Corporate actions processing has long been the “ugly stepchild” of the back office – no one wants to deal with it but it is essential that it keeps grinding on. Yet these highly manual and complex processes pose potentially serious risks. What is holding back automating this area?
Long neglected, corporate actions automation may finally be getting a bite at resources now that more demanding regulatory pressures are over, like the Markets in Financial Instruments Directive which came into force on 1 November last year.
Nat Sey, reference data business manager at Interactive Data (Europe), believes that this is a “sweet spot” for corporate actions technology vendors and back office managers now that “there is a bit of breathing space and we can focus on dealing with corporate actions issues once and for all”.
The Aite Group, a Boston-based analyst firm, defines corporate actions as any company-driven event that can materially change the nature of the inherent value of a security. This can range from a dividend payment to a hostile takeover in the form of a tender offer. Brussels-based messaging standards consortium Swift identifies over 65 different types of corporate actions events in its ISO 15022 messaging standard.
Corporate actions generally involve obtaining and verifying several pieces of time-critical information, so in that sense they are not single-event processes. Additionally, if a custodian is operating cross-border, there is the added complexity that the reporting rules are linked to local law and therefore different in each region.
Historically, corporate actions automation has been a difficult area to find funding for: buried deep in the back office and viewed only as a cost centre, they are complex processes with many manual interventions and a lot of proprietary processes that have built up in terms of proprietary messaging and different ways of interpreting information and different market practices.
The lack of standardisation, the complexity of the instruments and the amount of innovation that happens in the securities industry have made automation a large project costing thousands or millions of dollars to develop a process where quantifying the benefits is almost impossible – it is only when something goes wrong that the risk becomes real.
In the past the answer has been for the back office to throw more people at the problem. But manual intervention increases the risk – one misplaced piece of paper can mean that all the money made from one client in a year can disappear overnight. With the enactment of regulations like MiFID, which stresses pre- and post-trade reporting transparency and best practices, stable back office systems are now considered to be a prerequisite.
Brian Filanowski, EMEA business owner, pricing and reference data at Reuters, says that the development of algorithmic trading with an exponential growth in trade volumes and the sheer complexity and innovation in the instruments are also driving attempts to automate.
“At the end of the day all the stuff that goes on in the front office eventually ripples down to the back office and the back office starts failing,” Filanowski says. “I think that it is bursting at the seams now – all these things have happened at the same time and as they haven’t invested in the back office for years, it starts to fail. This ends up costing the client money because you can only hire so many people to clear and settle your trades manually or put Band-Aids on the problem rather than getting to the root of it and revamping it.”
The Aite Group’s research confirms a growth in expenditure in corporate actions automation. In its January report, Corporate Actions Systems Vendor Comparison, the research shows a large increase in IT spending on corporate actions management over the past three years, rising from $121 million in 2004 to $186.4 million in 2007 (see figure 1). The largest portion of this spend was allocated to integration ($107 million in 2007) and software solutions ($64 million in 2007). The Aite Group predicts that this trend will continue through 2009 with the IT spend topping $246.4 million.
Phillip Silitschanu, director of European research at the Aite Group and author of the report, believes that corporate actions have been the last “frontier” for reduction of risk and also for the increase of straight through processing. He agrees with Filanowski that the pressure is increasing as trade volumes swell and hedge funds begin to look at corporate actions as something they can arbitrage, as risk comes to the forefront and as profits margins get squeezed. “This isn’t something we can just stick in the corner and hope it goes away,” says Silitschanu.
The majority of processing errors are caused by incorrect or misinterpreted data, according to the Aite Group. The 1995 development of the ISO 15022 messages for corporate actions has gone a long way in resolving this problem.
Linda Bookheim, senior manager for markets, custody and asset services at Swift, agues that the next step is to get people to automate the process and then integrate the standards. “That has been the major challenge,” she says. “The biggest obstacles are two-fold: firstly, certain firms are so engrained in the physical process that they are almost scared to automate and think they will lose control over it; and secondly, a lot of firms are limited by the software that they currently use – if they do have automation, it has limitations and maybe isn’t ready to take automated feeds or standardised messages.”
Bookheim believes that change is happening in the way people are adopting the standards: they are starting to pay attention, attend industry conferences, talk about the issues, participate in the market practices groups, and participate in projects to improve the quality of the data. She points to the fact that Swift’s volumes have increased in those message types. “On average we have seen an increase every year of at least 20%, with this year seeing more than 21% increase over last year. Because corporate actions is a complex process, it does take time to automate the process, so some are just beginning to catch up. Hopefully we are seeing a snowball effect as more and more people automate, other people will also, in order to stay competitive, reduce cost and comply with regulations coming down the road.”
The quality of the messages is another major issue, so Swift has had to deal with how the messages are being used. “We have heard comments from users that they get the same event from multiple sources and every source has it coded a different way,” says Bookheim.
The Securities Market Practice Group, which is made up of 35 national market practice groups and facilitated by Swift, launched the Event Interpretation Grid in April 2006 to assist in the understanding and coding of different events. The EIG defines every event type and identifies a code that should be used for that event type. It then drills down to say whether this corporate action event is a mandatory or voluntary event, or a mandatory event with options. Then it further breaks that down for 22 different markets because different markets may process certain events or classify them differently.
Swift validates the syntax and structure of messages on the platform – but it doesn’t validate content or placement of certain fields. “The grid gives us the basis to start to validate but our customers said that they don’t want Swift to validate market practice because of the high risk of corporate actions not being notified on time or not being notified at all. So they still want to get the notice even if it is not a good notice,” says Bookheim.
Swift has responded to that problem with a service called Stimulation Test and Qualification System (STaQS), which will test for consistent compliance with SMPG guidelines for corporate actions. A version is already being used for SEPA, and the corporate actions STaQS will be going live in May 2008 for the 2007 standards release – the one in current use. Swift will make another release in July 2008 with the standards release of 2008, which will go into effect in November, so the industry be able to test STaQS between July and November.
Interactive Data’s Sey points out that ISO 15022 is not the only standard in town. “Right now ISO 15022 is where it’s at and it is what people are concentrating on, but that is not to say that it is the be all and end all – we are seeing much more interest in ISO 20022 than ever before, for example. The whole industry – and I don’t just put this at Swift’s door or ISO – has to be very aware of the challenge involved in approaching market participants with the notion of moving to 20022 when it has so recently had to undertake a lot of integration work in order to deal with 15022. What are the technical benefits? Its all in the presentation.
“There has been a lot of investment in dealing with 15022 – to suggest that it needs to be now thrown away and we move to 20022 would be a very hard sell. There must be a happy medium we can reach where a lot of that investment can be leveraged and moved over to the 20022 environment.”
However, Aite Group’s Silitschanu, for one, thinks an absolute standard to enable STP is just around the corner. “Once that happens, it will be the big bang in corporate action. I think you will see that standards coalesce this year, probably establishing themselves early or mid 2009. By 2010 you are going to see a huge revolution in the corporate action field.”
Gert Raeves, vice president of business solutions at GoldenSource, a data management systems vendor, is more sceptical that a development in one area will clear the logjam. “There isn’t a single problem with corporate actions so that you can say if only you used ISO then you are fine, or have a superior matching and exception management environment then it will all be fine. You need to do all of it. That is where the biggest challenge is for the industry – the maturity of understanding that.”
Although standardisation helps to harmonise the corporate actions landscape and increase STP rates, the idea of reaching 100% STP misunderstands the very nature of corporate actions, believes Mathias Papenfuss, head of asset services at Clearstream. “Because the world of corporate actions is moving fast in terms of innovation, investment bankers, lawyers, etc. are always coming up with new ideas about how to structure a corporate action event. Consequently, you are lacking standardisation and harmonisation because the market is full of innovation. Innovation, to a certain extent, is a reflection of diversity and change, and it is the biggest enemy of standardisation and STP because we are always forced into exceptional processes with specific exception handling,” he says.
He thinks that the industry has moved through a learning curve. “There were people out there that said we need to achieve 100% STP and set up big projects and then simply failed due to the diversity of the corporate action event types,” he says. He promotes Clearstream’s method of re-engineering specific modules within the end-to-end process. Putting together all these modules means that the majority of the chain is STP’d but you retain the flexibility that is required to keep pace with the innovation in this business.
Clearstream plans to automate information capturing and collection by the end of this year or early in 2009 – it has already automated information distribution. Papenfuss believes that the instruction handling module of the corporate action can be put easily into STP process, which Clearstream is working on in order to get something rolled out for defined event types in the third quarter this year. “We will have quite a big IT release at that point in time in order to improve and expand those capabilities,” he says.