The Hidden Risks Of 'Compliance With Applicable Law' Clauses In Financial Sector Outsourcing – When It Is Unclear Which Regulatory Framework Actually Applies To The Outsourced Service

The Hidden Risks of 'Compliance With Applicable Law' Clauses in Financial Sector Outsourcing – When it is unclear which regulatory framework actually applies to the outsourced service

1. Introduction

Outsourcing and service agreements in the financial sector almost invariably contain a clause requiring the service provider to comply with "all applicable laws". The wording appears uncontroversial and is rarely negotiated in detail. In regulated environments, however, the clause often fails to achieve its intended purpose, or the parties silently attach different meanings to it.

The difficulty lies in the fact that "applicable law" is not a single identifiable set of rules. Different legal rules define their scope of application by reference to different connecting factors. As a result, each party may assume that the other is responsible for complying with regulatory requirements that, in reality, have not been contractually allocated at all.

This article explains why the concept of "applicable law" becomes ambiguous in financial outsourcing arrangements and how this ambiguity can undermine regulatory compliance and contractual certainty.

2. The Operational Reality of Financial Outsourcing

Financial institutions, such as banks, investment firms or funds, rely on a broad ecosystem of external service providers. Core banking systems, cloud infrastructure, payment processing, data analytics and customer interfaces are frequently operated or supported by specialised IT and software vendors. For most institutions, financial services would no longer be possible without such third-party involvement.

This operational dependency is accompanied by an extensive regulatory environment. In addition to statutory law, institutions must consider supervisory guidance, circulars and other forms of soft law, as well as industry standards expected by regulators in practice. Against this background, outsourcing agreements commonly attempt to capture this framework in a single clause requiring the service provider to comply with "applicable law". Breaches are typically linked to significant consequences, including termination rights, liability exposure and mandatory disengagement from the provider.

At first glance, the clause appears trivial. Both parties assume that it merely confirms an obvious principle: each party must comply with the law. Yet it is often unclear which law is actually meant.

3. How Legal Rules Determine Their Scope of Application

Legal provisions do not determine their applicability according to a single uniform criterion. Instead, legal systems attach legal consequences to different connecting factors.

First, rules may depend on the characteristics of a person. Certain regimes apply because a party belongs to a legally defined category. Consumer protection applies to consumers but not businesses, employment law protects employees but not independent contractors, and certain disclosure obligations apply only to licensed professionals.

Second, the applicability of rules may depend on a specific activity. Many regimes apply whenever a defined service is carried out, regardless of who performs it. Operating a payment service, providing telecommunications services or offering financial advice may trigger obligations independently of the provider's general status.

Third, some rules apply because a party is in a particular factual position rather than because of status or activity. Duties may arise from control over premises, possession of data or the creation of a source of danger. The obligation is triggered by the situation itself, not by professional classification or regulated activity.

Accordingly, the question which law is "applicable" to a contractual relationship cannot be answered in the abstract. It depends on which connecting factor a given rule relies upon.

4. The Particular Complexity of the Financial Sector

In regulated financial markets, contractual compliance obligations operate in an unusually dense legal environment. Institutions must consider extensive statutory and regulatory frameworks alongside supervisory expectations and technical standards. At the same time, modern financial services depend on complex IT infrastructures and continuous data processing.

Nevertheless, outsourcing contracts frequently attempt to incorporate this entire framework through a generic obligation to comply with "applicable law". The parties often assume that this wording effectively binds the service provider to the institution's regulatory obligations.

Without further specification, however, the clause primarily refers to the law applicable to the service provider and its services. For an IT provider, this will typically include data protection, cybersecurity and general commercial law — not the institution-specific regulatory framework governing the financial institution itself. If sector-specific obligations are intended to be binding, they must be expressly identified. Service providers are generally neither able nor expected to independently analyse the full regulatory framework applicable to their clients, in particular if they operate in a highly regulated industry.

5. Diverging Interpretations of "Applicable Law"

The financial institution typically expects the service provider to observe those requirements it would have to meet if it performed the service itself. However, as a matter of contractual interpretation, a generic reference to "applicable law" does not incorporate the institution's regulatory framework. It merely refers to the law that already applies to each party independently.

For the service provider, this means compliance with the legal framework governing its own organisation and activities. For the institution, regulatory obligations arise from its legal status and regulated business activities. The clause therefore generally does not transfer any of the institution's regulatory obligations.

The result is a structural gap: the institution assumes the provider must comply with its regulatory framework, while the provider assumes it must comply only with the law directly applicable to it. In general, a proper interpretation of the contractual wording tends to support the service provider's understanding.

6. Drafting "Applicable Law" Clauses for Regulated Outsourcing

The solution is not to abandon the clause but to replace abstraction with allocation. The contract must distinguish between different categories of legal obligations and assign responsibility for each of them.

First, the service provider should comply with the legal rules directly applicable to its own organisation and services. For IT providers, this typically includes general commercial law, data protection and cybersecurity requirements.

Second, sector-specific regulatory obligations of the financial institution should be expressly identified and translated into operational duties. Rather than merely listing legal sources, the contract should define concrete actions such as cooperation duties, audit support, reporting obligations and technical safeguards.

The provider should not be expected to interpret complex regulatory regimes independently. The interpretation of the regulatory framework remains the responsibility of the regulated institution. A tailored definition of "applicable law" therefore becomes a mechanism for allocating responsibility: the provider complies with the law governing its services, while the institution specifies how its own regulatory obligations are implemented within the outsourced arrangement.

7. Conclusion

"Compliance with applicable law" is not a neutral boilerplate clause in regulated outsourcing. Without careful drafting, it merely confirms existing obligations while leaving critical regulatory responsibilities unallocated. Financial institutions should therefore review their standard outsourcing templates, and both parties should carefully address the allocation of responsibilities. Regulatory compliance cannot be achieved through abstract wording alone, but only through clear operational provisions within the contract.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.