Cutter AdvantEdge
Issue 38, May 2006
Corporate Actions and Operational Risk
The last area of the investment management industry to be fully automated is corporate actions. Current research highlights it as a potentially high risk area where failures in procedures could significantly impact a firm's reputation.
A survey by CutterResearch of over 50 large asset managers (averaging over $350 billion in AUM) revealed that approximately 50% use manual processes to manage corporate actions. Another 25% use a central repository and database tools to manage and monitor lifecycle components of corporate actions and only 25% have a fully integrated and automated corporate action system. Even more surprising is the heavy reliance on faxes for communicating corporate actions information. Web portals offered by custodians have seen increased use but there is slow progression of SWIFT messaging. Nonetheless, corporate actions systems vendors anticipate that SWIFT will become increasingly important for transmitting corporate actions details as four out of nine vendors have SWIFT Ready Label for corporate actions.
For those firms that have not automated, most are using Excel as data storage. As a result, they have no control of lifecycle processes and no disaster recovery facility. Given the complexity of corporate actions data and management, manual processes mean high operational risk and increased trade failure potential.
Other findings include an industry reliance on custodians for corporate actions data. As shown by the results below, few firms use market data vendors as the primary source for consolidated data.
| PRIMARY SOURCE | SECONDARY SOURCE | |
|---|
| Custodian | Vendor | 62% |
| Custodian | Custodian | 13% |
| Both | | 13% |
| Vendor | Custodian | 9% |
| Vendor | | 3% |
| | | 100% |
As a way to mitigate operational and trading risk, Cutter recommends auditing all processes and procedures for corporate actions and measuring operational risk in each lifecycle component. We further encourage clients to move away from reliance on paper and Excel, to centralize corporate actions data and establish tighter controls over data and election process. Even with these modest improvements there is no possibility of full automation, but operating risk is reduced.
Firms reduce risk and address disaster recovery issues by deploying a central repository and having tighter control of lifecycle processes. Nonetheless, while these firms have achieved some level of automation, there are still many manual processes.
The implementation of corporate actions systems ensures the organization of all events, elections and entitlements which lowers risk. In addition, It provides full disaster recovery and control over lifecycle components, but obviously also bring higher systems costs. Operating costs remain unchanged as firms deploying corporate actions systems have not reduced staff. Staff time has traditionally been spent on research and analysis of corporate actions events and systems do not reduce the research workload.
Given spending priorities for IT, corporate actions systems are a difficult sell to senior management. Most firms have elected to fund better known and well publicized risks (both regulatory and operational) and the potential operating risk of corporate actions errors has not taken precedence. However, if the front-office demands improved corporate actions data, the industry can expect increased spending on corporate actions projects.
| PRIMARY SOURCE | SECONDARY SOURCE | |
|---|
| Custodian | Vendor | 62% |
| Custodian | Custodian | 13% |
| Both | | 13% |
| Vendor | Custodian | 9% |
| Vendor | | 3% |
| | | 100% |
With slow implementation of industry standards, sluggish migration to SWIFT, gradual growth in the use of consolidators and limited adoption of corporate action systems, the industry has not embraced a sense of urgency regarding significantly improving corporate actions processing. As a result, management of investment management firms seems willing to accept extensive manual processes as well as the risk and problems inherent in managing current corporate actions processing. The good news is that many firms have made extensive commitments to improve firm-wide data quality and data management. As a result, improved controls over data quality and processes should yield improvements to corporate actions data and processes.