Everyone knows the importance of operational efficiency in the corporate actions department but still many financial services firms are willing to put up with too many manual procedures, limited systems functionality in their back office system and a over reliance on corporate actions staff to plug the gaps. This type of set up is the norm in far too many financial services firms and not surprisingly it often breaks down under pressure.

The possibility of missing important acceptance dates and the vulnerability of manual processes in high volume periods of corporate changes, the lack of STP in asset servicing makes corporate actions one of the riskiest operational areas for the firm and also the client.

In the wholesale markets the issue of STP in corporate actions always reverts to message standards but this is just a part of the story. To totally bring automation into asset servicing the message standards have to be combined with many other processes including processing, data quality, communication and risk assessments.  CheckFree is a leading supplier of corporate actions software with a number of top quality financial institutions using its software how do they see the corporate actions story unfolding for financial services firms?

Geoff Harries, vice president, product strategy, CheckFree, now part of Fiserv, said “Solutions today, need not only to comply with increasingly diverse market practises but also offer the internal controls and risk management to support operational compliance.” 

So the technology already exists to automate corporate actions but how does the securities industry build a clear business case for the investment in this technology?

The introduction of the Markets in Financial Services Directive (MiFID) raised the bar for client asset servicing with new rules introduced that require the financial services firm to provide greater protection to the investor. For too long corporate actions appears to have slipped under the radar of the regulators, with very little known about breaches of rules by financial services firms and it is hard to believe that this area of operations, which is bereft of industry STP, has never fallen down, so one suspects that there has been an ability to cover up any indiscretions during any regulatory inspection.

MiFID however, brings a greater concentration on the firm’s ability to fulfil their contractual obligations to the client. There has been plenty of media attention given to the best execution issues of MiFID and high interest in the subsequent remodelling of the market. However, the increase in venues for trade order and executions will increase the activities and complexities in the corporate actions department with so many areas of reconciliation and the potential to miss out of context transactions.

The number of clearing houses and depositories associated with different trading venues will also increase the pressure on reconciliations. Arbitraging between different trading venues could also impact corporate actions if cum and ex date positions are within the arbitrage. Investors maybe unaware of the potential for their trades to be dealt across different trading venues and the added pressure put on sell side firms to efficiently settle corporate actions.

When studying the MiFID articles it is obvious that the real heart of MiFID is more about client protection and quality asset servicing but the changes to best execution could have inadvertently increased the problems for sell side firms to adhere to these client protection and improved services rules.

Articles within MiFID put great emphasis on the correct identification of the investor by the financial services firm and then quantifying the risks they are able to bear. The classification of the client and the contract details, including service level agreements are a fundamental starting point to servicing the client’s needs. We can also add the agreed best execution policy, into this new mix of data which needs to be maintained on the firm’s client database.

Once the details of the contractual arrangements agreed with the client, are captured and stored, the next issue is to ensure the firm is actually complying with them. As they will be tested by audit and regulatory checks in due course and there are bound to be high penalties for any financial services firm, if they fail to comply with the client contract and service level agreements (SLA).

The SLA will detail the firm’s procedures and processes they will be following to provide the protection of the client’s assets. It should therefore be inconceivable that any firm would be comfortable in complying with client agreements for asset servicing, if they are reliant on manual workarounds and inadequate systems and controls, to ensure they are able to perform to the standard described in the contracts and in the SLA.           

More and more complex trading and more exotic dealing strategies are being created all the time and the current financial crisis will not stop the invention of ever more new financial products in the future. The more complex the market, the more complex the operational requirements become. This will put added pressure on the financial services firm to have systems that adequately support their business and the asset servicing needs of their clients.

As the globalisation of markets continues to grow more and more corporate events are being introduced that have multimarket, if not world impacts. The timescales for acceptance and the likelihood that third party agents will be involved during the settlement chain increases the risk that the financial services firm will fail. Obtaining investor instructions just adds another time delay potential, squeezing the acceptance period into a smaller window. Even if all the assets are held in a single depository the timescales to accept in time and take client protective measures are exacting. Over the years many firms that have failed to accept in time and have had to take on the cost to protect the investor. Although a worthy attitude it masks the real problems and gives false comfort that the corporate actions department is working efficiently, the new wave of regulations call for more transparency, making this approach to corporate actions problems unacceptable to the regulator.

Company reliance on the expertise of its employees to prevent loses and ensure compliance in corporate actions has always been unfair and puts too much pressure on people in the corporate actions department. This reliance by the board is a high risk approach and flies in the face of new rules introduced after MiFID. It has to be questioned; why is this the case? Proven Corporate Actions systems are on the shelf and waiting to be purchased, and there can be no doubt of their value. So how does CheckFree see the market risk of regulatory failure in the asset servicing space?

Geoff Harries, vice president, product strategy, CheckFree, now part of Fiserv, said “I think we all recognise that firms need to prioritise their investments in operational improvements.  What has changed is that it is becoming more public the lack of operational controls that exist within financial institutions and the risk to the end investor. This is prompting an operational response from client facing organisations as investor due diligence increases.”

Why then is it that many companies are struggling to make a business case for corporate actions systems? The most common excuse is that they cannot justify the cost, as they have a small number of staff and cannot afford to lose anyone. This is a ridiculous argument, clearly from people totally misunderstanding the high risks in the corporate actions area and the need to reduce them. Corporate actions risks are a hybrid of those found in the front office and those in the back office. The risks cover, replacement costs of the asset, as well as the risks of contractual failure. One has a balance sheet cost and the other even worse, a loss in the reputation of the Company.   

Geoff Harries, vice president, product strategy, CheckFree, now part of Fiserv, said “Operational complacency was generally a feature of the pre-credit crunch era. Increased focus on operational risk will now give the right priority to the corporate actions issue.  Only people living in complete denial would say there isn’t a problem, now is the time to fix it, before more internal compliance issues are aired and investor confidence reduced. The antithesis of this is operational excellence and people with forward thinking business models of asset and customer servicing.”   

So how important is a corporate actions system to ensure compliance by the financial services firm and also make sure they are adhering to the legality within their own client contracts?

Given the many legal and regulatory obligations which financial services firms are bound by, there can be no other conclusion than, that the installation of an effective corporate actions system is now not just a choice but a necessity! 

If the existing systems used are weak, these deficiencies will be found out sooner or later and firms will certainly fail compliance checks and break any number of regulations. Ignorance is no defence and the individual responsibility of board members to maintain sufficient systems for their business will be called into question. The laying off of operational responsibility in today’s financial markets simply does not happen anymore. The regulators are now more likely to come down hard on boards or individuals on the boards than levy corporate sanctions. Compliance is now very personal!

So corporate actions systems look like a must have, for all financial services firms, especially if they are to keep within new rules after MiFID. Firms must not risk potential client losses through lack of systems or breakdown of procedures for any reason. The increase in reputational risk that a breakdown in corporate actions processing causes will be unacceptable to the board. Asset servicing is a very competitive market and any firm that persists with old fashioned systems that are inadequate for today’s client servicing requirements, risk losing business.

Over the last ten years there have been great strides by software vendors to develop systems with functionality that brings automation into corporate actions processing. Yet many financial services firms still persist with risky old fashioned procedures with minimal systems support. Are they waiting for a massive failure in the corporate actions department to justify the cost of a solution or simply for the regulators to become more aware of the unacceptable risks taken by some, when managing their client’s assets?

MiFID has set a benchmark standard for processing corporate actions which requires all financial services firms to invest in updating their systems and in the case of corporate actions probably investing. The reliance on legacy back office systems is unacceptable as the functionality falls well short, of the specialised systems which can bring STP to the corporate actions department. The management of corporate actions risks is just as important as those in the front office and firms need to ensure they are operating efficiently to provide the best protection for their clients. Client protection is heavily engrained within MiFID but a service industry looking to rebuild from the ashes of the credit crunch, really should not need rules to ensure an excellence of service for the investor.       

By Gary Wright, M.S.I