With the recent development of the service outsourcing industry, an increasing number of financial institutions (including banks, securities companies, insurance companies and fund management companies) use financial service outsourcing to reduce costs, enhance core competitiveness, and accomplish strategic goals. Financial institutions are able to benefit significantly from IT outsourcing, which is an important part of financial service outsourcing. At the same time, they must also confront the managing risks that are associated with IT outsourcing. Based on our past experience with counseling on IT outsourcing to financial institutions, the followings are the primary legal issues relating to the terms in and execution of IT outsourcing agreements, using banking institutions (”banks”) as examples. The discussion will focus on how banks should manage potential risks from negotiating such an agreement.

I. Scope of Outsourcing by and Management Responsibilities of a Bank

A. Scope of Outsourcing

The scope of outsourcing is the first decision a bank needs to make before outsourcing its services. Currently, the China Banking Regulatory Commission (”CBRC”) has not established general restrictions regarding the scope of IT outsourcing that a bank can engage in. However, a bank should not outsource its IT technology management responsibilities and must report to the CBRC or its branch offices any important outsourcing engagement (see below Section I Subsection C, Report to Supervisory Authority or Notice to Client). Therefore, relevant supervisory authorities may not permit a bank to outsource the management or maintenance of some of its highly confidential or core information systems.

B. Cross-border Outsourcing

In recent years, a number of financial institutions have engaged outsourcing service providers in India, China, and other developing countries because of the lower labor and operational costs in these countries. However, the accumulation of outsourcing service to one or a few countries may amplify the “Country Risk” of the information. Once an offshore outsourcing country faces an incomprehensible problem, the financial institutions outsourcing their business to such a country may suffer irreparable harm. Therefore, the supervisory authorities in many countries tend to take a cautious regulatory approach towards the cross-border outsourcing implemented by banks.

The CBRC’s Guidelines on Risk Management of Outsourcing by Banking Institutions (”Risk Management Guidelines”) require that a bank which conducts cross-border outsourcing shall prudently assess the legal and regulatory risks to ensure the security of the clients’ information. The Risk Management Guidelines also establish that such a bank must make sure the regulatory authority at the place where the service provider is located have signed a memorandum of understanding or other agreements with China’s banking regulatory authority. Moreover, the CBRC’s Guidelines on Risk Management of Commercial Banks’ Information Technology (”Technology Management Guidelines”) require that the board of directors shall ensure a bank operates the core system containing client information, account information and product information independently and within the territory of China.

C. Report to the Supervisory Authority or Notice to Client

According to the Technology Management Guidelines, the banks shall exercise precautions when implementing important outsourcings (such as data centers and information technology facilities), and shall report these outsourcings to the CBRC or its branches in writing. In addition, the Guidelines require that any outsourcings involving client information be deemed an important outsourcing of the bank. As the existing PRC law is unclear about the definition of “important outsourcing,” we suggest that the banks consult with the competent supervisory authority at their domicile if they are uncertain about whether the outsourcing to be performed will be regarded as an important outsourcing subject to reporting duty to CBRC.

The Administrative Rules on Electronic Banking (”E-Banking Rules”) provide that banks shall report any outsourcing of electronic banking. According to the E-Banking Rules, a bank shall report to the CBRC before outsourcing the general design and development of electronic banking transaction processing system, authorization management system, data backup system, and other confidential information management and transmission systems.

In addition, the Risk Management Guidelines require the bank to submit an outsourcing appraisal report to the local branch of the CBRC regularly. However, banks will need further clarification or detailed guidance of the relevant authority on compliance.

In addition to the responsibility of reporting to the supervisory authority, in certain circumstances, the banks also need to inform the relevant clients about their outsourcing arrangement. For example, the Technology Management Guidelines require that a bank shall notify clients any outsourcing involving the client information.

D. Internal Approval

According to the relevant regulations, all IT outsourcing contracts of a bank shall be approved by the bank’s department of information technology risk management, legal department, and its information technology management committee. Certain IT outsourcing contracts may require the approval of the board of directors.

E. Compliance of Offshore Regulatory Authority

When implementing outsourcing, the foreign-invested commercial banks in China shall comply with the requirements of the CBRC as well as those of the regulatory authorities in their home country. Therefore, these banks need to manage the risk arising from the regulatory difference between China and their home country.

II. Summary Terms of Outsourcing Contracts

The CBRC requires that banks must enter into IT outsourcing contracts when engaging IT outsourcing services. The contracts shall be in written forms and clearly provide the rights and responsibilities of the parties. An IT outsourcing contract usually consists of the outsourcing agreement and the service level agreement.

A. Outsourcing Agreement

An outsourcing agreement shall at least contain the following terms: (1) the scope and standards of the outsourcing service; (2) the confidentiality and security of the outsourcing service; (3) the continuity of the outsourcing service; (4) the auditing of and inspection on the outsourcing service; (5) the dispute resolution arrangement of the outsourcing service; (6) the transitional arrangement upon revision or termination of the agreement; and (7) the liabilities in case of default.

The outsourcing agreement shall have both effective binding force on the parties and a certain amount of flexibility. An inadequate outsourcing agreement may lead to uncertainties during the service provider’s performance of the IT outsourcing service. In practice, some outsourcing agreements do not include detailed provisions to govern the service provider’s performance, quality of service, and rights and responsibilities of the parties. In this case, disputes may arise and the business that the bank outsources may be at risk if the parties are unable to timely execute supplementary agreements to address new situations, issues, and risks that arise during the performance of the outsourcing agreement. For these reasons, the banks should strive to make the outsourcing agreement as clear, specific, and meticulous as possible when drafting the agreement. However, due to the nature of IT outsourcing, a bank’s need varies in different phases of business development (especially when two parties have established a long-term cooperative relationship). Therefore, the parties may need to amend the agreement as needed to make sure the performance of the agreement will not be affected. If the outsourcing agreement lacks flexibility, the time budget and financial costs that the parties will need to bear for additional negotiations may increase significantly. The continuity of the bank’s business may also be compromised. Therefore, the outsourcing agreement should be flexible enough to be amended to adapt to the new situations appearing during the execution of the agreement.

B. Service Level Agreement

The service level agreement is entered into by the bank that plans to outsource its business and the outsourcing service provider regarding the assessment of business performance and service quality. The purpose of such an agreement is to evaluate, monitor, and control the operational and financial risks in relation to the IT outsourcing service. A reasonable and meticulous service level agreement is an integral part of a sophisticated IT outsourcing agreement. As an internationally accepted standard to evaluate IT outsourcing service, the service level agreement is a legal document executed by the bank and the service provider and is crucial to the bank’s supervision and management of the service provider.

CBRC requires that a bank considers the following factors when drafting a service level agreement: (1) whether the agreement has established qualitative and quantitative performance indicators to evaluate the service provided to the bank and relevant clients is sufficient; (2) whether the agreement appraises the performance of the service provider through the service quality report, periodical self-evaluation, and internal or independent external auditing; and (3) whether the agreement includes any steps to help the service provider to improve the procedures and performance when the service provider is unable to meet the agreed standards or indicators.

In practice, Chinese banks and their outsourcing service providers are inexperienced in formulating service level agreement. Therefore, the established terms might not suffice in protecting the interests of the parties. For example, the agreement may not include a term to protect the bank’s interests where material technical errors arise during the outsourcing service provider’s performance of the agreed service. In essence, both parties should exercise due care when formulating the service level agreement to ensure that the agreement is able to provide good protection to both parties.

As IT outsourcing for financial institutions in China continues to develop, relevant supervisory regulations are being updated and improved to keep up the latest development of the IT outsourcing practice of banks. Similar to the IT outsourcing of banks, the IT outsourcing of securities companies, futures companies, fund management companies, and insurance companies also involve many important legal and regulatory issues. The financial institutions engaging in IT outsourcing services shall effectively manage their outsourcing contracts to control the risks and make sure that the performance of these contracts will not compromise their responsibilities to the clients and the supervisory authority, as well as their compliance with regulatory requirements.

Source:http://www.mondaq.com/article.asp?articleid=109256

No topic continues to remain as hot in the tech industry and the world at large than the impact of China and India. Curiosity grows manifold when one learns that Indian IT companies are doing brisk business in China. They are doing this by servicing multinational clients which have expanded operations in China and need support. Homegrown tech majors are also using China as a service delivery location for their customers in Far East such as Japan, Korea, Taiwan and even the US. Tapping the domestic

Chinese market which has robust demand for services and solutions is equally high on the agenda for Indian IT majors.

Perhaps Tata Consultancy Services (TCS), India’s largest IT services firm, best exemplifies the success story of an Indian IT company emerging from mainland China. TCS pioneered the entry of Indian IT industry in China in 2002 and remains at the forefront of that thrust with 1,200 consultants, of which 92% are locals. “We believe in attracting and developing local talent,” says Girija Pande, chairman of TCS for the Asia Pacific region.

Today, TCS China is serving over 30 global and domestic clients from financial services, manufacturing, telecom as well as the government sector. Some of the key clients are: Eaton, Motorola, Cummins, China Foreign Exchange Trade System (CFETS), Guangdong Provincial Rural Credit Cooperative Union (GDRCC), Bank of China, China Trust Bank, Hua Xia Bank, among others.

Early this month, India’s largest software exporter enhanced its delivery capability in China by opening an offshore global delivery centre in Shenzhen. This is TCS’ fifth global offshore delivery centre in the Middle Kingdom, after facilities in Beijing, Shanghai, Hangzhou and Tianjin. The new Shenzhen delivery centre is aimed at strengthening TCS’ presence in the South China market and will be the preferred offshore delivery centre for TCS China when delivering projects to Asia Pacific markets. The Shenzhen delivery centre will also focus on providing local service to customers in the region and is expected to create more business opportunities for TCS in Guangdong and Shenzhen.

“TCS considers China as a strategic country and we are going to be there for a long time. In fact, there can be no Asia Pacific strategy for any company without China,” says Pande. After all, globalisation of the Chinese economy is leading to a growing need for modern software with the latest features and improved functionality. “Their domestic IT services market is double the size of Indian market. Given the transformation that is taking place, we see China as a market with huge domestic opportunities. Our strategy in China is a three-pronged approach to expand business: Service the multinational clients which have expanded operations in China and need support; Create China as sourcing base for servicing neighbouring market such as Japan, Korea and Taiwan; Tap the domestic market which has demand for services and solutions.”

Without any doubt, IT spending is rising quickly in China. Chinese companies are looking for support in IT services as they globalise. Gartner analysts say that Chinese enterprises have historically preferred to develop applications using their own labour because it costs less. However, this tendency has resulted in legacy and quickly obsolete software as well as inhibiting Chinese enterprises’ sustainability and business IT continuity. Growth will mainly be driven by replacing immature infrastructure with standardised systems. Manufacturing, financial services, telecommunications and government will remain top spending sectors.

It is obvious that Indian IT firms stand to benefit. Gaurav Gupta, managing partner, India, Everest Group says, “The market for IT outsourcing in China is about $15-20 billion, dominated by China to China outsourcing and regional support for Far East. The industry is growing rapidly in China and is expected to double in the next 3-5 years.” He adds: “The China to China outsourcing is predominantly being done by local Chinese suppliers, but increasingly global and Indian players are making inroads into the local market. However, most of these inroads are through the China operations of global clients as opposed to relationships with local Chinese companies or the government. TCS has probably made the most progress in local Chinese market relationships, as it formed a strategic partnership with the government that has given it access to the local market.”

Interestingly, it was in 2005 that TCS was invited by the Chinese government to form a joint venture—TCS China—to create a large scale global offshoring base in China, at the Z-Park in Beijing, providing IT outsourcing services and solutions to both the global and domestic market. The joint venture, supported by National Development and Reforms Commission (NDRC), leverages the strengths of the different partners in technology, software development, and consulting, including the best-of-class processes and practices of TCS. TCS Asia Pacific owns the majority stake of the company with 72.2% and the three Chinese partners—Beijing Zhongguancun Software Park Development Co Ltd, Tianjin Huayuan Software Park Construction and Development Co, Ltd, and Dayong Software Co, Ltd—supported by NDRC hold the remaining 27.78%.

TCS is not the only Indian IT major making rapid strides in the Middle Kingdom. Infosys Technologies is equally bullish on the business prospects emerging from India’s neighbour to the North. Srinath Batni, member of the Board, Infosys Technologies, says, “Infosys acknowledges the rapid economic growth and the vast talent pool available in the region and envisions building a world-class delivery hub in China. Infosys aspires to be one of the best consulting companies in China and a trusted partner to the clients in China to implement solution with global best practices.”

Infosys Technologies (China), headquartered in Shanghai started operations in 2003 with a view to become a world-class delivery hub offering IT-enabled business solutions in China. Batni says, “Over the years, the clients in China have expressed confidence in working with the company. Infosys has experienced a very positive business sentiment in China. Infosys China has seen rapid growth since its inception. The company operates today with over 2,600 employees from its two development centres at Shanghai and Hangzhou. 95% of the employees are Chinese nationals.”

In a smart business strategy, Infosys China has carefully laid the right foundation and groomed a good talent pool with processes, technology and tools to provide services to clients. It services over 80 clients in the region across sectors including banking and capital markets, high tech, manufacturing, automotive, retail industries, healthcare, and pharmacy. The company works with companies in all sectors, but has a special focus on the financial services, manufacturing and retail industries, Batni informs.

Going forward, Infosys is establishing a China Education Centre to develop software talent in research and education institutions at Jiaxing Science City (JSC). It is pertinent to note that Jiaxing is set to become a talent hub for IT and BPO industries as it is strategically located between Shanghai and Hangzhou. Accordingly, Infosys will train 1,000 engineering graduates from universities for entry level positions, and conduct soft skills and leadership training programmes for more than 2,000 employees annually at the China Education Centre. In addition, the centre will train the computer science faculty of Chinese universities in new and emerging technologies.

According to Virender Aggarwal, senior vice-president and head of APAC-MEA markets, HCL Technologies, China’s consistently high GDP growth has helped make it one of the largest economies in the world. The aptitude to augment this growth by leveraging technology opens up abundant opportunity and compelling long-term growth prospects for IT service providers. “This is especially evident in the IT industry where margins are coming down and buyers are increasingly cautious in the US and European markets that we have to look for new avenues of growth. China is also attractive from the perspective of a service delivery destination due to the talent availability and labour arbitrage. Hence the prospects of servicing customers near shore at close to offshore rates makes it more attractive,” he says.

“China is a large market that no large IT service provider like us can ignore. Using China as a service delivery location for the customers in Far East and the US is a good entry strategy employed by many IT service players,” says Aggarwal. However over the last decade, the customer base has been increasing specifically for the Indian IT service companies. “At HCL, our customer base in Greater China now has both Chinese local organisations as well large MNCs which we are servicing globally from China. However, going forward we would leverage our learning to tap deeper into the local China market even more aggressively.”

HCL Technologies has more than 150 consultants stationed in China servicing over 25 customers, which includes one of the world’s largest investment banks, a global contract manufacturing company, world’s largest aircraft manufacturing company, world’s largest mobile phone company.. The company’s operations include enterprise applications, maintenance and operations, application development, vertical services and infrastructure management. “We officially launched our Shanghai centre in 2007. The journey has been an interesting one, more of persistence and learning than abrupt results, which definitely has helped us gain the knowledge to build and deepen further into the markets gaining celerity in recent times,” says Aggarwal.

“All the key customers mentioned has been a difficult task to crack through given the unique nature and needs of the market. However now we have the right ingredients which includes strong reference customers, local talent and market understanding to move to the next level of growth,” says Aggarwal. “We plan to develop China into one of our key global delivery centre, which will comprise mostly of Chinese locals.”

To win in the new marketplace, companies must drive customer value, collaborate, combine the strengths of multiple cultures and take advantage of economies of scale on a global basis. As the Indian IT companies look to reduce their dependence on the US and European markets, they are demonstrating their innovative skills to penetrate and thrive in the Chinese market. In short, China is the mega opportunity round the corner.

Source:http://news.in.msn.com/business/article.aspx?cp-documentid=4322209