Risk

For many years Corporate Actions have been known to be very risky. The smallest mistake can easily result in huge losses (millions of Euros for individual companies that handle the events that is…). Please find below a bit more info about the risks involved. The risks apply to all market players in the industry. More about who the market players are can be read here. Some of the risks also apply to the beneficial owner.

Types of Risk

A mistake can easily lead to a substantial financial loss or -gain. (just like making losses, it is also possible to end up with a gain as a result of a mistake). Although it may look like a good thing to make a profit, the fact that someone makes an accidental profit as a result from a mistake is not considered to be good business practice. This time it was a profit, next time it might as well be a loss!

Every market participant expects a flawless service from the participant higher up in the chain in the industry. Most of the actions are regulated by SLA’s between parties in the industry. Even if a mistake does not directly lead to a financial loss, there is always the threat of suffering damage to one’s reputation. After all, having to admit to a mistake to a client is never going to make a very good impression.

The industry is being closely regulated and auditors will make sure that every procedure is being adhered to. Auditors are hired to ascertain that processes adhere with regulations and to reduce the risk of financial loss. Making a profit as a result of deviation (intentionally or not) of procedures is not in line with the procedures that are subject to audit.

Failing to make the right decision based on the information of the event may lead to suboptimal trading. The Front-Office should make sure to be updated with and understand Corporate Actions information at all times because it is certain it will impact on the price of the stock.

Reasons why Corporate Actions can result in huge losses:

Voluntary Events:

Many industry players receive their information about corporate actions events from multiple sources. Any of those sources could potentially pass on incorrect information.

This is certainly true when different countries are involved. The huge amount of systems and formats that are used (and that are constantly being upgraded) are therefore often not compatible. Having said that though, this situation has improved over the past 2 decades.

Even if the information received is correct, it can easily be misinterpreted. Although the industry is steering towards market standards, there is still quite a bit of human interpretation required. Some prospectuses can easily be more than 200-300 pages and a mistake is easily made.

It can take a long time before the information finally reaches the final investor since all the information needs to go via many market participants.

It can also be that information about a certain event is being missed, for example because the investor has got no holdings in the security on the moment of initial publication of the event, but buys into the stock at a later point in time. This shouldn’t happen, but it could happen.

Somebody in the company representing the investor (or the investor themselves) needs to analyse the situation and make a decision as to what cause of action to take regarding voluntary events. Since there are always many factors involved an incorrect judgement is easily made.

The fact that until now a large portion of all instructions are still being processed manually from free format templates explains why losses are still being made. There are also many events whereby Documentation is required with each instruction and this is breaking STP flows.

All voluntary events have so called “reply-by-dates” or put differently: DEADLINES. Every link in the chain needs good diary management to make sure that no deadlines are missed. This shouldn’t be a problem for STP instructions, but can be for non-STP instructions.

Sometimes an investor does not know what to do and ends up doing nothing. Sometimes Beneficial Owners cannot be contacted during the course of the event.

If a party is holding stock somewhere else, but doesn’t realise this because of reconciliation differences, they can miss out on the event.

Mandatory Events:

Mandatory events carry risk. If for example entitlements resulting from a corporate actions event are being passed down the chain too late, this might easily result in missed opportunities to sell the securities for a good price.

Also, if shares resulting from a corporate actions event are being short sold by the investor and the anticipated shares subsequently don’t come in (on time) this might lead to buy-ins which can be very costly.

Un-reconciled positions between market participants can also result in losses during mandatory events.

Trades being booked late or back-valued, can result in missed corporate actions proceeds.

Different sub-processes of the event being processed by different departments within the same organisation can easily lead to communication problems as well. Also there is the different need that the front-office and the back-office require when dealing with corporate actions. The front office may find timeliness of information more important than accuracy regarding deadlines or payouts in order to implement their trading strategies. The back-office require more accurate information in order to process the event without any mistakes for their customers and perhaps don’t mind if it comes in a couple of hours later.

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