Financial Markets Operations Management (43 page)

A few years ago, Exchange Data International posted the following quotation on its website:

“In most Financial Institutions the current process for handling corporate actions is predominantly paper-based, difficult to manage, open to discrepancy, both time and labour intensive and does not form part of the Client Management process.”

This quotation is no longer on the website, but the challenges noted do still exist, even in an era where much of the operation processing is reasonably standardised and automated.

We will consider the risks brought about by a “… predominantly paper-based, difficult to manage, open to discrepancy, both time and labour intensive…” array of processes.

The main sources of risk within corporate actions can be summarised as follows:

• Data/information risk;
  
• Replacement risk;
  
• Decision-making/election risk;
  
• Reputational risk;
  
• Reconciliation risk.
  

We set out below our thoughts on the main sources of risk.

There are almost as many ways in which issuers disseminate information on corporate actions as there are markets around the world. There is a varying degree of standardisation: better in the developed markets but less so in the developing/emerging markets. Lack of standardisation leads to manual interventions rather than automated information capture, with the data having to be checked to ensure accuracy (also known as
data cleansing
).

Global custodians will check the same information, as supplied by different suppliers/vendors, at least twice.

Message standards such as the introduction of ISO 15022 and latterly ISO 20022 have certainly helped the situation. So has participation by the buy-side in the SWIFT system, and more recently by non-bank financial institutions and larger corporates. This was a major change from the original policy of “banks only” participation in SWIFT.

We saw in the communication chain just how challenging it can be for the issuers to notify the investors, through many different parties, with sufficient time for the investors to understand the information and take the required action in order to settle the event.

This is the risk associated with the efforts, costs and embarrassment of missing an event which the investor has instructed its custodian to accept. As we saw with the missed rights issue, the financial costs can be significant.

This risk applies to voluntary events, both announced and predictable. Where an election decision has been delayed or a date has been missed, financial loss is almost certain and can be very expensive depending on the circumstances. Examples are shown in
Table 11.31
.

Not only should corporate actions systems help in the processing of any event, but they should also provide warnings of impending dates and deadlines, with appropriate escalation as the absolute deadlines approach.

The reputation of the investor's agent (fund manager, custodian, etc.) can be irreparably damaged if there are frequent mistakes made. Clients might leave or seek damages through litigation, the Front Office might lose trust in its Corporate Actions Department and, if clients are constantly being disadvantaged, the regulator might fine and censure the company.

Positions that are subjected to a corporate action event of any type should be reconciled at the start of the event and at the close of the event. Some events that take a considerable amount of time (e.g. class actions and takeovers) should be reconciled on a regular basis with reference to the Front Office or investor. This ensures that the correct amounts of shares or bonds are identified, market claims initiated/responded to and received/delivered as required.

In spite of the risks and complexities associated with corporate actions activities, industry initiatives to improve corporate actions do not appear to have kept up with, say, clearing and settlements. The move to T+2 settlement is just one example of the drive to standardise this part of the operational function across markets.

As long ago as 1990, work by the International Securities Services Association (ISSA) identified some weaknesses in this area and since then, various associations and working groups have attempted to introduce changes to the ways in which corporate actions activities are processed.

Furthermore, in 1990, KPMG Peat Marwick McLintock
⁸
made several observations on the subject, including: “Problems (with decision-making/elections) normally arise when the custodian receives late notice of clients' intentions.” and: “Failure to action instructions quickly will, in most cases, result in financial loss, interest claims and poor client relations.”

You will see in this section which entities have been involved, what they have recommended and what still needs to be addressed.

ISSA was founded in 1979 in response to the need for an organisation that could: “…disseminate information in the rapidly changing securities markets…”.
⁹
In 1990, it agreed a number of recommendations during its biennial Symposium §5 (ISSA 5), including recommendation 5:

By the time ISSA 6 was held (in 1992), many of the then current practices and shortcomings had been identified and a proposal was made for the standardisation of “Types of Corporate Actions”.
¹⁰
For example, in choosing between a “capitalisation issue” and a “bonus issue”, ISSA remarked that: “The designation ‘bonus issue' is somewhat misleading, since a conversion of reserves into capital stock takes place, i.e. the shareholder does not receive shares as a ‘bonus'”.

In addition, terms of reference for a new Working Group for Corporate Actions (and Proxy Voting) were drafted. By May 2010, the Working Group had finalised its Global Corporate Actions Principles as its: “…contribution to align current industry efforts to achieve a more efficient global corporate actions processing environment”.

The Working Group, by now under the chairmanship of Citibank's John Kirkpatrick, published a Progress Update Report in September 2013. In Section 2, the report highlighted the progress made since the previous update in 2012. In summary, three areas were described:

1. Efforts were largely unsuccessful in trying to persuade the issuer community to promote the Principles, as it did not regard them as being its problem.
   
2. As a result, the Working Group decided to approach CSDs and stock exchanges and persuade them to become the primary agencies for centralising corporate actions information in their individual markets. The CSDs have been surveyed on this matter.
   
3. Significant progress has been made in the paperless automation of corporate action processes once the data have been digitised. The industry take-up of the ISO 20022 standard has helped by enabling higher automation rates.
   

If corporate actions are of particular interest to you, the following files are available from the ISSA website (
http://issanet.org
):

• Global Corporate Actions Principles – Report (May 2010);
  
• Annexes to the May 2010 Report;
  
• Global Principles for Corporate Actions and Proxy Voting: Progress Update Report (September 2013).
  

Dr Alberto Giovannini, CEO of Unifortune SGR Spa, was asked by the European Commission to: “…address the most basic pillar of the infrastructure that supports financial markets: the
system that ensures that securities exchanged within the European economy are properly delivered from the seller to the buyer”.

In the first of two reports published in November 2001, the Giovannini Group identified fifteen so-called
barriers
to efficient cross-border clearing and settlement in the EU. Regarding corporate actions, Barrier 3 held most relevance; it suggested that rules on corporate actions (and other areas) should be harmonised at the EU level (see below).

In the second report (April 2003), the Group considered what actions should be taken in order to remove the problems identified in the first report. It identified two fundamental aspects:

1. The variety of rules, information requirements and deadlines for corporate actions, and
   
2. The rules and laws governing securities markets.
   

The report mentioned that one of the European Central Securities Depositories Association's Working Groups had looked at the use of ISO 15022 guidelines for the creation of information dissemination templates.

The ECSDA was formed in 1997 and provides: “a forum for CSDs to exchange views and take forward projects of mutual interest” (see below).

Working as part of the so-called Broad Stakeholder Group (BSG),
^11
11
in February 2013 the ECSDA published its 5th Implementation Progress Report/2012 Activity Report on the dismantling of Giovannini Barrier 3.
^12
12

The BSG made a commitment to: “…steer, monitor and coordinate private sector actions towards a comprehensive and timely application of the Market Standards for Corporate Actions Processing…”.
^13
13

The full text of the Standards can be found on the European Banking Federation's website.
^14
14
This is a very detailed document, but the subject matter covers the following areas:

• The information flow throughout the chain of relevant parties;
  
• Key dates and their sequence;
  
• The operational processing of corporate actions.
  

And looks at:

• Information from issuer to issuer (I)CSD;
  
• Information from the issuer (I)CSD to its participants;
  
• Information flow from (I)CSD participants to end investors;
  
• Key dates; and
  
• Processing
  

… for the following categories of corporate actions, as well as transaction management:

• Distributions
  
  • Cash distributions (e.g. cash dividend, interest payment);
    
  • Securities distributions (e.g. stock dividend, bonus issue);
    
  • Distributions with options (e.g. optional dividend).
    
• Reorganisations
  
  • Mandatory reorganisations with options (e.g. conversion);
    
  • Mandatory reorganisations (e.g. stock split, redemption);
    
  • Voluntary reorganisations (e.g. tender offer).
    
• Transaction management
  
  • Market claims (distributions);
    
  • Transformations (reorganisations);
    
  • Buyer protection (elective corporate actions).
    

The implementation of the Standards is being addressed by the European Market Implementation Group (E-MIG). Two of the conclusions that the E-MIG came to in a workshop held in November 2012 were that:

• Overall progress in implementing the Standards is steady but slow; however, efforts towards acceleration would most likely result in unwanted cutting of corners.
  
• The prioritisation of Standards is deemed helpful to applying limited resources in a focused manner; an additional prioritisation for markets with a lower level of implementation is not deemed advisable.
  

The reported levels of implementation are shown in
Table 11.32
.