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Revamping Corporate Actions

Dividend payments, stock splits, name changes, spin-offs and other corporate actions impacting securities already held in accounts were not supposed to be affected by T+1. But as the deadline for shortening the trade settlement cycle is challenging firms to further automate all aspects of their business, semi-manual and sometimes disjointed corporate actions systems are getting a second look.

    • Victor Hendrickson
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"We’ve all been exposed to these huge, huge risks for years," says Martin Pearce, senior vice president and director of investment operations at Boston-based MFS Institutional Advisors. "We’ve just accepted it because there have been no other options."

So much risk exists because corporate actions processing is complex, requiring multiple steps of messaging back and forth with shareholders, important decision-making and portfolio accounting. At most firms, this process is almost entirely manual and relies on staff expertise.

The mishandling of corporate actions events can cost firms hundreds of millions of dollars. For example, if, by participating in a tender offer, an investment manager stands to gain $1.00 per share on two million shares of a given stock but is not notified of the offer by its custodian for those assets, the custodian could be liable for that $2 million loss. This risk would extend to all other shareholders of this security serviced by the custodian.

MFS, with $140 billion under management, is in the process of implementing London-based vendor Heliograph’s corporate actions processing solution, Event. Pearce says corporate actions have so far taken a back seat to more immediate technology mandates like the euro conversion, Y2K preparation and the T+1 deadline.

Damon Kovelsky, an analyst at Meridien Research, says that with budgets as tight as they are right now, firms also need to have strong support at the top to fund corporate actions projects. "There are a lot of STP issues right now," says Kovelsky, who covers STP for Newton, Mass.-based Meridien. "It boils down to who’s going to get the funding, so you have to have the right advocates in the right places." MFS actually slowed down its project because of budget constraints, Pearce says.

Matt Schott, senior analyst at Needham, Mass.-based TowerGroup, says, however, that the opportunity to reduce the risks inherent in manually processing corporate actions is drawing a lot of attention because it also means cutting down on expenses.

There are three types of corporate actions—voluntary, mandatory and mandatory with choice. Voluntary corporate actions include tender offers, exchange offers, conversions, rights offers and warrants. The more common mandatory events include dividends, interest, stock splits, spin-offs, stock and cash mergers, name changes and redemptions. An example of a mandatory action that also gives shareholders an option is a dividend with choice of cash or shares.

Corporate actions processing involves notifying shareholders of these events, capturing shareholder instructions for participation in the events and processing the events against their existing positions.

It all begins with the initial gathering of announcement data. Firms generally receive multiple data feeds from vendors, and they must verify event details based on internal business rules. It can be difficult to accurately capture all the details, Schott says, because discrepancies often occur. "If you receive 10 pieces of information with nine the same and one different, who’s right—the nine or the one?" says Pearce.

From a data standpoint, firms run the risk of missing a corporate event altogether and also of notifying shareholders of events using bad data. When the data is reconciled, firms then need to notify all shareholders entitled to the corporate action and to alert them to what extent they are able to participate. This can pose problems because client portfolios often change on a daily basis. It requires constant recalculation of holdings to determine who is entitled to the action.

If the action is voluntary or mandatory with choice, the firm then needs to receive instructions from shareholders on whether or how they want to participate. Automating the notification-of-shareholders part of the process creates a longer time frame for shareholders to make potentially important investment decisions regarding their portfolios.

The flow of information between the front office, which facilitates shareholder investment decision-making, and the back office, which verifies and processes the data, is critical to accurately capturing instructions and posting transactions, Schott says. So even if shareholders are notified with correct data, manual processing increases the likelihood that shareholder instructions will not be captured and executed properly.

What should firms look for in a corporate actions processing solution? Swift messaging standards are key, Schott says. Swift has developed electronic corporate actions messaging formats under the ISO 15022 standards in an attempt to standardize electronic messaging between account servicers and shareholders. ISO 15022 standards identify more than 40 different corporate action event types.

Cindy Schreiner, principal consultant in Capco’s market operations group, agrees that standardized, electronic communication is key, and MFS’ Pearce says support of Swift messaging in Heliograph’s Event was a major draw.

In Schott’s report, "Corporate Actions: Big Risks Demand Straight-Through-Processing Solutions," he writes that the main reason behind the lack of automation is that the bulk of corporate actions processing depends on gathering announcement data that is not standardized and occurs on a somewhat random basis.

The Securities Industry Association’s subcommittee on corporate actions is currently pursuing two electronic communication initiatives—a central system for all relevant parties to communicate liability notices back and forth and a system where they can pass standardized corporate actions announcements to each other electronically. A standard template for issuing corporate events does not currently exist.

The subcommittee is working with the Depository Trust Clearing Corporation (DTCC) to help improve its Global Corporate Actions Hub, currently in beta testing. The Hub is a corporate actions announcement and message delivery network connecting custodians and investment managers. Use of the system would eliminate the need for proprietary custodian workstations and other methods for each custodian to communicate with each investment manager.

State Street’s Corporate Action Tracking and Interactive Network (Captain) is one custodian’s proprietary system for corporate actions communications. Captain enables users to receive and respond to corporate actions using a Web browser. Pearce says, however, that MFS works with 47 different custodians and wanted one solution with which to process its dealings with all custodial partners.

Rules-based capabilities are also important in a corporate actions solution because of all the different types of corporate actions, Schott says. The solution should be rules-based in how it processes actions and reconciles differing data feeds.

Some firms may develop proprietary corporate actions processing solutions, but Schott believes the complexity will lead most to pursue vendor solutions.

Xcitek Solutions Plus, jointly developed by Xcitek and Solutions Plus, is perhaps the best known corporate actions solution provider. It features an Internet interface that supports event notification and instruction capture. An export file can be created that has all entitled accounts, positions and shareholder decisions entered into accounting journal entries. It is compliant with both ISO 7775 and ISO 15022.

Financial Technologies International (FTI) is also a familiar name in the corporate actions world. FTI offers a real-time, rules-based corporate actions platform that sits on top of its suite of software products.

FTI’s solution is centered on user-defined "routes" and "steps." Each route represents the end-to-end life cycle of a particular type of corporate event, and each route is composed of a series of steps that perform the activities, such as determining entitlements and generating the notifications required to process an event, says Chip Williams, vice president of product management for global corporate actions and methodology.

The firm is in the process of converting the system to Swift’s ISO 15022 standard. A Web-based notification and response component is also being tested.

London-based SmartStream offers a stand-alone solution that can fit anywhere in a firm’s infrastructure, whether it is from Sybase or Oracle or is Unix-based, says Pasquale Gizzi, head of European presales. Gizzi says the system is exception-based, meaning it finds the exceptions when comparing different data feeds, internal files or external files. SmartStream’s strengths, Gizzi says, are in its ability to normalize data and process it while comparing internal positions to custodian positions.

Heliograph has rolled out Event to the US marketplace after achieving success in the UK, says Gert Raeves, securities product manager.

Heliograph features an enterprise application integration (EAI) middleware platform, offering architectural stability, Raeves says. Event is put on top of the middleware, which can accommodate all different types of messaging links. The solution consists of three steps—pre-decision, decision and post-decision.

Pre-decision activities capture external data, as well as transactional and holdings data, to determine a provisional distribution of an action’s benefits, Raeves says. Event allows users to create a complex set of rules to generate a normalized data model, which is compared to incoming vendor data to help decide which data to promote to a parent set.

The second phase creates an electronic information flow with shareholders. "All relevant parties are advised via e-mail or notification through a live browser interface," Raeves says. Event’s post-decision processing posts results, creates the framework for proper MIS reporting and reports back to shareholders.

A handful of other firms, such as Access International in Denver and London-based OST Business Rules, offer corporate actions processing or are developing solutions.

In choosing Heliograph’s Event, Pearce felt it was the only viable solution on the market because of a central system manager that presents Swift message formats as clear dates and values rather than tags that must be decoded. "Prior to Heliograph, there was nothing sophisticated enough to do anything with the messages," Pearce says.

Pearce says interoperability with other systems is straightforward because it uses MQSeries messaging "put" and "get" commands and XML to pass information back and forth.

Schott warns, however, that corporate actions processing should probably never be fully automated. "Because there are so many different varieties of corporate actions and how they are processed, you always want to maintain human expertise in-house," he says.Waters

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