Last week, in an FTF News story about a new white paper from financial messaging cooperative SWIFT, I focused on the toll that regulatory compliance is taking on financial services firms. I wasn’t able to delve into the corporate actions section of the SWIFT paper but I can do that now.
As I noted, the white paper’s findings are based on surveys of buy-side firm grappling with a variety of burdens with operations. One of the big burdens is corporate actions processing, which is labeled as “the least efficient aspect of post-trade services” by the report.
The SWIFT paper acknowledges that “the process of clearing and settling transactions in the capital markets, especially in the major asset classes of equities and fixed income,” are experiencing major improvements in operational efficiency.
“The same cannot be said of corporate actions,” according to the report. “Efforts to make corporate actions processing more efficient, in terms of issuing clear notifications to investment managers and executing their instructions as late as possible, have yet to succeed.”
The report cites several factors that have undermined efficiency in corporate actions processing such as the lack of “direct regulatory pressure for improvements in corporate actions.” Another barrier is the simple fact that a lot of constituencies have to come to agreement on a way forward — issuers, data vendors, stock exchanges, stock registrars and investors, and sub-custodians and global custodians. Building a consensus for reform among them is going to be difficult according to the report.
“Corporate actions, other than straightforward dividend or interest payments, are also intrinsically complicated,” according to the report. “This is partly because they reflect the laws applying in the domicile of the issuer, and partly because issuers and their corporate finance advisers can create complex options that are hard to standardize into corporate actions message templates.”
The report finds a ray of hope in the fact that managing corporate actions represents “a data processing challenge that can be overcome.” The key is to reduce variations in the data processed by custodian banks. “This is an issue the banks have an interest in addressing, because these inefficiencies also increase their operating costs, and expose them to potential additional costs of reimbursement for losses of value incurred as a result of missed or incorrect corporate actions instructions,” the report finds.
Another area of reform is the creation of consistent terms for corporate actions at the point of issue, according to the report’s authors.
“Investment managers point to problems as a result of the lack of use by market participants of established message standards and market practices in the description of corporate actions such as rights issues, scrip dividends, class actions, and merger and acquisition offers, and the variations in the ranking and presentation of options by custodians and data vendors that notify them,” report finds. “As a result, there are persistent inconsistencies between issuers, stock exchanges, custodian banks and data vendors. One manager says he has to use a third party system to re-process corporate actions information received from custodians, because so many different formats are used.”
While corporate actions message standards exist, some key players do not adhere them. “Investment managers say that corporate action message standards are now well-documented, and problems arise in interpreting and processing notifications and instructions because custodians and data vendors fail to adhere to them,” according to the report. “This is partly because the agreed standards are considered to be inherently flexible, but even in areas open to interpretation, well documented market practices exist to help custodian banks and data vendors populate fields correctly.”
By not adhering to the standard, firms are inhibiting automation. The report mentions a manager who retains an internal team of 20 people to process corporate actions that receives conflicting data about the same event from as many as 30 custodian banks.
“All corporate actions processing is handled by our outsourced providers,” according to an investment manager quoted in the report. “They will send corporate action decision requests to our portfolio managers, and chase for a response in line with the custodian deadlines. The process between our suppliers and the front office is manual.”
The authors of the report conclude that there is “unequivocal support” for standardized messages using verified data from a single utility. “We would be interested in buying a `golden source’ of record,” says an investment manager in the report. “There should be an industry utility.”
Rather than a single utility, buy-side managers pull corporate actions data from custodians and data vendors and then have to validate the data for consistency and have to reconcile the data. “30 versions of the truth have to be reduced to one for the portfolio manager to consider, and then his decision has to be converted back into 30 separate sets of instructions,” says a manager.
The paper also finds that buy-side managers want regulators to facilitate a “trusted utility” governed by regulators that “impose a binding set of rules on issuers and their advisers to publish corporate actions in standardized formats that can be automated.” A user-owned, user-governed utility “feels like the way forward,” according to one industry participant. “Everybody wants competition but, once you get competition, you get variation in standards.”
Of course, the conclusion begs the question of which industry entity could take on the role of a “user-owned, user-governed” utility to oversee the publishing of standardized corporate actions.
A huge groundswell of support from buy-side firms fed up with the current situation will eventually provide clarity on that point. As the buy side continues to feel the heat for more post-trade operational efficiency, they will have to finally reconsider their current situation with corporate actions processing.
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