In the wake of the financial crisis, transparency – transparency of investment assets, transparency about transactions, and transparency about financial performance – is a critical issue. The need to improve clarity in the financial markets is one of the key lessons we should be drawing from the events of the last several years.

 

At DTCC (The Depository Trust & Clearing Corporation), we hold for safekeeping almost all the equities, corporate and municipal bonds issued in the US, not to mention various securities issued in another 117 countries around the world. Because we maintain these securities and the book-entry records for them in our depository, we’re also a link in the chain of communication when a company wants to take an action with its stock, such as pay a dividend or issue new shares, or any of dozens of other actions.

 

Hundreds of these transactions – from stock splits to mergers to conversions - which we collectively call “corporate actions” – come spilling onto our desks every month —and they come in different formats and different languages.   Corporate actions information is passed around all over the globe, requiring financial institutions, particularly outside the U.S., to communicate between each other and their clients using international standards.  These standards address different securities with unique features and identification numbering schemes. The receipt of these corporate actions announcements, typically come from many different sources, entails comparing and validating the data in them for accuracy, and then disseminating them to all the parties involved.  This demands around the clock operations by offices from around the world. 

 

These hard-to-decipher corporate action events often demand time-critical actions or decisions on very complex transactions such as rights issues, takeovers, conversions or tender offers. In turn, responding to these corporate actions often means communicating decisions back through a daisy chain from investors to broker/dealers to asset managers to custodians to central securities depositories like DTCC to registrars and then—finally—back to issuers.

 

A single corporate action can impact hundreds of securities and because there is a lack of standardization for communicating this information, the information at times has to be manually entered into a data base. In this age of automation, that’s a total anachronism. It also makes it easy for error to occur.

 

These sorts of events are proof that distributing information about corporate actions into the market, in a way that leaves each intermediary individually responsible for interpreting the information - and translating it into a form that can be communicated to their clients is inefficient.   It increases risk, and ensures that from time to time someone somewhere will misunderstand the terms of a particular event.

 

How costly can errors be? A few years ago, we asked an independent consultant to look at this question. Their answer was shocking. They estimated that losses on corporate actions worldwide ran somewhere between €300 and €700 million -- or between $450 million and $1 billion…each year.

 

Obviously, the risk in the industry is very high, and it’s not limited to the U.S. market. Worldwide, the number of “announced” corporate actions every year is close to a million.

 

In a rights issue, for example, if inaccurate data causes mistakes in how an investor’s instructions are communicated to the custodian, the custodian may fail to process the right instruction, and thereby fail to obtain the shares involved. Then, to re-establish a position once the error has been revealed, the custodian would have to purchase or sell the requisite number of shares at the current market price rather than the usually discounted price under the rights offering. And guess who pays the difference in the end? Initially, it’s the custodian. Ultimately, of course, it’s the shareholder, because these costs usually get passed up and down the chain as well.

 

For shareholders, risk is extensive…and expensive. Reducing this kind of liability and these potential losses clearly spells out the need for standardization for interactions within the market place to reduce the operational, financial and reputational risk involved in processing corporate actions.