It is probably safe to assume that for many asset managers, corporate actions and proxy voting are not at the top of the list of priorities when managing a portfolio. In their minds, attention is better focused on areas that generate profit for underlying clients, as well as coping with copious amounts of regulation.
Well imagine the shock to many that failing to take notice of the value of opportunities offered to managing corporate actions is in the billions of dollars. According to a recent white paper from law firm Greenberg Traurig LLP, asset managers are failing to optimise corporate actions decisions on a massive scale. Greenberg Traurig concluded that it’s ‘only a matter of time’ before legal and regulatory action is taken against them for their failings.
Specifically, the paper found average aggregate losses to beneficial owners from scrip dividends – a payment that gives shareholders the choice of receiving a cash dividend or the equivalent in additional shares of the company – totals $1.3 billion annually, and between 2011-17, approximately $8.9 billion were missed.
“It’s now only a matter of time before regulators commence investigations and enforcement cases and civil plaintiffs commence lawsuits against asset managers that systematically fail to maximise the value of corporate action determinations,” said Robert Frenchman of Greenberg Traurig,
“We think the courts are especially likely to uphold fiduciary obligations, where many are knowingly failing to recover the full value of corporate action events that are the undisputed property of their investors.”
Authors of the white paper insist that “there is no reason that asset managers (or the custodians that act on their behalf) should not have systems in place that value corporate action determinations on the election date, and that process corporate action determinations such that the full value of the optimal election is captured for the beneficial owner.”
If there has been so much lost as a result of inefficient corporate actions decisions, why has this not been realised sooner?
One reason is that is has little to do with actual corporate actions processes, but rather the people involved in it. “It is important to stress the problem is not necessarily the processes, but it is down to the decision making because every manager has the ability, but the decisions they making are often suboptimal ones which leads to inefficiencies,” says Jonny Ruck, co-CEO, Scorpeo US, a corporate actions technology firm. “Many see corporate actions as a distraction to managing the portfolio, and therefore overlooking the value on offer. The value is far too great for that to be an excuse.”
“On an individual basis, managers tend not to care because it is just a small amount per fund per issue, but what you get is incremental losses where at the end of the year, there is a significant loss in value. Until you utilise some of the technology on offer that automates corporate actions, this problem will continue to exist because managers won’t be changing their ways.”
Are custodians to blame?
Asset managers are potentially more susceptible to these inefficiencies than other market participants because of the number of data providers involved in the execution of their business. The fact there are so many intermediaries involved in their business, and for some that may have up to 10 custodians providing conflict event data, sometimes in non-STP formats, means they are more open to losses.
The amount that is lost in revenue reflects the inefficiencies of the entire corporate actions and proxy voting chain.
This is because a lot of the information from a proxy event is not standardised or digitised from the source. Rather, there is a lag when custodians manually input the information into an electronic format and then passed on to the next intermediary. This where the information is most susceptible to deviate and even be delayed for the end investor as this process is repeated.
“They [custodians] scrub the data using their own tools and disseminate to the next intermediary in the chain, who will also apply their own scrubbing process,” says Jon Smalley, co-founder of Citi’s Proxymity.
“Once it finally gets to the end-investor, who has to make the decision on that vote, you have the potential to get several different versions of the truth. The net effect it has on asset managers is that decision times are so compressed.”
However, it is wrong to assume that custodians are entirely to blame. To a large extent, the entire corporate actions process continues to be manually-driven, with a lack of investment in automated solutions still prevalent in a lot of market segments.
According to Michael Wood, global product manager, at Broadridge Global Asset Servicing, fragmented architectures at many of the larger-sized firms complicates the objective of normalising the data needed for efficient corporate actions decisions.
“Asset servicing is at the end of the processing chain and getting consistent, up-to-date access to a global stock record or global Security Master across multiple business lines has historically meant bespoke integration across 10+ systems,” says Wood.
In addition, he explains a lack of coordination between the front- and back-office in both investment banks and asset managers typically result in breaks in the open trade position, further hampering their corporate action decision-making process.
“Most systems also do not pull the long, short, traded and hedge positions in a single view for the investment managers responsible for making election decisions, leading to sub-optimal results,” Wood adds.
“The inability to efficiently get notifications and entitlements to the front-office means decision makers could miss revenue opportunity measured in the billions.
“Recent consultant analysis identified fund revenue lost from utilising standing instructions for cash elections, but the opportunities extend to the on-loan and hedge portfolios as well. Infrequent, large losses make the internal headlines, but it is likely the absence of awareness in the suboptimal management of positions, reference and market data that is the largest cost for the industry.”
Further to the defence of the custodians, Scorpeo’s Ruck also believes they are victims of the choices of their clients when it comes to the corporate actions process.
“Custodians are aware of the issue and the amount of value being missed, but if managers do not see a problem and are not asking for a solution, it is unlikely custodians will opt for an industry solution,” Ruck highlights.
Redesigning the process
The main challenge for both asset managers and custodians is bridging the operational and data differences not only between the front-and back-office of the asset manager, but also between the client and their fund administrator/custodian, and even between custodians themselves.
Historically, few solutions have been available to adequately address these challenges for both sides. Therefore, one way to go about finding a solution is looking at how stakeholders can redesign the corporate actions process to eliminate inefficiencies.
“Corporate actions and proxy voting is a process and a stakeholder problem, rather than a technology problem. There is significant percentage where the final delivery of election is delivered by paper, even though we are perfectly capable of electronic delivery,” says Smalley.
Several firms are looking at new technologies such as blockchain and machine learning to automate and digitise corporate actions. BNP Paribas Securities Services and HSBC are among a number of custody banks testing the use of blockchain technology for proxy voting and corporate event announcements.
Broadridge has also attained a US patent to develop a blockchain-based solution for proxy voting, and has agreed to collaborate with banks including JP Morgan, Northern Trust and Santander to use the technology to enhance global proxy vote transparency and analytics.
Proxy voting and corporate actions have been touted as the perfect starting point for applying blockchain or distributed ledger technology (DLT) to the post-trade industry. However, the success of using DLT to eliminate inefficiencies largely depends on how they will be implemented across the board.
“DLT has not solved the question of liability related to corporate actions. If a custodian solely relies on a single notification of which they have no liability, they will try to scrub and enrich the data their own way, and then you are back to the same problem,” adds Smalley.
Furthermore, the industry may opt for a more simple-to-implement solution rather than going with the complex DLT option.
“In all honesty, it’s not likely to be a cutting-edge technology that can make the largest impact for any specific company, but rich business rules that assist in the normalisation of data, that can configure to the asset manager’s specific challenges, and the ability to ignore the exceptions that don’t add value,” says Broadridge’s Wood.
In addition to technology, regulation could also provide an impetus for the industry to look at new solutions for corporate actions. Europe is set to revise the Shareholders’ Rights Directive (SRD II), which aims to stimulate shareholders’ long-term engagement and increase transparency in the voting process in relation to proxy voting and shareholder identification, as well as improving issuer-investor dialogue.
“The regulation may be a stimulus for the industry to look for a market solution to proxy voting and corporate actions, rather than each build their own. It could also act as a catalyst for intermediaries and issuers to push who they communicate through, and for a more streamlined process over how they disseminate information,” adds Smalley.
The signs from the industry to review and automate the corporate actions process are positive. Now that there is an actual quantified value attributed to how much investors could earn if they pay closer attention to corporate actions and proxy voting, demand for custodians and the industry as a whole to review, redesign and implement a more automated process could really take hold.