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    The European Securities and Markets Authority (ESMA) published a paper that examines the systemic risk posed by increasing use of cloud services, along with the potential policy options to mitigate this risk.

    Given the high concentration of cloud service providers, the paper examines the possibility that a single cloud service provider outage could generate simultaneous firm-level outages, posing systemic risk. The analysis uses operational risk data to simulate outages among central counterparty clearing members and show that cloud service providers need to be significantly more resilient than firms to improve the safety of the financial system and to compensate for concentration risk. The results of the analysis provide a framework to analyze the benefits and risks related to third-party outsourcing, which can be used by policymakers and regulators in the context of ongoing policy work on cloud service providers. The study also sheds light on the kind of data needed on outages to estimate risks and costs related to third-party outsourcing. The paper notes that use of cloud service providers typically improves the resilience of financial institutions at individual level, while concentration risk can lead to systemic risk due to a higher probability of simultaneous outages. 

    In financial settings where only longer (multi-period) outages impose systemic costs, cloud service providers can best address systemic risk by strongly reducing incident resolution time, rather than incident frequency. The analysis also shows that the use of an idealized back-up cloud service provider successfully mitigates systemic risk from cloud service providers. Back-up requirements may need to be imposed by policymakers, however, as the systemic risk is an externality to individual firms. The analysis also shows the need for detailed data on outages by financial institutions and cloud service providers; this will allow a better calibration of the model and improve the assessment of trade-offs between different uses of cloud service providers by firms. Given the ubiquity of cloud service providers and continuing migration to use of their services—a trend accelerated by the COVID-19 pandemic—it is crucial for policymakers and market participants to assess benefits and risks of outsourcing to cloud service providers. An important example in the European Union is the proposed Digital Operational Resilience Act, or DORA, that envisages a mandate for the European Supervisory Authorities, working with other authorities, to oversee third-party providers of critical financial services to address related systemic risks.

     

    Related Link: Paper (PDF)

     

    Keywords: Europe, EU, Banking, Securities, Basel, Lending, Cloud Service Providers, Cloud Computing, Operational Risk, Systemic Risk, Concentration Risk, Operational Resilience, Regtech, Financial Stability, DORA, Third-Party Arrangements, ESMA

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