ISS: Can you give us some background on the topic you intend to discuss and the ground you plan to cover?
Sean Cain: There is an industry need to automate Corporate Action (CA) processing into downstream systems such as accounting, trading, and brokerage systems. As each downstream system is different, and there are currently no industry standards when it comes to CA Entitlements Processing, the vast majority of downstream processing is manual and extremely risky.
ISS: For new readers, can you sketch out the industry context in which the discussion will take place?
Sean Cain: The CA industry has made major strides in the past few decades in regards to risk reduction. The industry has done a great job in standardizing and automating CA notifications, instructions, and payments via SWIFT messaging. When you attend industry conferences, much of the discussion is dominated by continued work in these areas.
ISS: We’ve heard you use the phrase ‘Forgotten STP’. What’s the significance of that?
Sean Cain: Forgotten STP refers to the downstream processing of CA entitlements into accounting, trading, or brokerage systems and is a critical area that requires more dialogue. While currently there is a large focus in the industry on continued standardization and STP for notifications, instructions, and payment messages, in comparison there is very little industry focus and discussions on the CA entitlement processing to downstream systems.
ISS: Can you explain what you see as the key trends in that area?
Sean Cain: CA entitlements processing automation differs greatly from system to system. As every system is unique, the capabilities of each system and the enhancements required to automate processing in each system is extremely varied. There tends to be a lot of automation in the industry on simple income and mandatory events (cash and stock dividends, stock splits, interest payments, etc). These events are less complex by nature, but do make up a large percentage of the action volume, which is a good start.
ISS: But it is only a start?
Sean Cain: Yes, and there is a long way to go. There is very little automation on voluntary events and complex mandatory events, yet this is where the majority of complexity and risk is. These types of events can cause significant issues with costly errors and compensation to the front office, business partners, and individual investors.
The industry has continued to focus on STP, and rightfully so. Any time an event is manually updated at any stage of the CA lifecycle, risk is introduced.
Given the vast majority of industry work on STP has focused on the notification, instruction, and payment portions of the lifecycle, it is imperative to begin focusing on the CA entitlement processing to downstream systems and the resultant business value.
ISS: For the less technically minded in the universe, can you point to a real world metaphor to convey the importance that you clearly feel the subject merits?
Sean Cain: By processing an action incorrectly in downstream systems, you have the opportunity to undo any of the previous controls in place all at once and introduce extreme risk to the organization. It is comparable to a race car team building and testing various safety features and controls for their car and then using these safety features to qualify and race during the main race. Then, when there are only a few laps left and the racing is most intense, the driver removes their seatbelt, helmet, and other safety features and controls until the race is finished.
ISS: You also speak of the most risky aspect of corporate actions. What would you identify as the most risky aspect? And why?
Sean Cain: As mentioned, all aspects of the CA lifecycle create significant risk of financial loss and can result in a number of downstream issues to business partners and clients. The culmination of all of the work performed is the processing to downstream accounting, trading, and brokerage systems. There are at least three implications that might arise from incorrect or untimely processing, all potentially causing operational problems and financial exposure.
One, incorrect shares or cash can be projected to the front office or to the account holder. If these incorrect projections are acted upon, there could be liability and compensation for the operations team in charge of the processing. In addition, the front office or the investor is not able to see the full picture and this may impact investment decisions they are making, resulting in potential reputational risk to the front office, other business partners or external clients.
Two, if processing is delayed, the front office or account holder can be disadvantaged by the opportunity cost of not having the resulting shares or cash available to act upon. When dealing with large entitlements, even the smallest delay or market movements can lead to losses incurred.
Three, for operations teams that strike NAVs (Net Asset Value) for accounts, if the incorrect or untimely processing results in an incorrect NAV, there is a potential for losses for the operations team. For anyone buying or selling the account at the incorrect NAV, the operations team is liable to make the transaction whole. If this NAV error spans over multiple days, which is common if the payment is not received and reconciled the same day as processing, then the potential compensation amount increases each day.
ISS: Does the lack of a central authority help or hinder in the development of greater STP?
Sean Cain: Corporate Action processing is executed on a wide variety of proprietary systems so I don’t believe there will ever be a central authority to oversee the process and mandate automation.
Companies are doing the best they can in the current environment by added controls and oversight, but the lack of automation stifles the ability of operations to grow with scale and take on increased complexity. In addition, no matter how strong the operational controls are, if a process is being done manually, there will at some point be a breakdown and it could result in significant financial exposure.
ISS: Sounds grim, and complicated. What do you think needs to change?
Sean Cain: It is very difficult to automate CA processing. Basic processing can be automated easier; however, when taking into account rebooks, cancellations, and complex processing, this requires substantial investment and continuing supervision. Aside from the larger firms that can make this substantial investment, all other firms will need to rely on their vendors and service providers to drive this automation.
ISS: A case of many hands make light work?
Sean Cain: When vendors partner on integration and automation, it benefits everyone. For example, if a CA Workflow System can automate CA processing with an accounting or trading system, it is instantly attractive to a prospective client. The automation provides immediate business value to the client by improving their controls, automation, efficiency, and ability to scale. From a vendor’s standpoint, this results in a more satisfied client that is able to fully entrench all of their CA workflow into the application. Risk in the operations world will always be a top concern and vendors that can differentiate themselves by managing information and workflow seamlessly through multiple applications will fill an important gap.
ISS: How do you envision this working?
Sean Cain: Downstream systems need to make automating processing easier. Too many systems require complex inputs or tax-lot level processing that is very difficult to automate. A system should be built, or updated, in a flexible way where it can take the key inputs and details of the event, including complex inputs such as voluntary elections or taxability, and be able to process at an event or security reference data level. There are too many systems that when complex elements are introduced, the user needs to resort to manual, account level, or even tax-lot level processing. In addition, when an event is amended or cancelled, the more flexible systems are able to reprocess these items at the event or reference data level. These systems are in the minority in the industry, as there are too many systems that require extensive manual inputs to cancel and reprocess each transaction individually. Even if there are processing uploaders involved and robust operational controls, the operations team is taking on risk in these scenarios.
ISS:Which way next, do you think?
Sean Cain: I think we will see a greater emphasis on CA entitlements processing automation as a next step in the industry. It is an important differentiator to clients when choosing between multiple systems. For example, if I’ve already implemented a trading or accounting system, and I’m looking into a CA workflow system, if one is integrated with my current downstream system, it makes the decision very easy as there are immediate benefits to improving workflow, controls, accuracy, scalability, timeliness, service to business partners and STP, while reducing risk, time spent, and resources.
ISS: And finally?
Sean Cain: It is no longer feasible for operations teams to function properly without a CA Work- flow System. Without even taking into account benefits such as scalability, growth potential or enhanced service to business partners, all it takes is one small manual mistake and resulting exposure to justify a CA system. As more operations teams bring on CA Workflow Systems, they will become more entrenched in the overall process, and in turn operations teams will demand and require further automation such as downstream processing.