure of these services could result in incomplete or delayed transactions, which could damage market integrity and customer trust.

The disruption or failure of these vendor services could pose significant operational, financial, and reputational risks to your financial institution, which is why delivery of these services requires enhanced monitoring and regulatory oversight.

Best practices for checking vendor regulatory compliance include:

• Annual Compliance Reviews: At a minimum, your financial institution should conduct annual compliance reviews of its vendors. These reviews should include an assessment of the vendors’ policies, procedures, and controls to ensure they remain compliant with current regulations.
• Dynamic Risk-Based Monitoring: Your institution can implement dynamic risk-based monitoring, where the frequency and intensity of compliance checks are adjusted based on the vendor’s risk profile. For example, a vendor with a history of non-compliance may require more frequent reviews.
• Ongoing Monitoring: For high-risk vendors, ongoing monitoring may be necessary. This can include real-time monitoring of vendor activities, regular reporting, and continuous assessment of the vendor’s compliance status.
• Trigger-Based Reviews: You should conduct additional compliance reviews when there are significant changes in regulations, a vendor’s operations, or the services it provides. For example, if a new regulation is introduced that impacts the vendor’s activities, an immediate review may be warranted.

You can ensure you remain compliant with regulatory requirements while minimising the burden on the institution and its vendors by adopting a tailored approach to vendor compliance monitoring.

Responding to Vendor Non-Compliance with Regulatory Changes

When any vendor non-compliance is detected, your institution must take swift and decisive action to address the issue. Steps to contemplate include:

• Considering Contract Termination: In cases where the vendor is unable or unwilling to achieve compliance, you may need to consider terminating the contract. This should be a last resort as it can have significant operational and financial implications.
• Escalating the Issue Internally: If the non-compliance is severe or persistent, the issue should be escalated to your institution’s compliance committee or senior management. This ensures that the appropriate level of oversight is applied to the situation.
• Issuing Corrective Action Plans: You should work with the vendor to develop a corrective action plan that addresses non-compliance. The plan should include specific actions, timelines, and responsible parties to ensure compliance is achieved.
• Remediation and Collaboration: Your financial institution should explore opportunities for remediation, working with the vendor to address the root causes of non-compliance. This may involve providing additional support, resources, or training to the vendor.

By responding effectively to non-compliance, your financial institution can mitigate the risks associated with vendor relationships and maintain its regulatory standing.

Contractual Safeguards for Vendor Compliance with Regulatory Changes

To ensure that vendors comply with regulatory changes, your financial institution must carefully construct its contracts with those vendors. These contracts should include provisions that protect your institution’s rights and provide mechanisms for managing vendor compliance issues effectively. Key contractual elements to consider include:

Audit and Inspection Rights

• Clause Description: Include a clause that gives you the right to conduct audits or inspections of the vendor’s operations, particularly in relation to regulatory compliance. This right should extend to subcontractors if applicable. Regular audits help ensure ongoing compliance and identify potential issues before they escalate
• Practical Example: You could conduct periodic audits to verify that the vendor and its subcontractors are following Anti-Money Laundering (AML) procedures correctly.

Dispute Resolution Mechanisms

• Clause Description: In the event of a dispute over regulatory compliance, the contract should outline a clear dispute resolution process. This could include steps such as mediation, arbitration, or legal action, depending on the severity of the issue
• Practical Example: If there is disagreement over whether the vendor has met its compliance obligations, the dispute resolution clause would guide the process for resolving the issue, potentially avoiding costly litigation.

Indemnification for Regulatory Non-Compliance

• Clause Description: The contract should include an indemnification clause where the vendor agrees to compensate you for any losses or damages resulting from the vendor’s failure to comply with regulations. This clause protects your institution from financial losses due to fines, penalties, or other regulatory actions
• Practical Example: If a vendor’s non-compliance leads to a regulatory fine, the indemnification clause would require the vendor to cover the cost of the fine.

Requirement for Regular Compliance Reporting

• Clause Description: The contract should stipulate that the vendor must provide regular compliance reports, detailing their adherence to applicable regulations and any actions taken to address regulatory changes. These reports should be submitted on a predetermined schedule and reviewed by your institution’s compliance team
• Practical Example: A vendor might be required to submit quarterly reports on their GDPR compliance measures, including any updates made to their data protection protocols.

Right to Amend the Contract for Regulatory Changes

• Clause Description: Include a clause that grants your institution the right to amend the contract if necessary to comply with new or modified regulations. This ensures that you can quickly and legally adjust the contract terms to address regulatory changes without renegotiating the entire agreement
• Practical Example: If a new data privacy law is enacted, you could amend the contract to require enhanced data protection measures from the vendor without needing a full contract review.

Right to Terminate for Non-Compliance

• Clause Description: The contract should explicitly state that your institution has the right to terminate the agreement if the vendor fails to comply with applicable regulations. This clause should outline the circumstances under which termination would occur, such as failure to implement required changes within a specified timeframe or repeated non-compliance
• Practical Example: If a vendor fails to comply with AML regulations despite being given adequate time and notice, your institution could terminate the contract to avoid regulatory penalties.

Subcontractor Disclosure and Compliance Requirements

• Clause Description: Contracts should require vendors to disclose the use of any subcontractors and ensure that these subcontractors comply with relevant regulatory changes. The vendor should be held accountable for the compliance of their subcontractors, as any non-compliance could affect your financial institution
• Practical Example: If a vendor uses a third-party data processor, the contract should obligate the vendor to ensure that this processor adheres to the same data protection regulations as the primary vendor

Including these clauses in vendor contracts strengthens your ability to enforce compliance and manage risks associated with regulatory changes. By proactively addressing these issues in the contract, your institution can mitigate potential non-compliance risks and ensure that your vendors remain aligned with evolving regulatory requirements.

Updating Your Vendor Compliance Policies and Handling Contractual Knock-On Effects

To keep up with regulatory change, your financial institution must regularly update its vendor compliance policies and address any contractual implications. Key considerations include:

• Amending Contracts: When regulatory changes occur, contracts with vendors may need to be amended to reflect new compliance requirements. You should work with your legal team to draft and negotiate contract amendments, ensuring that the vendor agrees to the updated terms.
• Communicating Changes to Vendors: Any changes to compliance policies or contract terms should be communicated clearly to vendors. You should provide vendors with the necessary support to understand and implement the changes.
• Ensuring Compliance with New Terms: After updating policies and contracts, you should conduct follow-up reviews to ensure that vendors are complying with the new terms. This may involve additional training, audits, or monitoring.
• Regular Policy Reviews: Your institution should conduct regular reviews of its vendor compliance policies to ensure they reflect current regulations. This may involve updating existing policies, developing new policies, or retiring outdated ones.

By proactively managing policy updates and contractual changes, your financial institution can ensure that its vendor relationships remain compliant with evolving regulations.

Wrap-up

Ensuring vendor compliance with changing regulations in the financial services industry is a complex but essential task. Your financial institution must adopt a proactive and collaborative approach, working closely with your vendors to navigate the regulatory landscape and mitigate risks.

By following the strategies outlined in this article, you can enhance your vendor management practices, protect your operations, and maintain your regulatory standing in a rapidly changing environment.

In a world where regulatory expectations are continually evolving, no financial institution can afford to take vendor compliance lightly. By staying informed, communicating effectively, and maintaining rigorous oversight, your institution can ensure that its vendors remain compliant, safeguarding your reputation and your bottom line.

If you’d like to hear about how Gatekeeper can assist you in ensuring vendor compliance with regulatory change, don't hesitate to get in touch with us.