Processing Corporate Actions White Paper Introduction “Corporate actions are a nightmare to deal with and they take the number one position in Operational Manager’s risk dashboard” Corporate Actions processing is fraught with problems. Many of these problems derive from the complexity of delivering information from issuers/offerors to the ultimate investors. The current delivery process does not rely on standard information generated electronically. Instead, intermediaries are responsible for manually generating the electronic records of Corporate Actions documentation that investors need. As a consequence, intermediaries create multiple versions of the same information and pass these to subsequent intermediaries along the chain. The creation of each new version inherently carries the risk of inaccuracies, event misidentification and delays. These errors are compounded by the keying and re-keying of information as it passes between intermediaries. There is hope! Over the last few years the number of touch points required for processing corporate actions has come down considerably such that end-to-end straight through processes (STP) is becoming a real possibility. Technology has evolved over the years to standardise and automate many components in the process, however the inherent unstructured nature of corporate actions and the fragmentation of the stakeholder information chain still makes it difficult to see how true STP can be achieved. The recent move towards the use of eXtensible Business Reporting Language (XBRL) for financial reporting for every public company, has established a disclosure requirement for the 21st century. Recent reports from the DTCC, Swift and XBRL US advocate that Corporate Actions documentation should also be tagged using XBRL technology, which is fully compatible with the global ISO20022 data standard used for data exchange among financial services organisations. The purpose of this paper is to outline the actions that firms can take to streamline their use of corporate actions information and to propose the use of a new digital notary service from Codel that will allow data to be verified automatically as corporate actions information is consumed. Risk & Cost The following diagram shows the typical life cycle of a corporate action: Corporate Actions – Typical Life Cycle Announcement Entitlements Instruction Settlement Processing Management Processing Raw Info Position & Act on Process Benefits Instructions Receipts Cleanse Info Source of Account Receivable Dues Store Info Notification Process Receivable Management Follow up on Dues Write offs/ Pay offs 1 Each stage in this life cycle is filled with operational risk: Interpretation risk: The issuer (or offeror) typically announces the corporate action in a news release or regulatory filing, using unstructured text that must be interpreted, transformed and summarized by the financial services industry, generally with no input from the issuer on the data conveyed. Multiple messages from numerous intermediaries transmitted to the investor can result in a lack of consistent, accurate communication of the issuer message; Timing risk: The need for manual interpretation and intervention by intermediaries results in delays in communicating information to the investor, which reduces the amount of time investors have to make informed investment decisions; Accuracy risk: Multiple parties extracting, manually rekeying and disseminating the same information increases the potential for errors in data delivered to the investor. Often errors are not recognized until near instruction deadlines, and Significant costs in the current process: The lack of straight-through processing (STP) throughout the corporate action chain results in cost and liability. These are sometimes absorbed directly by investors. More frequently, they are directly absorbed by financial intermediaries, but then indirectly absorbed by investors in the form of higher fees for other services. These costs are in incurred in the current process as a result of unnecessary repeat ‘handling’ and modification of data. System Interoperability A corporate action system cannot operate as a standalone system, irrespective of whether the firm is an investment manager or a custodian. Tight integration with other systems leads to better STP and fewer touch points, however there is always going to be a requirement for these systems to import data from other systems so that in time the data can be consumed automatically for STP purposes. Existing Systems Architecture Systems currently incorporate key functions including; Managing the event calendar, as most corporate actions are sequentially driven processes, Managing the communication with a potentially large number of stake holders, the ability to provide bespoke services for specific markets that may differ in the way they handle corporate actions, Reconciliation and error handling, Future Systems Architecture To maximise the benefit of using corporate actions information published in XBRL format future systems will need to include all of the above functionality together with the following additions: Systems should support ISO global information standards for Corporate Actions data, including the messaging standard ISO 20022, whilst continuing to support the current disclosure process; Systems should be able to interpret information assimilated in XBRL format so they can use the metadata tags inserted by issuers at the source (normally a limited set of key Corporate Action information data points); 2 Systems should also be able to verify corporate actions received in either XBRL or legacy formats by reference to the cloud-based digital notary provided by Codel. Codel provides this service to issuers, depositories and exchanges for them to notarise or ‘codelmark’ all their corporate actions data, a process whereby a unique digital fingerprint of the Corporate Action is filed with Codel’s searchable registry (see diagram below). Users can then use the Codel registry to determine authenticity retrospectively. Codelmarking can be done by the issuer themselves or on their behalf by depositories, custodians or exchanges. For more information on Codel for Corporate Actions see: Processing Corporate Actions Data and Managing Reference Data (2) If corporate actions information has not been codelmarked at source, systems should allow the codelmarking of existing formats and legacy information that they receive to provide onward traceablity for audit and compliance Systems should be able to seamlessly disseminate, without alteration, the issuer’s electronic original version and optionally an additional version that has been codelmarked, in as close to real time as possible or within a timeframe as requested by the end investor Systems should also allow, where necessary, the ability to keep an audit trail of data that is converted from one format to another (for example when information is extracted or compiled) and optionally for this process to be codelmarked so that an independent record is kept as to integrity and faithfulness of transposition – ‘codelmasking’. Proposed Corporate Action Ecosystem Trading Systems Tax Systems Lending Systems Reconciliation Systems Cloud Registry for External systems and messaging infrastructure Verifying Data ** Position Management System Corporate Actions System Accounting & Valuations ** Proposed 3 Complex Financial Instruments The evolving nature of financial instruments over the years has posed new challenges to the corporate actions process. A classic example is that of structured instruments. Given the highly customised nature of transactions in these instruments, corporate actions on the underlying nature of these securities can change their very nature and in varying ways. Often, there are no precedents on how to account for valuations, or changes in terms, for example long-term instruments may be negotiated between the beneficial parties and often there are no precedents on how to account for the revised valuation that arises. In addition a corporate action change might affect an underlying security or a component of a structured instrument, for example in the case of credit default swaps. An institution might purchase protection on an index and a component of that index could be acquired by another organisation that is outside the index, so fundamentally changing the value of the instrument. Capturing the announcement of the change is one thing, knowing how to deal with the derived contract or position for valuation purposes is another! In a climate where the bespoke nature of the instrument can prevent automation and limit STP, it is essential to be able to establish the relationship between the instrument, index and legal entity/owner so that an accurate position can be established and to prevent failures. The ability to check the integrity of corporate actions information as it is processed through a verification registry such as Codel allows users at the same time to establish the identity of the originator of the corporate action and quickly to establish the relationship between the issuer and the group relationships that exist in aggregations of companies and individuals for example in an index or total return swap where the income is determined on a basket of securities and where even one corporate action such as a cash dividend can affect the total returns and the payment structure of the swap. The corporate actions process has to be flexible and the system configurable to accommodate these instruments. Manual intervention may be necessary in certain circumstances. Codel provides a manual inter-phase that can be used to register and verify non- standard instruments and to provide an initiation point for their potential future assimilation through automated processing and consumption. Measurement and containment of risk through Key Risk Indicators (KRI’s) and analytics enables the operations manager to trace risk and take corrective action. However dashboard analytics that provide advance warning can be enhanced by quick referral to corporate actions identity through the Codel registry and that use a pre-set identity profile and rules for funds or indexes can ensure that analytics flags up the affect on positions. Conclusion It is now a given that financial institutions will embrace corporate actions automation however it is the approach to this automation that will determine success. Securities processing has become commoditised. The key differentiator will be how well companies manage this change and how flexibly they can accommodate the emergence of new financial instruments and the affect that corporate actions has upon them. Codel has a significant role to play in helping firms to assert their worth in an extremely competitive and challenging environment. 4