With increasing volumes of corporate actions come regional reforms, more responsibility, and new regulatory challenges — and asset managers have it far from easy. Experts discuss the issues.
What developments has the corporate actions space seen over the last few years? Is there significance in the timing?
Mark Proffitt: The increasing volume of corporate actions in the last few years, as well as the complexity of individual announcements, provides a significant challenge for both global custodians and investment managers. Standardisation of corporate actions messaging and communication flows has helped data providers and consumers to cope with the volume, but there is still some way to go to deliver an efficient end-to-end process.
Regulators are driving the agenda towards responsible investment, efficiency and transparency. Accurate and timely corporate actions data is part of the solution but an actual decision still needs to be made by the investment manager to ensure maximum returns for investors. Optimising the value embedded within corporate actions through effective decision making has often been overlooked as the industry tries to improve processing, but the incremental value can be significant with very positive impact across the investment value chain.
Maria Krasnova: A series of significant improvements in Russian corporate actions practices have been the latest steps aimed at bringing Russia’s financial market infrastructure in line with international standards. The corporate actions reform initiated by the National Settlement Depository (NSD), the Russian central securities depository (CSD), in 2013 came to fruition on 1 July 2016, when the set of laws and regulations establishing the legal basis for a modern approach to corporate actions came into force.
The key elements of the reform are:
- The Russian CSD becomes an official corporate information centre, receiving information electronically in a standardised form directly from issuers and then distributing it via participants and on its website. In case of a discrepancy between information distributed by the CSD and any other information, the CSD’s information will prevail.
- Customers of custodians will only be able to participate in corporate actions through their custodians. Custodians will send electronic instructions on behalf of their customers through an intermediated chain up to the issuer. No power of attorneys or any other documents will be needed for custodians to represent their clients.
- Securities holders will be able to participate in general meetings in four different ways. Two of them remain the same: a securities holder physically present at a meeting; or sending a completed paper ballot by post. Two new ones have been added: e-proxy voting—sending an electronic ballot through custodians; and e-voting—direct voting via a dedicated website.
- ISO 20022 has been implemented as a basic format for corporate actions in Russia, although ISO 15022 will be also available for international constituencies.
There is significance in timing. For the last four to five years the Russian securities market infrastructure had incurred a series of important improvements such as the establishment of the CSD and implementation of modern settlement services.
Corporate actions remained the last area where paper-based processes prevailed and therefore risks and costs associated with corporate actions were perceived as unacceptable by international investors. Now, Russian securities market infrastructure meets all efficiency, safety and transparency criteria.
Stephen Quigley: Developments have included the global open ISO standard 20022 that establishes a recipe for creating financial messaging standards. In the US, this includes the Depository Trust & Clearing Corporation’s reengineering of its core systems for corporate actions processing to follow ISO 20022 messaging. In Europe, it includes the Target2-Securities initiative to establish a single platform to settle securities, which uses the ISO 20022 format.
Other developments include a higher adoption rate of ISO standards such as 15022, which governs the format of electronic message exchanges used in banking and commerce, as well as the recognition of the need to reduce risk by eliminating the manual process and to mutualise to pare costs and risk.
In many instances, timing drove these developments. They reflect such factors as increased complexity and the combination of corporate action types, and include the need to decrease operational costs across the board: higher volumes in corporate actions; globalisation, which requires the ability to manage more countries and their rules and processes; and higher customer expectations about service and the timing of decision making to the market.
How big a part has new technology, such as blockchain, played in improving corporate actions and proxy voting processes?
Krasnova: Given the scale and the depth of the Russian reform, it was obvious that it would significantly affect the entire Russian securities market, thus we had to be very careful when designing new corporate actions processing models and when deciding on the technologies to implement. Our aim was to establish modern, standardised processes across the industry, encouraging straight-through processing wherever possible, so that all kinds of market participants could operate safely and efficiently by using reliable and affordable services that the CSD provides.
Meanwhile, we understand that we must not ignore the rapid development of financial technology, so we started researching the opportunities of blockchain technology and how we can use it in our business.
In April 2016, the NSD blockchain-based prototype for e-proxy voting successfully passed the testing related to bondholder meetings. Our next step would be to subject this prototype to all kind of evaluations: business, legal, and cryptographic, which will give us a more definite idea of whether the prototype is suited for real CSDs’ processes.
Proffitt: Technology initiatives to standardise corporate actions messaging have helped to improve efficiency in the face of significant volume growth. There are a number of projects underway to look at the potential application of distributed ledger technology in corporate actions with the creation and distribution of a single, trusted record or ‘golden copy’ of corporate action events.
Participants are aware of the need to continue to add value to clients and invest in areas where there are efficiency gains. Collaboration on an industry-wide scale may come, but in the short term there are benefits of distributed ledger technology deployed bilaterally to improve process efficiency and explore the benefits of the technology as it evolves. If announcements from issuers can be processed more effectively and voluntary corporate actions can reach the decision maker in a timely fashion with a level of surety, that will be a very positive development.
Quigley: Traditionally, technology has focused on maximising and automating existing manual processes. But we foresee a fundamental change in that model as technology does away with many manual processes such as reconciling and cleansing announcements and reconciling entitled ownership positions.
Technology advances, such as computing technology that enables decentralised settlement systems built on distributed ledgers, promise to be key, but only if concerns can be resolved around security, performance, agreement and adoption of standards and liability issues. Through its Blockchain Innovation Lab, Broadridge is exploring ways to transform these types of processes using distributed ledger technologies.
Does improved corporate action participation benefit asset managers from a regulatory point of view?
Quigley: Alternative asset managers may see big benefits from streamlining corporate actions to managed service providers. This will improve quality of reporting to support regulations such as FormPF, the Basel Committee of Banking Supervision regulation 239, the Markets in Financial Infrastructures Regulation, and others.
Krasnova: As I mentioned earlier, on 1 July 2016 the new stipulating key provisions of the corporate actions reform came into effect. One of the main benefits for asset managers connected with these changes is the widespread use of electronic data interchange in accordance with international standards, and the possibility to do most of procedures via their depositories. This is especially important for foreign asset managers. Now they do not need to collect hard copies of documents, translate them and adjust them in accordance with Russian legislation.
Proffitt: Active participation helps investment managers meet investor demands for responsible investment and maximises the potential value available in corporate actions. From a regulatory perspective, there is increasing focus on the fiduciary obligations of investment managers and active participation can help to achieve these objectives while minimising the risks associated with errors or omissions in corporate actions processing and decision making.
Regulating for corporate actions participation is very difficult as what counts as ‘participation’ is a grey area. In reality, all elections can technically be defined as participation, even where there is a standing instruction or default election applied. Underlying investors want to achieve the best economic outcome possible, and making the appropriate decision fulfills the fiduciary duty that the manager owes to their investor.
To achieve this, portfolio managers need to read all the documentation around a corporate action, which can often run into hundreds of pages, but also understand the impact a corporate action will have on their underlying positions. This is not easy and there is limited expertise available to help or advise. There are solutions, however, that deliver the best economic benefits without affecting the manager’s election decision, and thus always ensure that they have fulfilled their fiduciary duties to their clients.
Are asset managers outsourcing their corporate actions obligations? Why?
Proffitt: Asset managers are outsourcing some, if not all, of their corporate action processing. However, we need to differentiate between the obligation to process corporate actions and any obligation to make election decisions on corporate actions. It is generally regarded that the real obligation is the decision-making process and it is very unusual for an asset manager to outsource this element. Only the asset manager can understand its own fund, its investment mandate and obligations, and it should therefore maintain full autonomy over the decision-making process. If there are opportunities to gain the best economic outcome irrespective of its election decisions, this will benefit the fund and the end investor. This is not outsourcing the decision-making process, but ensuring that there is a safety net in place to ensure that the fund receives the best economic outcome.
Quigley: Many alternative asset managers use fund administrators to outsource auxiliary services including corporate action processing. The main reason is to improve net asset value, as well as overall client reporting timeliness and quality.
What kind of challenges remain for cross-border corporate actions? How can participation be further improved?
Krasnova: In order for foreign investors to benefit from the Russian corporate actions reform it is important to implement new services across the entire chain of intermediaries, including global custodians and other non-Russian institutions. All procedures related to corporate actions need to be adjusted in accordance with new requirements. We understood the challenges our international constituencies may experience and we were willing to remove all the obstacles that may prevent them from participating in corporate actions. NSD chose to design new processes based on international standards developed by the global securities industry. That is why we expect new services to be easily accessible to all kinds of investors.
ISO formats were chosen to support automatic information processing. Even though ISO 20022 has become the basic standard for corporate actions processing in the Russian market, ISO 15022 is also available and, as we can observe, has been successfully used for foreign investors’ instructions processing.
Proffitt: Cross-border corporate actions continue to throw up many challenges for managers, often related to the manager’s own mandate within the fund. Existing regulation and specific mandate terms often restrict the ability for managers faced with cross-border corporate actions to elect as desired. In these instances, even though the managers may be aware of the best economic outcome for their funds, their hands are tied, preventing them from participating. Finding a solution to ensure the best economic outcome while meeting regulatory and mandate restrictions can improve investor returns, but it can also positively affect the issuing company. In many instances a corporate action, for example a rights issue, scrip dividend or share buy-back, may be designed to encourage shareholders to participate with economic incentives, to achieve the intended outcome. Finding a way to achieve that will benefit all involved.
Quigley: Several challenges persist as they apply to cross-border corporate actions. But they will dissipate, and participation will improve as global hurdles are addressed and clarity develops about intermediated securities among participants, regulators and others. In general, the obstacles relate to generating operational efficiencies and to identifying the correct legal framework, all in the current fragmented global legal system that makes transparency difficult to attain.
More specifically, the challenges include: regulations and legal issues that vary from country to country; the many local languages and cultural differences that add a layer of complexity; adoption of standards of market practice; and an absence of a central reporting process.
In addition: there is a very limited and inconsistent flow of information to investors from companies; a paper-intensive proxy voting process; the absence of mandated entitlement notification rules; and much higher clearing and settling costs. Such costs can be up to 10 times the cost of domestic securities. Further, foreign exchange fluctuations can be extremely volatile and the lack of consistency in messaging protocol boosts the failure rate of trades and settlement.
Frankly, participation will improve as all parties address these challenges, develop more standardisation and increase trust.