Automating Corporate Actions: Four Ways to Generate Successful ROI

Automating the handling of corporate actions should be a given, considering the financial risk fund managers, broker-dealers and banks face if they make just one mistake.

Apparently that’s not necessarily so. The reason: justifying the expense to C-level management isn’t as easy as it sounds, despite the need for automation being greater than ever before. The volume of corporate actions is on the rise. And as trading volumes grow, so does the potential for operational risk or errors which must be taken into account in calculating loss reserves and regulatory capital which must be set aside.

A new report issued by research firm Celent aims to help with the challenge of persuading the C-level to invest. Its premise: do the right math and you have a solid argument. Such a scenario, of course, is based on the assumption that corporate-actions processing falls into the full-trade lifecycle and is not a separate, unrelated function. “Corporate actions tools sit alongside or are integrated into the cash and securities reconciliation space, security masterfiles and other rules engines that are optimized to handle increasing amounts of data and workflow,” say Celent analysts David Easthope and Isabella Fonseca.

Quantifying the return on investment has been a key stumbling block to securing a budget for automation, corporate actions specialists at ten broker-dealers and banks confirm. “We might come up with hypothetical projections for how much a single error could cost, but that hasn’t been enough to prompt change,” says one manager of a reorganization department at a New York brokerage. “Our management says that we just need to pay closer attention to voluntary actions or tighten deadlines for when investors must respond.”

Voluntary corporate actions refers to the panoply of tender offers, exchange offers, redemptions, mergers and acquisitions, and other reorganizations which require investors to give their consent. Informing shareholders about them is just the tip of the iceberg. Shareholders must then vote on whether or not they wish to proceed and, in some cases, even what type of compensation they wish to receive. Once the votes are received and tallied, the appropriate adjustments must be made to portfolio accounting; valuation; and other books and records systems.

Just one error in notifying an investor of a corporate action or not registering the returned vote can lead to several glitches in the downstream process, not to mention legal liability should the investor sue. Automate the entire process from the time of notification to the time of election — deciding the fate of a corporate reorganization– and all the necessary back-office changes and voilà, the job is done. Or one would hope so.

Here are the four ways that Aite’s Easthope and Fonseca say financial firms quantify the merits of automating the corporate actions process. About ten corporate actions specialists contacted by FinOps agree that they have successfully used one or more of the following arguments.

1. Reduced Expense Related to Legacy Technology and Multiple Datafeeds

Firms often maintain a number of vendor feeds and technology platforms related to corporate actions. How are the cost savings calculated? Take the total costs of the current technology and subtract the costs of the corporate actions solution. The total costs of the status quo can be calculated by adding the licensing costs associated with corporate action data vendor feeds, maintenance agreements on the various software applications and internal labor costs for maintaining each interface, updating vendor relationships, and interacting with vendors.

2. Reduced Labor Costs Related to Data Quality and Workflow

It takes an army of staffers to handle corporate actions manually and ensure their accuracy. Reconciliation breaks — as in fixing discrepancies between what information is presented by an issuer and what information ultimately gets stored — can easily be the most costly aspect as it likely requires dedicated staff. So all a financial firm has to do is take the sum of the labor costs and subtract the potential reduction in hours for manual intervention and reconciliation, as well as the reduction in the size of the staff or their compensation to come up with the saving gained by automation.

3. Reduced Operational Risk

Operational risk is the most difficult to quantify because some of the data inputs can be subjective. Easthope and Fonseca recommend the following series of steps:

a) Assess the number of annual complex corporate actions;

b) Assign election rejection; late announcement; late notification; near deadline processing; after deadline processing and pricing error rates-based percentage of complex voluntary corporate actions;

c) Find the sum of the events in step b and determine a probability these events will lead to monetary loss;

d) Multiply the sum of the events by the probability;

e) Find the value of assets under management and multiply by 0.009 and

f) Multiply the value generated by step d with the figure generated by step e. (The figure 0.009 refers to the average loss weighted by firm based on Celent’s previous research).

The difference between the final figure calculated by the initial pre-corporate action automation and the new post-corporate action automation is the reduction in operational risk.

4. Enhanced Front Office Efficiency and Customer Service

Automating corporate actions creates temporary arbitrage opportunities for brokerages and fund managers, but quantifying the value of those potential opportunities is difficult. Relying in “anecdotal evidence” is the only way to go and should be used as a value-added rationale rather than the first line of argument, advise Easthope and Fonseca. The same applies for client retention. No customer wants to know it missed benefitting from a corporate action or got the wrong information.

“Winning and losing client business has often been overlooked when it comes to corporate actions, but it can prove to be a critical, albeit unquantifiable factor,” acknowledges Brendan Farrell, executive vice president at SunGard in charge of the XSP corporate actions business application.

The quantifiable arguments in favor of automation, such as reducing expenses related to legacy technology and additional staff, he agrees, are the most powerful and easiest ones for corporate actions operations specialists to present to C-level management. “All management wants to hear are dollars and cents cost reductions,” agrees a New York-based corporate actions specialist. “The faster we can prove cost reductions, the faster the CFO will sign the bill for new automation.”

ISO 20022 Driving Automation

Just where does the use of ISO 20022-compliant formats for corporate actions messaging fit into the equation? Celent’s white paper never explicitly discusses the sophisticated XML-based protocol, but it stands to reason that its more widespread adoption in the US market will go a long way to eliminating manual procedures and even the use of less reliable legacy ISO-15022 message types. Leading the charge is the US market infrastructure Depository Trust & Clearing Corp. which will be eliminating the use of proprietary message types for notifying participants on corporate actions events in favor of using ISO 20022 message formats by the end of 2015. However, participants will still send their elections on voluntary corporate actions in proprietary message formats rather than ISO 20022.

“DTCC’s corporate actions transformation project will clearly have some trickle down effect from banks and brokerages to fund managers,” predicts Farrell.

Will that entirely eliminate the use of the old ISO 15022 message types or even fax? Probably not, but it will make it more difficult to deal with these older formats, and clarify the associated operational risk issues — a sure bet to align with C-level efforts on reducing operational risk.

“While most of the initiatives on automating the corporate actions process will come from the bottom up, risk mitigation has taken on greater importance for chief financial, chief compliance and chief operating officers so they are also exerting pressure on operational staff and middle management to change otherwise inefficient processing,” says Farrell.