Steve Martin, senior business analyst, at Dion Global Solutions, looks at the issues and risks created by, or associated with, corporate actions and the wealth management industry in the UK.

Steve Martin, senior business analyst, at Dion Global Solutions, looks at the issues and risks created by, or associated with, corporate actions. As corporate activity – mergers and acquisitions for example – increase, so do the issues. His views are not necessarily endorsed by the editors of this publication but as ever it is delighted to share such insights and we invite readers to respond.

In the post-2008 shake up of the financial markets, the regulatory response continues to emphasise transparency, customer engagement and investor protection. The UK’s Financial Conduct Authority is no exception. Its ongoing focus on “client outcomes” through the Treating Customers Fairly initiative has significant implications for the way firms provide information to end clients.

In particular, wording from the FCA makes it clear that processing corporate actions falls under the TCF remit. Crucially, failure to notify end-clients about corporate actions and their potential impact is deemed “unfair” and subject to reprimand.

The recent increase in corporate activity – a possible result of the economic upturn – cannot therefore be underestimated. It calls for wealth management firms and brokers to rethink their approach to corporate actions in order to mitigate against significant financial and reputational risks.

The costs of corporate inaction
Quantifying the value of the financial risk in this intensely scrutinised landscape is almost impossible. Suffice to say sizable slush funds have been set up across the industry, which is a clear indication of its importance and the potential scale of the issue.

On the other hand, reputational risk resulting from inadequate approaches to corporate actions is more tangible. A negative judgment from the FCA would immediately call into question the reliability of the firm and raise a red flag to current and prospective clients.

Diagnosing risk

The key to mitigating financial and reputational risk is found in the firm’s operations. As ever, the ability to address risk depends on understanding where it comes from. In the case of processing corporate actions, there are three distinct possibilities. The first is that the firm will completely miss an event. This could be through a failure to monitor generally available information or, more likely, failure to receive a notification from the accredited registrar or custodian. This highlights a broader risk of having multiple people in the chain – where more people equates to greater risk.

The second is that the firm fails to understand which corporate actions are relevant to which client and, therefore, fails to communicate them to all affected parties. However, because each client is different, there is no single template approach.

Some firms tackle this by segmenting clients according to similarities in their characteristics. This may involve categorising them as discretionary, advisory and execution-only. However, not all firms will follow this approach and many will, instead, segment according to the type of corporate action. This might include different approaches for rights issues versus takeovers.

In the case of a rights issue, for example, it may be that broking firms need to send a message that indicates how much stock is being taken up. When a takeover offer is on the table, it could be that a firm has to record the amount that needs to move into escrow. A portfolio or investment manager should be able to see if something they are considering buying or selling is subject to corporate action. This requires more than simply knowing who holds what stock - there is the wider context to consider.

Finally, a firm needs to ensure it proactively manages client responses. Making sure no responses are missed is one part of this. Another is making sure clients actually do respond. It could be argued that if a client fails to acknowledge or respond to a notification, he or she has no further claim on the firm but the dictates of good service suggest reminders and second chances might be appropriate.

Life-saving operations

It is clear that firms must manage various scenarios, so it is important that tried and tested processes are used to ensure the correct clients are notified about all relevant corporate actions. This must extend to include making the required elections and then proving that the firm followed the appropriate procedures.

While segmentation is important, taking a holistic approach to corporate actions is vital. Firms must have access to data affecting entire portfolios. This requires the same information to be available to portfolio managers, relationship officers and investment managers so they are well informed on whether to buy or sell.

Automating the response

The key to achieving this lies in automation. However, corporate action is traditionally an area without a great deal of automation. The problem is that manual processing and spreadsheet dependency often lack efficiency and reliability - and, crucially, scalability.

Being able to scale is vital in light of the growing volumes of corporate action notifications. When the number of corporate actions doubles, so too does the workload. Correcting errors and omissions may eliminate financial risk but, on the downside, it becomes a significant overhead in its own right. Corporate scalability – and so sustainability - demands some kind of change. Therefore, automation is becoming unavoidable.

For some, that automation may tie in with efforts to gather and cleanse data from multiple sources. For global firms receiving numerous feeds, this data scrubbing to provide a golden source is crucial and therefore the costs involved are justified. However, for firms receiving just a few copies of the data, this becomes less of an issue and instead the focus must be on the process – in particular how that data is engaged with and disseminated across the firm.

Automation plays a vital role in this. It helps provide a complete picture across the whole firm including the back office, where better integration can lead to more efficient day-to-day processes.

Ultimately, an effective approach is to automate where this does not already exist and then better define the processes around it. However, this need not be the labour and cost-intensive solution that some might fear.

At a time of unprecedented change, when recurring demands are made on firms’ data management, processing and reporting capabilities, nobody wants to add to their operational burdens. Fortunately, the corporate action challenge is readily solved without sinking money into cumbersome systems. This only leaves the question - is the benefit of processing corporate actions properly worth the investment to overcome the challenges involved? For the overwhelming majority of firms, the answer is a resounding “yes!”.