(Originally published as All together now.)
Today an equity trade can move from the mind of a portfolio manager through execution and then to the back office almost without being touched by human hands. In the U.S. stock market, at least, computers often trade with other computers, and then still more computers clear and settle the trades. Straight-through processing is on its way to becoming a reality.
Handling a stock-for-stock merger is another matter. Investment managers and global custodians must rely on printed prospectuses -- or even newspaper advertisements -- for information on such events, and instructions for handling them are often relayed by telephone or fax, raising the risk of missing an important deadline. Recently, however, market participants have begun tackling the difficult issues involved in automating “corporate actions,” or changes to the capital structures or financial positions of issuers that affect any securities they have already issued. The most common corporate action is the dividend; others include more complex activities, such as rights issues, tender offers, conversions, acquisitions and mergers and early redemptions.
“One of the last areas of the back office to be automated is corporate actions, and it is also an area that has one of the largest risk potentials,” says Linda Book-heim, senior business manager for partner solutions with responsibility for corporate actions at SWIFT, the financial-industry-owned messaging utility headquartered in Belgium.
Handling corporate actions is a multistep process fraught with the risk of error. An action is typically announced by an agent, such as an investment bank, and disseminated by such market data services as Bedford, Massachusettsbased FT Interactive Data; the typical big custodian subscribes to seven such services. The custodian, through a vendor or with its own personnel, checks the notifications against one another and sends a “golden record” along to fund managers and investors -- who may or may not notice it. Many corporate actions require a timely response, which often arrives very close to the deadline. Those instructions go to the issuer, which then settles the event with delivery of cash or securities and concludes with reconciliation. Information about the actions and instructions for responding travel to and from the fund manager by mail, fax, electronic message or even telephone, multiplying the risk of losing information.
In a 2004 study commissioned by New Yorkbased clearance and settlement utility Depository Trust & Clearing Corp., U.K.-based consulting firm Oxera said that the investment management and global custody industries face multibillion-euro exposures in processing corporate actions. And although fund managers may in the past have been content to write off the occasional small loss, new rules imposing a higher level of fiduciary responsibility, like Sarbanes-Oxley, are concentrating attention on corporate actions.
The volume of corporate actions, and thus the burden of responding to them, is growing. DTCC -- the biggest processor of corporate actions in the world -- says the volume worldwide rose 77 percent in dollar terms in the five years ended in 2004. The value of global mergers and acquisitions rose 43 percent in the first nine months of this year.
Countries’ requirements for releasing corporate action information vary and in some cases are nonexistent. “In Australia you will only be able to understand what the issuers are putting into corporate events by reading the newspapers,” says Aaron Overy, London-based marketing manager at CheckFree Corp., a Norcross, Georgiabased company that offers corporate action automation software. European countries, meanwhile, have made no improvements in harmonizing business law to make handling corporate actions easier, says Tim Lind, senior vice president of product strategy at GoldenSource, a New Yorkbased vendor of data management tools for financial services companies.
Fully automating corporate actions will require the adoption of standards; flexible technology; cooperation among brokers, custodians and asset managers; time to agree upon common market practices, such as methods of instructing custodians to transfer securities; and a significant back-office investment by an industry that would rather spend its IT dollars on trading systems.
End-to-end automation remains years away for most firms, but the industry is making progress. Vendors such as CheckFree and Zurich-based market data firm Telekurs Financial are providing corporate action systems built around the International Organization for Standardization’s ISO 15022 message standards. The standards, mandated in November 2002, make these vendor systems more flexible and easier to implement. The Geneva-based ISO’s Securities Standards Evaluation Group and other industry committees are working to define standard messages that can be processed electronically, says Karla McKenna, New Yorkbased vice president of Citigroup’s global transaction services and co-chair of the Global Securities Market Practice Group.
Working out carefully defined standards takes time, says McKenna. “We have been working on it for three quarters and are very close to completion,” she says. “That’s a year’s worth of effort to try to make sure the definitions and usage are unequivocal.”
“Because you have uncommon systems across the industry, coming to agreement takes a lot of time and effort,” says Tim Sheeley, Dallas-based vice president in securities processing for J.P. Morgan Chase & Co.'s worldwide securities services unit. “I think you will start to see the fruits of that in the next two to three years.”
The problems start with issuers, which don’t necessarily think about how a corporate action will be processed. “Investment bankers like to create new ways of organizing capital, which leads to events the world has never seen before,” notes GoldenSource’s Lind.
One goal of the myriad committees now operating around the world is to get investment bankers to think about how corporate actions get processed. The complex terms and conditions in a 90-page prospectus can’t always be easily inserted into the fields of a standard SWIFT corporate action message.
One way to attack the problem is to digitize the prospectuses. Automatic Data Processing, a securities processing firm based in Roseland, New Jersey, has developed a Web site where users can view and search a prospectus and even grant other parties access to a file in the ADP library. J.P. Morgan, an avid user, has been able to customize the site for its clients.
To help custodians keep fund managers up to date, DTCC last year launched its Global Corporate Action service. GCA provides comprehensive and fact-checked information to its subscribers, which include Credit Suisse First Boston, Merrill Lynch & Co., UBS and several hedge funds.
The missing link in straight-through processing of corporate actions is often the investment management firm. Small fund managers that handle just a few actions each week don’t need to make a big investment in automation. Now vendors and custodians have developed offerings for smaller firms.
“The buy side is looking for solutions that allow their IT people to put together a system quickly and cheaply so their investment professionals can do their job,” says Will Clemens, vice president of San Franciscobased Advent Software’s straight-through-processing product line. “A complex corporate action often has taxability and cost basis considerations along with multiple payment options,” says Clemens. “Those decisions will often depend on data sets and analysis that aren’t always forthcoming from a custodian or from SWIFT.” Advent Corporate Actions feeds the necessary data directly into Advent fund accounting applications and tracks the fund manager’s action on a Web site as long as the action remains unresolved.
J.P. Morgan offers fund managers a Web site where they can view a list of pending corporate actions and enter their instructions for responding. Two years after launch approximately 30 percent of the bank’s investment management clients are using the service.
Still, focusing the attention of investment banks and fund managers on corporate actions won’t be easy. “Every firm will tell you corporate actions are problematic: Data is poor, reconciliation is ineffective, and the technology hasn’t kept pace,” says Robert Iati, partner at Westborough, Massachusettsbased research firm Tabb Group. “But dollar for dollar, they would rather put their money into trading systems.” Others are more optimistic. Michael Atkin, senior analyst at Burlingame, Californiabased information industry research firm Outsell, predicts that substantial automation will take place in the next four to five years. “To do business in increasingly complex markets with shrinking margins, firms need to deal with any infrastructure shortfalls that exist,” he says. “Those are the firms that are actively pursuing corporate actions.”
