Preface

From the Editors Desk

1. Strategic IT Cost Reduction - Doing More with Less 05

2. Investment Banking Transformation into a Bank 13Holding Company

3. Post-merger Integration: Best Practices for Information 23Technology Mergers and Integrations

4. Alternative Investments: Leveraging Event-based 29Processing for Real-time Information

5. Securities Operations: Operating Model Best Practices 35

6. Maximizing the Impact of Business Transformation 41

7. The Next Generation Prime Broker 51

8. Processing Corporate Actions - A Continuing Challenge 57

9. Securities Processing: Evolution and Trends in 63Exception Management

10. Trends in Clearing and Settlement in Europe 69

11. Offering Managed Products - Challenges in the 75Middle and Back Office

12. Handling Client Risk 81

13. Mitigating Rogue Trading Risks by Leveraging Your 87Investments in AML

14. Creating an Enterprise Risk View for the New Age 99Investment Bank

Transformation in Securities Operations

Challenges and Trends in the Industry

Managing Risk

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Contents

Financial services firms have spent several million dollars attempting to automate the Corporate Actions process over the years. Several product vendors have entered this space in recent times and messaging infrastructures have improved considerably. In spite of all this, the risk quotient of the process has not changed much. New financial products have emerged, hedge funds have grown (at least till recently) and structured markets have seen phenomenal growth. Throughout this evolution, the corporate actions shop floor has been catching up. This article takes another look at the challenges and risks in the corporate actions process, the impact it has on other fund administration, back office processes and recommendations for mitigating risks in the process.

SECURITIESOPERATIONS

Processing Corporate Actions -A Continuing Challenge 08

Omesh Sundaramguru Roy Antony

Background

System Landscape

Over the past few years, the number of manual touch points required for processing corporate act ions has come down significantly. Technology has evolved over the years to standardize and automate many components in the process and several vendors have products catering to this space. Industry standards and communication protocols have also evolved significantly. But, the inherent personality of corporate actions has not changed much. It still remains a nightmare to deal with and it takes the number one position on every Operations Manager's risk dashboard. As newer and more complex financial instruments are created, they bring in additional challenges for processing. Enabling Straight Through Processing (STP) in corporate actions still remains a desired end state.

Exhibit 1 depicts a typical life cycle of a voluntary event and the various stages where manual touch points are high.

A corporate actions system cannot operate as a stand alone system, irrespective of whether the firm is an investment manager or a custodian. Tight integration with other

systems leads to better STP and lower manual touch points.

Managing the event calendar: The corporate actions process is a sequential date driven process; every step in the process is date driven. Announcement date, ex date, record date, effective date, open and close dates, last date for instruction receipt, value date and settlement date are some of the typical dates in the corporate actions chain. Managing these dates across events and portfolios is crucial for accurate and timely processing of corporate actions.

Managing stake-holders: In some markets, the number of stake holders for an event can be large - agent banks, clients, data providers, transfer agents, depositories, etc. - all requiring strong interfaces to not let vital information slip through the cracks.

Managing spikes in volume: Another challenge is that corporate actions are quite seasonal. There are spikes in volume during specific periods of the year. Operations Managers need to plan staffing strategically to handle volume spikes and mitigate operational risk.

Market specific behavior: Different markets process corporate actions differently. For

Fundamental Challenges

Exhibit 1Corporate Actions Life Cycle

AnnouncementProcessing?Raw Info?Cleanse Info?Store Info

Entitlements Management?Positions and

Benefits?Source of

Receivable

Receivable Management?Follow up on

Dues?Write offs /

Pay offs

Settlement?Process

Receipts?Account

Dues

Instructions Processing?Act on

Instructions

Corporate Actions - Typical Life Cycle

Notification Process

Source: Infosys Research

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instance, depending on the country catered to in the European Union, notifications have to be delivered in a local language. Understanding the local market conventions is very important, even though they may all have a common payments infrastructure.

Effect on Other Processes: An incorrect action leads to several downstream effects. For instance, it can lead to a reconciliation break, fund redemptions or purchases happening at incorrect net asset values, an unaccounted debit interest, opportunity cost of cash blocked, and so on.

Existing technology: Leveraging existing systems can be a big challenge too. Many banks have corporate actions applications, modified so many times that their original purpose was completely different from what they are being used for today. Tactical changes to systems in the short term can make the system expensive and difficult to manage over the long term. Managers need to ensure that their processing platform continues to provide value in terms of competitive differentiation, enhanced revenues and better r isk management.

The Perils in the Life Cycle

Corporate Actions for Complex Financial Instruments

Each stage in the corporate actions life cycle is filled with operational risk. In a custody shop, these risks can sometimes be large enough to create a significant dent in the bottom line and a serious loss of reputation (Refer Exhibit 3).

The evolving nature of financial instruments over the years has posed new challenges to the corporate actions process. A classic case is structured instruments. Given the highly customized nature of transactions in these instruments, corporate actions on the underlying securities change the nature of the instruments in many ways. Often, there are no precedents on how to account for valuations because a corporate action just struck an underlying security or a component of the structured instrument. Let us take credit default swaps for instance. An institution can buy protection on an index and a component of the index could get acquired by another organization that is outside the index. While capturing the acquisition announcement is not that big a deal, how the derivative contract subsequently gets modified for positions and

Source: Infosys Research

Exhibit 2Corporate Actions Ecosystem

Corporate Actions Ecosystem

TradingSystems

LendingSystems

TaxSystems

ReconciliationSystems

Position ManagementSystem

Corporate ActionsSystem

Accounting &Valuations

External systems and messaging infrastructure

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valuations can be a challenge. Similarly, in a total return swap, where the total return is on a basket of securities, any corporate action (such as a cash dividend) can affect the returns and the payment structure of the swap. The basis for any adjustment for corporate actions in the derivatives market shall be such that the value of the position of the market participants, on the cum and ex-dates for the corporate action, continues to remain the same as far as possible. This will facilitate the retention of the relative status of option positions - viz., in-the-money, at-the-money and out-of-the-money. It will also address issues relating to exercise, assignments, margining and risk management. Adjustments will need to be made for all impacted open contracts in both futures and options markets. The real challenge here is with respect to entitlements, calculation, position management, accuracy and timely valuations. As structured instruments continue to become more complex, it is hard to establish pre set rules and always expect an anticipated

outcome. The corporate actions process has to be flexible and the systems configurable to accommodate these instruments. Manual interventions in some instances by specialized staff may be necessary too.

Given the challenges, it is important for the Operations Manager and the risk department to be able to measure risk and have a strategy to contain risk, if not eliminate it. A dashboard that captures the Key Risk Indicators (KRIs) and provides analytics will help the Operations Manager to track risk and take necessary action. Exhibit 4 is an illustrative Level Zero dashboard. The risk department should be able to drill down into the details for any particular measure. Dashboard analytics can also provide upfront warnings based on intelligent benchmarks. For example, a warning rule could be '30% of total volume is voluntary action with a deadline between Dec 20 and Jan 10'. Analytics of this nature provides the necessary warning to ensure

The Operations Manager's Dashboard

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Exhibit 3Risks in the Corporate Actions life cycle

Stage in the Life Cycle Risks Overall Automation Ease

?An event missed?Inaccurate capture of event

Entitlements Management ?Incorrect accruals?Incorrect NAV

Announcement ProcessingMedium

Low

Low

High

Instruction processing ?Missing and instruction?Switching instructions ?Missing an agent deadline

Settlement ?Incorrect accounts used?Incorrect balancing entries?Missed postings

Notifications ?Notifying incorrect party?Notifying incorrect positions?Missing a notification

Medium

staffing and to make sure that no instructions are missed.

While corporate actions systems have evolved over the years, a lot more has to be done to address the challenges in processing and increase operational efficiencies. For firms considering overhauling their existing corporate actions platform, building corporate actions systems and processes can be expensive and fraught with risk. A big bang approach is certainly not recommended. Embarking on a large multi-year program to transform the corporate actions landscape, runs the risk of budget over-runs and can put the team in 'catch up'

An Implementation Approach to Corporate Actions

Measure Count

Announcements Processed 6000

STP Failed - Exceptions 300

Missed announcements 35

Incorrect announcements 10

Instructions that Missed deadline 3

Post event Entitlement Corrections 500000

Reversals posted 750000

Valuation Impact 0.03%

Reconciliation breaks in Corporate Actions 1000000

Value of benefits Pending Past Value Date 35000

Average age of Benefits Due 240 Days

Instructions received late from the client Details1

Closing Date captured incorrectly Details2

Instructions that Missed Deadline - Details Level One

Exhibit 4An Illustrative Dashboard

mode forever. This is especially true if the nature of operations is large and diverse. A modular approach is recommended. Organizations should identify a specific area in the chain that is easy to automate and where exception handling will be minimal. This can mean focusing on a specific asset class for a limited set of geographies and for a particular component of the corporate actions chain. A quick win usually results in better confidence, realized value and tangible benefits. Identifying the 'beginner' candidates will require analysis of current processes, historical data of errors, fines and losses, seasonality of corporate actions, and a study of current systems landscape. Many times, organizations either directly jump into buying a product (under the assumption that the

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product can address all corporate actions pain points) or start with a large program to transform the corporate actions system. These approaches will only lead to disappointment.

It is now a given that financial institutions will embrace corporate actions automation. However, it is the approach to this automation that will separate the winners from the rest. Securities processing has become

Conclusion

commoditized for the most part. In a market where it is tough to differentiate oneself, having the most robust process and technology to contain risk and service clients is a critical success factor. New financial instruments will emerge, new markets will open up and so will newer types of corporate actions. The right solution will enable the firm to be agile in responding to these developments, mitigate risk, enhance service delivery and stay ahead of competition.

Omesh is a Principal with the Banking and Capital Markets Practice at Infosys Consulting. He has about 12 years of experience in the capital markets domain. He has worked and consulted for top tier investment banks across US, Europe and Asia Pacific.

Omesh SundaramguruPrincipal Infosys Consulting

Roy is a Principal with the Banking and Capital Markets Practice at Infosys Consulting. He has about 14 years of experience in the Securities industry. He has led several consulting engagements and worked in US and Asia with various Large Global Custodians, Banks, Stock Exchange and Clearing Corporation.

Roy AntonyPrincipal Infosys Consulting

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