A changing operational landscape

Tracking and processing corporate actions have become major priorities for many buy-side firms. Clive Davidson reports on the measures being put in place to manage the risks

Corporate actions is one of the last areas to receive attention, as asset management firms attempt to improve the efficiency of their back-office operations and reduce operational risks. Because corporate actions can be so diverse and complex, and involve communications back and forth between several parties, they are difficult to reduce to a simple set of standard formats and processes. But failure to effectively handle corporate actions can cost firms dearly, so there is now a concerted move in the industry to introduce some standardisation and automation.

Rights offers, conversions, stock splits, dividend payments and stock and cash mergers are just some of the 50 or more types of corporate actions asset management firms face. Furthermore, some are mandatory, some voluntary, while others have elements of both – for example, a dividend payment with a choice of stocks or cash. And corporate actions can involve everyone in the investment chain, from the issuer of the securities, to the exchange, the investors, the fund or asset managers and custodians. There are many points at which the process can go wrong, and the consequences can be severe.

“There are high risks associated with corporate action processing,” says John Caplice, IT programme manager at Dublin-based KBC Asset Management (KBCAM), which has e8 billion worth of funds under management. Getting an
action wrong, or missing a deadline can be costly to rectify. “To mitigate these risks, it is essential that a good infrastructure is in place for managing the corporate actions process,” he says.

Simon Still, chief operating officer at London-based private client investment manager and broker Brewin Dolphin
Securities, which has £17 billion under management, agrees: “Corporate actions is an area of operations where serious money can be lost,” he says. If a firm fails to notify shareholders about their rights to a new issue, or fails to pass on their instructions by the deadline, it can be responsible for the losses incurred. “The cost of buying the shares in the market after the deadline can be vastly different from the day of the listing,” he adds.

The difficulty in managing corporate actions lies partly in their diversity. “To date, it has been relatively easy to automate the trading and settlement process because of the high degree of standardisation that is possible. This has not been the case with corporate actions,” says Andrew Downs, director of investment operations at Newton Investment Management, the UK asset management subsidiary of Pittsburgh-based Mellon Financial, with £22 billion under management. “The terms of one corporate action can be very different from another, so
automating the reconciliation and instruction process has proved very difficult.”

The trend towards more global investment, with investors buying securities in many different regions and investment firms operating across regions, adds to the challenge, says Donal O’Brien, IT director of London-based back-office system specialist Wilco International. Countries can have different models of corporate actions, and there are issues such as tax and how it is applied and claimed.

Complexity can also be a problem, with events such as the reconstruction of stocks by a company following a major take-over, resulting in complicated, multi-faceted actions.

Investment managers will either monitor the markets for announcements themselves, typically using information services such as Exshare or Exbond from London-based FT Interactive Data, or the corporate actions feeds from London-based Exchange Data International, or they will receive the information from their custodians. The time taken to communicate the information up and down the chain – traditionally done by fax – creates further risk and is another of the main drivers for attempting to automate corporate actions processing.

“When dealing with large, complex corporate actions, the industry has needed to build sufficient slack into the various deadlines to allow all parties to complete their reconciliations,” says Downs. “These reconciliations typically contain a high level of manual input, so can take several days to undertake. As a general rule, as complexity increases, so does the time built in for reconciliations. While this is necessary to manage the op risk, it is unlikely to be desirable from an investment perspective.”

To reduce these risks and improve the efficiency of handling corporate actions, firms are now looking for technology to automate the process. Until recently, few specialised corporate actions applications have been available, but software suppliers are starting to introduce packages that will automate at least some parts of the process. Among the corporate actions automation packages that have recently come on to the market are eVent from HelioGraph, Radica CAPS from Mondas and SmartStream Corporate

Actions from SmartStream Technologies. All three specialise in technology for the straight-through processing of financial transactions and are based in London. US corporate actions software suppliers

include New York-based Financial Technologies International, and New York-based Xcitek and Alabama-based Solutions Plus, which offer a joint product called Xcitek Solutions Plus. Data management technology suppliers, such as Asset Control, based in the Netherlands, are also starting to offer functionality to support corporate actions.

Wilco has had a corporate actions module for its Gloss securities processing system for some time, and is developing a high-volume application to operate with Gloss or other processing systems. “What surprised us [during development] is that a full-blown corporate actions system is at least as complex as a back-office system,” says O’Brien.

Among the functions these systems offer are the collection of announcement data; its validation; the dissemination of the information to the securities holders and the request for their instructions; the collection of instructions and, where
applicable, their forwarding to the relevant custodians; the calculation of shareholder entitlements and confirmation of the actions.

Collecting and validating corporate actions data can be a complex task on its own. Newton, which is implementing the SmartStream product, deals with around 25 custodians. Some offer information electronically, but via proprietary links. Developing and managing 25 interfaces to the custodians’ systems is not viable, and furthermore, the formats the information comes in are not standardised. “So while we could in some cases draw the information down, it would be difficult to automatically extract it and push it into our systems in a cost-effective manner,” says Downs.

Following a corporate announcement, “the first stage is to ensure that custodians are in agreement as to what the terms of the corporate action are”, says Downs. “Custodians occasionally have different interpretations of a complex corporate action, or may impose different terms with regard to deadlines.”

Downs, like O’Brien and a number of other people in the asset management industry, believes a key step towards a solution to the problem of linking to multiple sources of information, and being able to automatically extract and compare it, is the use of a new International Organization for Standardization (ISO) securities messaging standard, ISO 15022. This is seen to have the structure and flexibility required to cope with the diversity and complexity of corporate actions, and has been adopted by Swift, the financial

industry messaging service provider. But it is early days, and only a few firms have implemented the new messages so far.
“ISO 15022 will be important in time,” says O’Brien. But until then, systems must work with the currently used formats, and be flexible to incorporate new standards such as ISO 15022 as they are adopted by the industry, he says.

The new corporate actions software packages also aim to help asset management firms automate communication with their clients. “All interactions about a corporate event must be linked and available in one place,” says Caplice, of KBCAM, which has purchased Heliograph’s eVent system to enable the company to implement “a straight-through process for corporate actions throughout all stages in the lifecycle – announcement, decision, instruction, entitlement and confirmation,” he says.

Brewin Dolphin has 34 offices around the UK, and it uses the Mondas Radica CAPS system to disseminate corporate
actions information to its portfolio managers, to collect the instructions in again and pass them straight through to the custodian or other nominee company. “Now, when we get [a corporate actions notification] we have it on every investment manager’s desk electronically,” says Still.

Because organisations keep inventing new ways of financing their activities and rewarding those that hold their securities, flexibility is a key requirement of the new corporate actions packages. “Some firms have in the past built their own applications, but a characteristic of in-house software is that while it can be tailored very closely to a particular firm’s business, it can prove inflexible,” says Caplice. The HelioGraph eVent system can handle a variety of messaging types, including Swift and the Financial Information eXchange.

Later this year, custodians, investment managers and broker-dealers in the US should have a new corporate actions
service available to them. The central securities depository and clearing organisation, Depository Trust & Clearing Corporation (DTCC), plans to launch a Global Corporate Actions Hub (GCAH) – an internet-based clearing facility for corporate actions announcements and instructions. The system, which is in the final stage of testing, will provide access via browsers for single messages, or file transfer for multiple messages, and will support the use of ISO 15022 messages. Custodians will be able to send notifications to investment managers via the GCAH, which will consolidate information from various custodians and forward a single message to the investment manager, says Lorraine Morrison, head of the GCAH project at the DTCC. In return, the investment manager can reply with a single message and the hub will disseminate the relevant information to all the custodians. The first end-user application to interface with the GCAH is Xcitek Solutions Plus, and the DTCC is in discussions with other third-party software suppliers to develop interfaces in the near future, says Morrison.

As with all financial services’ straight-through processing projects, automating corporate actions involves electronically linking many organisations, and standardising the way they communicate. Such projects cannot be completed overnight, and it will be some time before things such the ISO 15022 messages and the GCAH are widely used. In the meantime, firms can look at the new third-party applications to see how these might help them improve the efficiency with which they handle corporate actions within their own environments and thereby reduce their op risks.