Automation Boosts Corporate Actions
March 14, 2011
While the processing of many back-office functions is now automated, corporate actions have remained mired in e-mails, 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," said 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 e-mails 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 decisions by the fund manager are required.
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 sent 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 e-mail 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," said 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. "It can easily come to a seven digit figure for a single mistake," said Holly Miller, president of Stone House Consulting, a consultancy in Thornton, Pa., 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, aka 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 ISO 20022 messages on corporate notifications can be communicated to DTCC's participants in closer to real time," says Rob Epstein, vice president of asset servicing at DTCC. "The pilot will consist of announcement notifications of all corporate actions including mandatory corporate actions such as income and dividend payments as well as voluntary corporate actions such as tender offers, exchanges 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.