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The global securities industry faces risk of multi-billion-euros, and individual securities firms face potential risk that could run into tens of millions of euros from just one complex corporate action event, according to a new report by Oxera, an independent economics consultancy in Europe.
The study, Corporate Action Processing: What are the Risks?, measures two types of risk:
Front-office trading risk – Acting on incomplete or incorrect information may lead to sub-optimal trading decisions, with the risk estimated to range from €1.6b to €8b per year globally.
Back-office processing risk – The losses from mishandling a single, complex corporate action event have the potential to run into tens of millions of euros.
Corporate actions are one of the last significant areas of risk associated with largely manual and non-standardized processing in the securities industry. The Oxera study is the first effort to quantify the risk and loss of corporate action events in the global securities marketplace.
Dr. Luis Correia da Silva, Oxera Director, comments: "Corporate actions are not just a back-office issue, but also impact trading strategies in the front office, and the efficiency of capital markets more broadly. Given the industry's increased focus on operational risk management, our research has brought into focus the importance of raising awareness that corporate actions represent very significant potential risks and costs."
Close to one million corporate actions take place every year worldwide. Rights issues, tender offers, conversions, takeovers, mergers, early redemptions and dividend payments are just a few examples. A single event may involve hundreds of different market participants (including custodians, fund managers, broker/dealers and depositories), ultimately cascading down to thousands of investors. Each of these participants faces high risk because corporate action processing is complicated, deadline-driven, not standardized, and, to a large extent, still manual, according to the report.
The study is based on extensive research and anonymous interviews conducted by Oxera with a cross-section of brokerage, fund management and custodian firms. While the research focused mostly on Europe, the study notes that the issues surrounding corporate action risks are similar across markets, including the Americas and Asia-Pacific.
The Oxera study was sponsored by The Depository Trust & Clearing Corporation (DTCC), which is the largest processor of corporate actions and the largest securities clearing, settlement and servicing organization in the world.
"We sponsored this research as a first step to measure the magnitude of risk corporate actions represents to the industry as a whole," said Jill M. Considine, DTCC chairman and CEO. "Oxera has done an excellent job interviewing industry participants, assessing the risk factors involved and providing concrete numbers on the potential losses."
"Our goal in funding this study is that it serve as a catalyst, ultimately moving the industry to improve and strengthen the handling of corporate actions globally," said Considine. "Corporate actions may not be a top priority at many financial services firms; however we agree with the Group of Thirty's 2003 recommendation to automate and standardize corporate actions, and believe this is essential to improve the safety and efficiency of international securities markets."
The report identifies two primary areas of risk facing all market participants:
Errors in the downstream flow of information: There is no standard way in which events are announced by issuers; there is no single securities identification system that is universally accepted; different information sources are often inconsistent; and processing details and terminology are often highly specific to a particular market or financial instrument.
Errors in the upstream flow of instructions: The sheer number of different financial intermediaries (custodians, fund managers, broker/dealers, and depositories) involved in any one event requires a complex chain of communications (with many instructions delivered via phone, fax, telex or unformatted email, and processed manually).
Although the study does not focus on the costs and inefficiencies of current corporate action processes, securities firms were found to spend huge amounts of resources on failure prevention.
"Last year, at the depository, we processed a record $2.2 trillion worth of corporate action payments, and our volume increases consistently every year," said James Femia, managing director, DTCC Asset Services. "We understand the nature of the costs and risks involved, and believe that a broad, global perspective is needed to ensure progress."
"A number of firms that were interviewed by Oxera expressed interest in further in-depth research on corporate actions," said Femia. "We would support a more comprehensive study with the cooperation and participation of additional market participants across a more geographically diverse area."