1a. Corporate actions:
what is the problem?
So what is behind this scale problem? Why are investors uniquely disadvantaged as they look to expand their corporate action volumes and what risks are they struggling to manage?
Click on each risk area below to explore the challenges
1.
Time is at the heart of the problem...
The time taken by custodians to notify clients is the central issue for investors.
Whilst the majority of investors rely on their custodians as their core source for corporate event notifications (as they are effectively the book-keepers of record for all events in an investor's portfolio), this may not be the most scalable practice.
Custodians and investors face different objectives in their corporate action processing. Given their implicit accountability for the notifications they send to investor-clients, custodians are incentivised to publish only what they know to be true - meaning that they prioritise accuracy overs speed and completeness in their notifications.
In many cases, custodians' Service Level Agreements commit only to notifying clients of an event 24 or even 48 hours after the market announcement and - over time - custodians' batch processes have been built to take that long in order to verify information, map it to client positions and then issue a notification.
In many cases, this practice is at odds with an investor's core objective, which is to be able to size and understand the impact of a corporate event quickly - so that they can then act on the event before the market moves against them.
This is particularly true in key events such as tender offers and rights issues (where the event can trigger a significant price impact) and for bankruptcies, mergers and other reorganisation events - meaning that investors are increasingly compelled to create their own 'coping mechanisms' in order to mitigate event risk.
For this reason, the average regional back office for an investor will pay for and consume up to 9 different data sources (all of which are heavily duplicative) - meaning increased costs of sourcing, managing and processing.
Meanwhile, smaller investors (who lack the means to invest heavily in multiple datafeeds) find themselves uniquely disadvantaged. Without prior notice of events they can find themselves either resorting to manual lookup mechanisms or being faced with extremely short event deadlines in which to make a critical investment decision.
"We’d like to work on a settlement date basis – but in practice we have to work on a Settlement date +1 basis because of our custodians"
COO, Tier 1 Fund manager
...which means:
- High event risk carried by fund managers
- Extensive cost of coping mechanisms to source / validate data ahead of custodians
- Rushed decisions by fund managers (especially during peak periods) can lead to incorrect elections
“The gap leaves us on our own for a day or more – where we have to make up for delays in data ourselves”
Head of Operations, Leading Investment Manager
...and time is money
A lack of time leaves less time to negotiate for better terms...
Late information from custodians doesn't just mean more costs - it can also mean expensive (and disadvantageous) investment decisions and impeded portfolio performance.
In the event of significant elective events (such as tender offers), larger investment managers will often want to leverage their collective influence in order to negotiate special or improved terms with corporate issuers. By optimising their significant influence as debt or stock holders across potentially hundreds of portfolios, large fund managers can often secure special conditions that will maximise the value they deliver to end-investors and hence increase portfolio returns.
But this process of negotiation can not work without time. Whilst issuers may provide for a 5-day turnaround or deadline on key events, investors often find themselves with only 1-2 days in which to engage with the issuer - sandwiched as they are between the generous custodian deadlines for (slower) notifications and (quicker) responses.
In the absence of sufficient time to manage a full negotiation, these managers may end up forced to accept generic (and less favourable) event conditions and hence see their portfolio returns degraded.
...which means:
- Worse terms on key events
- Lost income for end investors
“A standard 5-day turnaround event can often end up as 1.5 days for the portfolio manager to elect”
Head of Investments, Tier 1 Investment Fund
Watch the expert view from our Corporate Actions for Investors webinar
Including views from Franklin Templeton, DTCC and the ValueExchange
...and time is risk
...knowing the event versus knowing entitlements.
Unfortunately the challenges of time-delays can not be fixed simply by running ahead of custodian information.
Given custodians' role as the book of record for events (i.e. entitlements will only be processed and received as per the custodian's records), event notifications and records from custodians will always have to be verified and reconciled by investors prior to any action being taken.
In practice, this means that an investor may have a complete view of an elective event on announcement day (leveraging third party data sources and their own data gathering) - and so they may be ready to act. Yet, for some events, the investor will still need to receive the entitlements notification from their custodian prior to acting in the market - creating blockages in the investment decision that can trigger opportunity cost and risk.
...made worse by short-fuse events
And what if there simply isn't time to lose?
The many challenges associated with time-delays on event notifications only spiral when events are announced that have a very short window between announcement and instruction deadline (i.e. "short fuse" events).
In these cases, investors find themselves in a lose-lose situation. Either they run ahead of their custodians (and risk creating potential reconciliation issues) or they wait to learn about the event potentially hours before the event deadline is due.
During this period they may need to manually source additional information on the events (such as specific event options, tax implications or special conditions), they may need to verify the materiality of the event across their own holdings or they might need to recall the securities (if they are out on loan, for example).
Each of these steps is risky in a business-as-usual mode (creating operational risk, settlement risk and potentially client risk) but these risks multiply exponentially when run under extremely short time-pressures.
Time pressure leads to elevated reliance on “best efforts” by custodians
And how do we manage today?
With few other options available, investors are forced to rely increasingly on their custodians' "best efforts" to manage corporate event instructions today.
As they seek to understand events, negotiate terms, engage with their own asset owner customers, complete their own instructions and manage their end-to-end event risks, investors today are compelled to instruct their custodians very close to (or potentially after) pre-determined deadlines.
In these cases, investors have to accept the execution risk of any potential issues in the processing of the event - and hence be ready to absorb the cost of a missed subscription, for example.
Given the concentration of corporate events in key periods of the calendar year, the risk of something going wrong during dividend-season is significant. Yet, despite having been the last to hear of an event, the investor ends up carrying the risk.
“We don’t want to play in the deadlines space”
Head of Operations, Tier 1 Fund manager
...which means:
- Smaller fund managers are harmed because they can’t apply pressure on custodians for extended deadlines: can have instructions rejected
- Increased operational risk (at the custodian), especially during high-volume periods
