In focusing strictly on settling domestic and cross-border trades, the new central settlement platform, Target2Securities (T2S) may end up causing unintended operational glitches and additional costs when it comes to how corporate actions of European issuers are processed.
Or so fear some managers who apparently aren’t buying the assertions made by custodians and securities depositories that they have the work for corporate action events “under control.”
T2S is the European Central Bank’s attempt at ensuring Europe remains economically competitive with the US and other regions by trying to reduce the cost of settling domestic and cross-border securities transactions. Several dozen European national securities depositories have agreed to outsource — or transfer –their settlement functions to T2S in phases between 2015 and 2017. That would leave them with handling the rest of the post-trade processes, including corporate actions.
But first thing’s first: the depositories in over thirty countries must hope that their participants, now accustomed to a three day settlement cycle, can successfully migrate to a two-day timeframe next week.
Decoupling the process of settling European securities trades from handling corporate actions may be easy to do technologically, but not operationally, warn buy-side corporate actions specialists who are attending SWIFT’s annual SIBOS event in Boston this week. Some fund managers are concerned that when it comes to handling corporate actions, European securities depositories may not nail down one critical procedure: instructing T2S about corporate action payments that must be made — that is, the depositories reconciling their books with the T2S system records to ensure they have the same understanding of the positions held in particular issuers and just who owns the securities in question on record date. That’s the date on which an investor must be registered on the books of the issuer of the securities to be entitled to receive the corporate action.
Corporate action events can be as simple as a dividend or income payment or as complicated as a tender or exchange offer. Securities depositories notify their bank and brokerage members about future corporate action events and ensure the correct accounts are credited with the distributions. Those participants, in turn, service their institutional clients — or the ultimate owners of the securities. At issue is the potential for errors — or payments credited to the wrong counterparties — should a corporate action event take place after securities of a European issuer are bought or sold, but before the transaction must be settled.
Buyers of securities are supposed to receive the proceeds of a corporate action if the transaction — or purchase of the securities — is made before the ex-date of the distribution event. That’s the date on or after which securities are traded without a corporate action attached and always preceeds the record date. The seller of the securities could end up with the corporate actions payment if the transaction was not settled by the record date for the corporate action. Should that happen the buyer of the securities must then file a market claim on its own, or through a financial intermediary such as a custodian bank or broker-dealer member of a securities depository.
Fund managers who spoke with FinOps are worried that, if European securities depositories do not interact correctly with the T2S platform, the correct party — aka the fund manager as the end investor — will not receive the correct payment. Because the depositories must now handle corporate actions processing apart from settlement, there is a higher potential for error, some fund managers believe. Hence, there could be a backlog of claims to handle, and cleanup won’t come cheap. “We expect higher operational costs in figuring out how to recoup or collect missed corporate actions payments or compensate counterparties who believe they deserved the payment,” one corporate actions operations specialist at a European fund management firm tells FinOps.
What do custodians think about the potential for glitches in the corporate actions process as a result of T2S? Apparently they aren’t worried. And neither are securities depositories for that matter.
“I don’t think there will be a higher number of claims, because of the reduced timetable for settling trades,” asserts Justin Chapman, senior vice president at Chicago-headquartered global custodian Northern Trust. In fact, the number of claims could well go down, he believes.
Edwin DePauw, director of market harmonization for the Euroclear family of depositories, agrees adding that the additional harmonization — or multi-national standardization — in how European corporate issuers manage the corporate actions process will help reduce the number of claims further. Such standardization has been recommended by a corporate actions working group of market players with the ECB monitoring issuers’ compliance with the standards.
So far, European issuers have agreed to reduce the number of days between the ex-date and the record date and the number of days between the record date and the payment date of the corporate action. Instead of relying on a timetable of one day to several weeks, European issuers say they will pay the corporate action — either in the form of a dividend or income payment, securities, or a combination — the day after the record date or “as soon after as possible.” The timetable between the ex-date and the record date will also be cut to one day.
Of course, even the best laid plans might not be enough to prevent errors in corporate actions processing. There is always the possibility that the number of European trades which fail to settle on time could increase next week as a result of a shorter settlement cycle. In fact, a study just released by research firm Celent and commissioned by post-trade communications service provider Omgeo warns that 60 percent of Asia-Pacific firms are unprepared to meet the two-day timetable. Should a worse case scenario occur, the number of market claims related to corporate actions could increase well before T2S is implemented.
Still, dePauw is hopeful that as the bank and broker-dealer participants of European securities depositories are eventually whammied with fines for either not matching the details of their securities transactions on time or ultimately failing to settle their trades on time they will take action to improve their post-trade communications process with their fund manager clients. Doing so, he says, would ultimately reduce the number of settlement fails and the number of market claims involving corporate action payments.
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