Financial Markets Operations Management (39 page)

In this section we will cover the general principles that govern the processing of all corporate action events, whether they involve cash only, securities only or some combination of both. You will then see how certain corporate action events are processed and the challenges they present to the operational staff.

We will examine the corporate action event types shown in
Table 11.3
.

In general, the processing of corporate action events typically involves the following nine processes:

1. Communicating the event/event announcement
   

   Once the issuer has decided to initiate a corporate action event, it will have to pass on full event-related information to all market participants and CSDs, who, in turn, will notify their customers (i.e. participant local custodians). The local custodians will notify their
   customers (i.e. the global custodians), who will notify their customers/fund managers, etc. Every organisation must be able to gather the information and verify its accuracy. It is important that the underlying beneficial owners are notified as quickly and accurately as possible.
   

2. Reconciliation – ante event
   

   Positions should be reconciled to ensure that the correct entitlements are either received in full or claimed where necessary.
   

3. Event creation
   

   Having notified their clients about the upcoming event, the custodians will create an “event” in their in-house systems. All relevant dates like deadlines, pay dates, ex dates and record dates need to be correctly diarised to ensure that important actions are taken at the right moment and are not forgotten. If necessary, the information published by the agent should be translated before it can be sent to the customers. Any unclear information will need to be investigated by contacting the information provider and/or the issuer's agent.
   

4. Claims processing
   

   Positions that are entitled to benefit from an event but have been delayed (e.g. failed settlement) should be identified and claims processed.
   

5. Instructions processing
   

   Voluntary/optional events are operationally the most risky. The issuer's agent will have a timetable for decisions and appropriate actions. Failure to meet these deadlines will usually result in the customer missing the opportunity to participate in the event.
   

   In order to meet the issuer's deadline, every participant in the communication chain will need to allow time to pass the information on and receive any instructions. It may be the case that the beneficial owner has to make a decision several days ahead of the issuer's deadline.
   

6. Entitlement calculation
   

   Once information has been received and verified by the custodians, they must first calculate the securities amounts and/or cash that the beneficial owners are entitled to. Secondly, the custodians must advise their customers of the full terms of any event, what the options are and what results can be expected.
   

7. Payment/delivery
   

   Once the lead agent releases the results of the event (cash, securities or both) the custodians should update their internal books and records under advice to their customers.
   

8. Reconciliation – post event
   

   Every event needs to be reconciled after completion to ensure that every aspect of the event has been processed correctly.
   

9. Reporting
   

   Reporting on the progress of the event takes place throughout the event.
   

Whilst every corporate action event is different, the above processes can act as a template for processing corporate actions. We will now look at a number of different events to see what happens, to understand the operational risks and the types of controls that will mitigate these risks.

Shareholders usually invest in shares in order to benefit from either capital growth or income. Here, we are concerned with income and this is the result of when a company chooses to distribute any profits. This distribution is made by way of a cash payment to those shareholders who are entitled. Companies are not obliged to pay cash dividends even if there are sufficient profits. They might argue that it is better to reinvest any profits in the business (and in so doing hope to grow the business and increase the share price).

The company's board of directors will publish its half-year or full-year results and announce its intention to pay a dividend. This publication is made on a declaration date. For example, Barclays Bank declared its second interim dividend for the year ending 31 December 2013 on 30 July 2013 together with the rate and other relevant dates (see
Table 11.4
).

In addition to the Barclays ordinary shares listed in London, there are American depository receipts (ADRs) traded and held in the USA. As the ADR ratio is 1:4 (one ADR:four ordinary shares), a dividend of 1p per ordinary share would equate to a dividend of 4p per ADR. The GBP/USD exchange rate was set by Barclays at 1.569273, resulting in a cash payment rate of USD 0.062770 per ADR.
²

The second stage is to reconcile the investor's position in order to establish how many shares are traded cum-entitlement and of these, how many shares are outstanding due to a delayed settlement.

The third stage is to create the event in the books and records, including diarising the key dates, advising clients and passing cash entries over the accounts. The accounting entries have to achieve two objectives:

1. To accrue the dividend amount on the ex-dividend date (whilst we know how much the dividend will be at this point, the dividend has not yet been paid).
   

2. On the payment date, the accrual will be reversed and replaced by an actual payment, as listed in
   Table 11.5
   .
   

We have ignored the impact of taxation on the dividend; we will return to this topic later in Section 11.10.

As a cash dividend is regarded as a mandatory event, there is no requirement to send any instructions to the issuer. We can therefore move to stage 5 and calculate the entitlements. Taking the Barclays dividend above as an example, the entitlement calculations and corresponding accounting entries are shown in
Tables 11.6
and
11.7
respectively.

If the issuer wishes to retain cash in the business it can give the shareholder the option of taking either cash or shares to the value of the cash dividend. So whilst the sharing of the profits, once approved, can be regarded as a mandatory event, we now have the situation where a choice has to be made. The convention in most markets is that shareholders will accept the dividend in cash rather than opting to take shares. (Accepting cash gives the shareholder reinvestment choices; taking shares does not.).

In order to cultivate the number of shares allotted, we have to be informed of two pieces of information:

1. The amount of cash per share:
   This will be straightforward and will be announced by the company in the usual way.
   
2. The cash value of each new share:
   In order to do this, the company needs to know the market price of each share. The problem is that the share price changes all the time, making it difficult to inform the shareholder how many shares they will receive. To overcome this problem, the company will fix a price based, for example, on the average closing price of the shares over the last several days or so. The exact basis on which this consolidation is made will be contained in the original event announcement.
   

An example of this type of corporate action involves the final dividend of 59.0p per share for the year ended 31 March 2013 by ABC plc. (see
Table 11.9
).

As you will have noticed, there is a decision that needs to be made in terms of whether to take shares or receive cash. In most cases, the default option is to take cash; in other words, if the shareholder wishes to take cash then he need take no action. If, however, he requires new shares, then he must make this decision within the deadline specified by the company.