Automating Corporate Actions: Fund Managers Trail

The more things change the more they stay the same when it comes to corporate actions processing.

Although financial firms as a whole are adopting more automation to communicate with each other and investors on income and dividend payments as well as reorganizations such as mergers, tender offers and takeovers, fund managers are trailing their sell-side peers, says a study just released by London-based investment management consultancy City IQ. Fastest on the uptake of corporate actions automation: custodian banks and securities depositories.

About 63 percent of the 149 respondents across the globe said they had either automated the process of receiving and sending information on corporate actions or were developing projects to do so. The US leads the pack, followed by Asia-Pacific, the UK and continental Europe, albeit for different reasons. Anticipated growth in the number of corporate actions is the motivation for US firms, while the potential for reduced costs spurs Asia-Pacific shops to action. The potential for financial loss is the hot button for UK firms.

Among the respondents, 80 percent of local custodians, 80 percent of market infrastructures, and 70 percent of global custodians say they are either fully automated or engaged in automation projects. By contrast, less than 40 percent of fund manager respondents to the survey, sponsored by global network messaging giant SWIFT, say they are doing so. The survey did not split out respondents by industry sector.

Corporate actions processing includes everything from either receiving or forwarding notification of a corporate event all the way to casting a decision about a corporate reorganization and adjusting net asset valuations and trading strategy. Voluntary corporate actions, such as mergers, tender offers and exchange offers are considered more difficult to handle than mandatory ones — such as dividend and income payments — because the details are more complicated and the potential for misinterpretation is greater.

Global custodian banks are often the linchpins in the lifecycle of corporate action events as they forward information received from local custodians, data vendors, exchanges and securities depositories to their fund manager clients, They are on the hook to make those customers whole if they forget to notify them, give them the wrong data, or do not correctly process any decisions received on voluntary corporate actions.

The findings of City IQ’s survey aren’t surprising to the operations directors at US and European fund management contacted by FinOps Report. “It’s the same old story. If it isn’t broken, why fix it,” says one operations director at a US fund management firm. “We are told to make the most of what we have because there are other budgetary priorities.” His comment was mirrored by three US peers and two European peers.

Why the Lag?

The survey’s results appear to confirm what fund management firms tell FinOps. Limited return on investment was cited as the greatest impediment to automation followed by competing internal priorities. Higher on their to-do list, they say, is improving data quality and aggregation for regulatory reporting. Completing Form PF for the Securities and Exchange Commission and proposed new SEC rules for disclosures by mutual funds worries US fund management firms the most. Their European peers are focused on the Alternative Investment Fund Managers Directive, UCITS V, Solvency II, the European Market Infrastructure Regulation,  and the US Foreign Account Tax Compliance Act.

Fund management firms also tell FinOps they can afford to be a bit lax when it comes to operational efficiency for managing corporate actions. Custodians are still willing to accept email or fax, or even do the work for them. When the fund managers make their decisions on voluntary corporate actions, they have to meet the deadlines imposed by custodian banks, which will then forward the information to the transfer agent or registrar of the corporation involved. About 46 percent of the custodians surveyed said they offered fully outsourced corporate action services and 12 percent said they will do so.

When it comes to which functions in the corporate actions lifecycle are automated the most: incoming and outgoing messages between all of the players in the corporate actions gets the highest scores. Workflow management didn’t fare as well receiving a score of about 2.1 out of a possible 4. Handling voluntary corporate actions did the worst, receiving a score of about 1.83. In both categories the US had the highest average scores, followed by the UK, Europe and Asia-Pacific.

The poor scores for workflow automation suggest ongoing risk for global custodians, it results in lost or mishandled information and decisions from fund management investment shops whose back-office corporate actions specialists forward information on corporate events to front-office decisionmakers. In the case of voluntary corporate actions, the back office might send emails or faxes to remind portfolio managers and trading desk analysts of a voting deadline. Even if they transfer the exact same information received, the messages could get lost or overlooked in the shuffle of far too many messages.

Just because a decision is requested doesn’t mean, the task will be done. If portfolio managers and other front-office staff miss the deadline set by the custodian bank to cast their votes, they can always fall back on the good old default mechanism. The custodian bank will choose the cash payment option for the entitlement, rather than a combination of stock and cash or just stock.

Granted, fund management shops might miss an opportunity to earn more revenues, but they will likely not be called out on the shortcoming by their investors or regulators. That’s not the case for large custodian banks which could face the penalty of higher regulatory capital requirements to compensate for bad operational decisions. They can’t afford to miss notifying a client about a corporate action or not forwarding its decision.

Jury Still Out

The most surprising conclusion from the study? When it came to deciding whether to use ISO 15022 or ISO 20022 message types to distribute information and make decisions on corporate actions, ISO 20022 still is not the clearcut winner. This is despite the continual efforts of  SWIFT and market infrastructures such as the Depository Trust & Clearing Corp. (DTCC). The umbrella organization for clearing and settling US securities transactions has been scrapping its proprietary messages in favor of a US version of ISO 20022 standards for corporate action notifications and elections. (See FinOps Report, May 8, 2015: DTCC Embraces ISO 20022 for Corporate Action Elections).

The XML-based ISO 20022 messages are widely considered to be superior to the older ISO 15022 message types, which relied heavily on narrative text, particularly to explain complex corporate actions. As a result, custodian banks and other financial intermediaries faced a higher potential for misinterpretation and costly errors.

The survey showed that the percentage of respondents believing that ISO 20022 message types will bring more value than ISO 15022 declined over the same survey conducted in 2012, while the percentage believing that ISO 15022 messages will be more valuable increased. About 40 percent of respondents to the 2015 survey say that ISO 20022 messages will bring more value down the road compared to 50 percent of the respondents three years ago.

Custodian banks stood out among the lot of respondents for not embracing ISO 20022 message types wholeheartedly. Although they are among the largest participants of securities depositories and have participated in the DTCC’s corporate action migration program, they are apparently satisfied that ISO 15022 message type will do the trick. That isn’t surprising considering the slow pick-up of ISO 20022 message types among their fund manager clients.