While the processing of many back-office functions is now automated, corporate actions have remained mired in emails, faxes – and general inefficiency.
That, however, may be about to end.
The standardization of electronic messages by communications network operator SWIFT and software packages that automate the creation, sending and tracking of notices about mergers, dividend payouts, stock splits, spinouts and rights issues are converting paper flow into screen flow.
“While much of the efforts in corporate actions has been spent on ensuring accurate data, there is now a push towards more evolved workflow and monitoring to automate the more difficult aspects such as entitlement, elections and settlement,” says Fritz McCormick, senior analyst with Boston-based research firm Aite Group.
A survey released last week by Aite and software firm SimCorp provided a sense of how much remains to change. The analysis found that 35 out of the 45 fund managers cited manual processing of notifications as the top cause of mistakes.
Too many fund managers still send their custodian banks, emails and faxes of their decisions, which must be interpreted, transcribed and input into electronic systems. Also causing glitches: bad or inconsistent data on the details of the corporate action and the failure to properly record a decision made by a portfolio manager into internal accounting systems.
The biggest concern: “Voluntary” corporate actions. These are the mergers, spinouts or other reorganizations on which votes are required. That’s because the fund manager is required to make a decision on just what to do about an exchange offer or tender offer and a custodian bank must register that decision.
By contrast, the processing of facts about income and dividend payments is pretty straightforward. Of the estimated five million corporate action notifications, Depository Trust & Clearing Corp. (DTCC), the umbrella organization for clearing and settling transactions in U.S. securities, in 2009 to its bank and brokerage clients most were in income, dividend and so-called mandatory corporate actions
Voluntary actions face many hurdles, before completion. For instance, a fund manager can misinterpret the information or simply miss a deadline in sending an instruction to a custodian bank by email or fax. Worse, the manager might not properly document the decision, in what gets sent.
That means a custodian bank could make the choice by default. “In the case of a payout in a merger the fund manager may end up getting cash even though it intended on stock,” says Jenny Brorson, chief business consultant in New York at SimCorp, which specializes in technology for investment managers. “The cash could end up being worth a lot less than the shares so the fund manager would have suffered a direct or indirect loss.”
Fund managers typically don’t disclose just how much such mistakes cost – unless they end up fined by the Securities and Exchange Commission. They can be pretty expensive. “It can easily come to a seven digit figure for a single mistake,” says Holly Miller, president of Stone House Consulting, a consultancy in Thornton, Penn., specializing in investment managers.
Even making the correct decision is no guarantee that the corporate action will be processed correctly. The portfolio manager might assign the wrong corporate action to the wrong underlying account or input information incorrectly. When that happens, share positions can be incorrect and so can the net asset value of the portfolio.
Just how can a fund manager avoid some of these landmines? Automating messages about instructions is a start. The Society for Worldwide Interbank Financial Telecommunication, a.k.a. SWIFT, and DTCC will begin a pilot program on April 25 where five banks will exchange messages that adhere to a standard known as the International Standardization Organization 20022 format. Among these are custodian banks Brown Brothers Harriman and Bank of New York Mellon.
“The objective of the pilot program is to ensure that the ISO 20022 messages on corporate notifications can be communicated with DTCC’s participants and they can make their selections in the event of voluntary corporate actions,” says Robert Epstein, vice president of asset servicing at DTCC. “The pilot test will begin with notifications on income and dividend payments but will gradually expand to include voluntary corporate actions such as tender offers, exchange offers and redemptions.”
DTCC will be eliminating the use of its proprietary messages in favor of SWIFT formats by 2015. The switch is part of a massive overhaul of its corporate actions infrastructure, which when completed will allow banks and brokerages to receive corporate action notifications from one system instead of about 60.
DTCC’s adaptation of the ISO 20022 message types is a significant step toward their acceptance in the U.S. by fund managers. U.S. managers have historically lagged behind their counterparts in Europe, corporate actions experts say.
Only custodian banks and broker-dealers typically receive corporate action notifications from DTCC. But doing so via the SWIFT network or the DTCC’s proprietary Smart network and adapted ISO 20022 message formats will allow them to pass along the same information to a fund manager without having to rekey any data. Previously, the data would have to be rekeyed into SWIFT’s ISO message formats
Automating the flow of information between fund managers and custodian banks, however, won’t be enough if the fund manager doesn’t send the information to the portfolio manager in time to make a decision. “The portfolio manager is often left out of the loop or informed at the last minute,” says Gerard Bermingham, vice president of Information Mosaic in Dublin.
To that end, software suppliers SimCorp and Information Mosaic are trying to put the response into the touch of a button. SimCorp’s Dimension software, used by over 170 fund managers, will not only reconcile information received from multiple data vendors and custodian banks, but forward it to a fund firm’s back office. The firm itself then can send the same information to the portfolio manager, who can make a decision, record the decision and send it off to a custodian bank in the ISO 20022 format.
In October, Information Mosaic introduced messaging and analytics software which also permits the front-office of the fund manager to be automatically notified of a corporate action via an email. The head of a trading desk or other administrator in the front office can review the corporate action details, manage their decisions by deadline, analyze and review their decision. This can be done by reviewing various outcomes, such as “in the money” and “out of the money” calculations, before transmitting the choice first to the back office and then onward to the custodian.
“Recording the portfolio manager’s decision within other operating systems such as order management and compliance are significant so the trading desk doesn’t make a mistake and trade shares it isn’t supposed to in the case of a tender or exchange offer,” says Miller.
Another area of improvement now under works: reducing the potential for misinterpretation of information by financial intermediaries, which can ultimately be passed along to the fund manager. That means allowing issuers to tag corporate action notifications in the eXtensible Business Reporting Language or XBRL which can then be reformatted by financial intermediaries to ISO 20022 messages.
A strong case study is needed before the Securities and Exchange Commission can actually mandate such tagging now required for financial reports. Last year, Citigroup started a pilot program set up by DTCC, SWIFT and XBRL US, the U.S. arm of XBRL International, to send [information to investors about dividends paid on American Depositary Receipts using XBRL tags. XBRL US says that it wants to expand the testing this year to include issuers.
This story originally appeared on Securities Technology Monitor.
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