WealthManagement Magazine

Wringing the Risk Out of Corporate Actions

The world of corporate actions has become increasingly complex for retail brokerage professionals. Not only are customers investing in a dizzying array of sophisticated instruments, but the corporate action events that can impact these investment alternatives have surged in number while becoming ever more complex and often having cross-border implications all of which translates into greater risk.

The world of corporate actions has become increasingly complex for retail brokerage professionals. Not only are customers investing in a dizzying array of sophisticated instruments, but the corporate action events that can impact these investment alternatives have surged in number while becoming ever more complex and often having cross-border implications — all of which translates into greater risk.

By some counts, there are nearly 100 types of corporate actions — events that reflect changes in the capital structure of the security or the underlying company. In addition to dividend and interest payments, there are conversions, exchanges, liquidations, calls, rights distributions and many other significant events (see sidebar).

When it comes to corporate actions, there is a dichotomy between the need for accuracy and the need for timeliness. The front office needs information as soon as possible and may be willing to sacrifice accuracy around dates or rates to pursue certain trading strategies. The back office requires the exact dates, rates and other information to process corporate actions correctly, and ensure customers' books and records are updated accurately.

Quantifying the Risk

Excluding “scheduled interest payments,” close to one million corporate actions take place every year worldwide. A single event may involve hundreds of different market participants, including custodians, investment managers, broker/dealers, depositories and, ultimately, thousands of individual investors. Each of these market participants faces risk because corporate action processing is complicated, deadline-driven, nonstandardized, and, to a large extent, still manual.

In addition, the sources for gathering information on corporate action announcements are diverse and of uneven quality. Indeed, different sources sometimes provide conflicting information about deadlines and conditions. In addition, the information, which once arrived only by postal mail, now comes through a variety of means, including faxes, newspaper notices and email messages. And even when the announcements are made electronically, the format can vary depending on the source. Complicating matters is the fact that announcements originate around the world and are issued in many languages, with differing standards and requirements.

What do these layers of risk translate into in terms of financial exposure? A recent study by Oxera, an independent economics consultancy in Europe, estimates that the global securities industry faces multibillion euros in risk associated with corporate actions. For individual firms, the potential risk can run into millions of euros from just one complex corporate action event. The study was sponsored by DTCC to help the industry better understand the costs and risks related to the processing of corporate actions globally. It examined two types of risk: back-office processing risk — the losses resulting from mishandling a single, complex corporate action event — and front-office trading risk — failure to act on information may lead to sub-optimal trading decisions.

Seeking Harmony

Fortunately, the global financial services industry recognizes the need to bring greater harmony and reduced risk to corporate actions processing, which will also advance the goal of straight-through processing. The Group of Thirty and other industry organizations believe that corporate action standardization and automation are essential to the future safety and efficiency of international securities markets.

Uniform standards are crucial to advance straight-through processing for corporate actions. Developing and adopting standards helps to ensure that data is communicated through a common framework, helping the financial services industry drive down costs and manage risk. To help create industry standards among issuers and financial intermediaries that process global corporate actions, most countries have established National Market Practice Groups (NMPGs). For instance, in the U.S., the International Securities Association for Institutional Trade Communication-International Operations Association acts as the U.S. NMPG for global corporate actions.

To tackle these issues, some of the larger b/ds are beginning to re-engineer and automate the infrastructure they use to transmit corporate action information to financial professionals throughout their organizations, as well as to their clients. These firms are replacing multiple, redundant data feeds with single, enterprisewide repositories of quality corporate action announcements, which facilitates the dissemination of timely, accurate and consistent data.

This centralized approach achieves another critical industry objective: cost reduction. With a single source of corporate action information transmitted globally, firms are cutting their expenses significantly by eliminating the manual, time-consuming work associated with scrubbing corporate action information.

In the world of corporate actions, what's good for the back office is good for the front office. If the back office has a single source of reliable data, it can feed this information to the firm's prime broker business, trading desks and derivatives desks. The result? Traders don't have to look elsewhere for accurate information, eliminating internal confusion and delays that can result from relying on varying information sources. This enables them to make swifter trading decisions based on accurate data.

Ease of access is another benefit, as firms are able to deliver corporate action information that's integrated with their trading tools. And when all the parties in an organization are using corporate action information from the same scrubbed data source, the result is a cleaner, straight-through process throughout the firm.

More Satisfied Customers

Customer service also gets a boost from this centralized approach, because when it comes to processing corporate actions, nothing worries client-service professionals more than not finding out about an event until it's too late to take action and relying on incorrect data.

Added to that is the potential ripple effect of erroneous information across a large firm's diversified customer base. After all, a problem with corporate action information does not affect just one client — it can impact hundreds, perhaps hundreds of thousands, of individual investors. Clearly, a single mistake has the potential to have an enormous impact, in terms of both financial risk and customer service.

To address these concerns, firms are leveraging their new repository systems externally to streamline communications with customers. They are using information from their central repositories to drive client notifications, so that announcement records pass straight through to the beneficial owners.

Retail brokerage firms that re-engineer their corporate actions processes and leverage the power of central information repositories are taking a giant step toward reducing risk and cost while strengthening customer service. In other words, everybody wins.

Note: To obtain a copy of the Oxera report, visit dtcc.com/gca.

The author is a vice president, Global Corporate Actions, The Depository Trust & Clearing Corporation (DTCC)

Types of Corporate Actions

There are dozens of different corporate actions. Some of the more common events include:

Bonus Issues
Bankruptcies
Calls/Installments
Class Actions
Coupon Distributions
Consents

Changes:

  • In Domicile
  • Name
  • In Par Value

Conversions
Defaults

Dividends:

  • Cash
  • Stock
  • Special

Dividend Reinvestment
Exchanges
General Information
Income Distributions
Liquidations
Meetings
Mergers
Payment in Kind
Pre-refunding
Puts
Reclassifications
Redemptions
Redenomination
Reorganizations
Return of Capital

Rights:

  • Bonus Issue
  • Distribution
  • Plan of Adoption
  • Redemption
  • Subscription

Spin-offs
Stock Splits
Warrants

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