For 2 years I tested an automated corporate actions system. I cannot name the system here, but can say that it won awards at the time and has been in the financial news press since. However, for our business we found that the system was not compatible.
The reason for sharing this information is to highlight the complexities of automating corporate actions. I started writing this article in 2009 and then abandoned it as I felt that nobody was really all that interested. However, as automation has been in the news I thought it was a good time to dust it off and have a new look.
For any system to work it must be able to follow set rules. Unfortunately, corporate actions processing is not as simple as imputing MT564’s into the trading and accounts software.
Advantages of Corporate Actions Automation
Before choosing to automate corporate actions you should consider all the advantages and disadvantages. The main advantages are:
- Reduced risk of human error. If the process is computerised from start to finish then there is a reduced risk of human intervention breaking it. Typical human errors which cost companies money are inputting incorrect ratios and the wrong instructions from fund managers.
- Reduced risk of lost advices. Sometimes the biggest financial losses can occur simply because a company failed to act within a given timeframe. Post not being received is sometimes the cause.
- Increased speed of information. In theory an automated system can vastly increase the speed at which notices are passed from registrar to fund manager via the custodian and middle office (where applicable). Most offices work on a 24 hour turnaround for corporate action notices, an automated system which uses SWIFT messaging can achieve same day notifications if all parties are compliant.
- Faster Corrections. If a system is fully automated a fund manager can correct their instructions extremely close to the deadline – this assumes that all instructions are sent on to the custodians without human checking.
Disadvantages of Corporate Actions Automation
Automation always carries disadvantages. Some of the main disadvantages of automation are:
- An almost total reliance on a software provider to keep your systems up to date. A change in market rules or processing methods could throw a system out of line.
- Complex relationship between systems. An automated corporate actions system never works in isolation. Although the sending and receiving of messages via the SWIFT network may seem to be the main focus of the software, its interaction with the accounting systems is vital. Businesses may run more than one accounting system with different systems for holding client shares and stock on loan.
- When the accounting system is updated the software may also need updating. Working with a software provider adds risk to operations as the accounting systems may roll out a vital security update at short notice which will conflict with the corporate actions software.
- Lack of manual intervention. One of the biggest risks in an automated system is when there is no way to manually intervene when something has gone wrong. Software providers call these situations “workarounds”, in reality it is a major failing.
One of the main reasons for wanting am automated system is to avoid human error. Human error is normal in any working environment and most corporation actions departments soon learn to mitigate this risk by enhancing procedures and checking to ensure that the chances of an error are greatly reduced.
How Automation Works
Different systems operate in slightly different ways, but mostly they will follow this workflow:
An MT564 is received into the system. This is an initial corporate action notice from SWIFT. Data is extracted and added to the corporate actions database. If it is a new event then a new corporate action is created, if an current event this information is added to the event details. It is at this stage that the first human input is required, as if the new advice does not agree with previously received advices, rather than overwriting the event it should provide an opportunity for the event to be manually updated. This only happens when multiple custodian advices are input into one system.
If this is a mandatory event then the system only needs to update the corporate actions diary to then inform the administrators of the date to process. A more advanced system may communicate directly with the accounting system and make the required changes on the even ex-date, however, in most cases this step will not be followed as it is vital to ensure all trades and reconciliations are resolved first.
For voluntary events there are several additional stages. The corporate actions advice will set up the event and also set the custodian deadlines. It will then send out notifications to fund managers, quoting the corporate actions deadline (which is generally 24 hours before the custodian advice). If a fund manager instructs then an MT565 is sent to the custodian and the instruction details are added to the system so that the corporate actions administration team can view the decisions made and update systems accordingly.
That is obviously a very brief outline of how these systems work. In reality there are a lot of variations due to the many complex corporate action types.
Before starting a project to implement an automated system it is vital to determine if the costs of the project in the long term is going to really reduce risk. A corporate actions system is not a one off payment to replace a headcount in an office, it is a long term strategic decision. By implementing a system you are essentially choosing to outsource a part of the processing to a 3rd party, i.e. the software house. You have to weigh up the benefits of automation against the costs of losing some of the control of the process.
From the work that I did on automation it became apparent that the systems which we looked at were just too often prone to failure which could lead to greater financial cost than any human error that we had encountered. Such problems included event details being updated based on incorrect information, client instructions being reversed or not sent at all due to system deadlines being missed and a total failure to correctly process various issues from start to finish. Sometimes the workarounds took more time and posed greater risk than not having the system at all.
Saying all that, many people have implemented systems successfully, and as more experience is gained systems improve.
The best system will always be one in which the corporate actions processing is an integral part of the stock trading and accounting systems, rather than a 3rd party piece of software.