What would you say are the major risks around corporate action information?
You can see a whole industry built up around data vendors and software providers, and even a service that we have, a scrubbing service of corporate actions data, because there’s a lack of standardisation.
We are in a market that still lacks harmonization when it comes to market practice and has had trouble adopting a single messaging standard across all industry players. That’s a good opportunity for us to drive the market to a global standard in ISO 20022. I know there has been a lot of debate about bringing in 20022 when we’ve already have 15022, but we believe that the benefit of 20022 is that it is a far more flexible messaging standard that is going to help drive adoption, and there are going to be some real benefits to migrating to that. Especially in the US, where we lack adoption of a standard, DTCC is migrating all of our clients over to that standard in the next few years. We think it’s really going to help the marketplace achieve greater straight-thru processing.
How’s your partnership with SWIFT going?
There are two components to that. On the outbound side, we work very closely with SWIFT regarding the creation of the standard, and ultimately, the distribution of the information out to the marketplace. Right now, we’re in a pilot with some key firms and testing the ISO 20022 message; not only through the traditional DTCC network, but now, for the first time, the SWIFT network, so we are providing clients the option of receiving both of those messages through both the channels. On the inbound side, there is the partnership between us, SWIFT and XBRL. We’re essentially trying to put a proof-of-concept in practise using American Depositary Receipts (ADRs) in the US, demonstrating how effective it is to use XBRL as a tagging mechanism. We’re working very closely with the four major ADR banks in the US in a pilot program, and eventually we’ll be expanding it out to more security types.
Are you seeing increased levels of complexity?
Absolutely, both as part of DTCC’s service as a US depository, processing events on behalf of our members, but also in our global service, the Global Corporate Actions Validation Service (GCAVS), where we scrub corporate actions across global marketplaces. The level of complexity on these events has increased significantly. What we hear from our clients, and a lot of others in the industry, is that it’s really not the 95 per cent of vanilla events that’s the issue; it’s that other five per cent. Although that five per cent is a relatively small volume, people need to focus on it, because if you miss one of these, or elect incorrectly, or fail to notify a client correctly, the risk is enormous. A lot of things that have been built up over the years, such as those data vendors that I mentioned, are really designed to address that five per cent of events. It may not be the volume has increased, but the complexity has. As investment bankers and lawyers dream up new ways of making deals, complexity is going to continue. We’ll be at the mercy of those financial engineers.
How much of an effect do you think corporate actions has on trading strategy?
A lot. We’ve seen an increasing number of hedge funds that have an event-driven trading strategy. Our service focuses on being timely and accurate, but sometimes you will get people from the front office who just want it timely. “Real time, don’t worry if it’s not 100 per cent accurate and complete, I just need to react to it.” That’s challenging, because you have to determine your offering versus your client base, and the needs of that client base. If you’re looking at corporate actions from the front office, the perspective is very different from the back office. But our job is to determine what the offering should be for that particular segment of the market, and to meet those needs.
GCAVS went into listed equity derivatives in October 2010. Could you explain the reasoning behind this?
We upgraded to run on a more modern technology from an internal perspective, but the change also added a lot of value. What we had was a proprietary message format, but we wanted to move to an industry standard, so we decided on building a whole suite of ISO 20022 messages for communications with our clients. It’s global in nature, built on a lot of market practises and guidelines, and we thought that it would be in our best interest to move all of the legacy DTCC applications onto that global platform and build it out, so it’s one comprehensive global platform that supports all of our corporate actions.
The decision to handle listed equity derivatives was based on feedback from clients who were looking for solutions that could satisfy all of their data needs. Given the economic environment, firms are evaluating all of their data needs and looking to optimize the value and minimize the cost. Where possible, firms are looking to source their data needs from as a few providers as possible. The addition of events on listed equity derivatives is an example of that.
What is client reaction like to ISO 20022?
In the US, the firms we talked to saw it as a major change to the industry, but a positive one. Specifically, the pilot firms that we’re working with are quite anxious to push this forward, and ultimately want to get us to the end state where we’re able to communicate outbound messages to our clients and get messages from them in a fully ISO 20022 compliant mode. We’re also starting to hear from Europe and Asia, whose initial reaction was, “why should we change?” I understand it, because they were more firmly entrenched in the ISO 15022 world, whereas the US was not, but I think they’re coming around.
How are you dealing with client concerns around tax changes?
We have a suite of tax services that we provide to our participants, and we try to stay at the forefront and work closely with IRS, the US Treasury and other taxing authorities globally to make sure that we’re helping to, if not define some of these changes, understand the challenges that may come about once these laws are introduced. We try and stay very proactive and be part of the process, rather than reactive. On February 8, 2012, the IRS issued proposed Foreign Account Tax Compliance Act (FATCA) regulations that require foreign financial institutions (FFIs) to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. To properly comply with these new reporting requirements, an FFI will have to enter into a special agreement with the IRS to become a participating FFI. FFIs that do not enter into an agreement with the IRS will be subject to a punitive 30% US tax on income and gross proceeds payments. One particular problem we had with FATCA was the concept of withholding on gross proceeds payments to non-participating foreign financial institutions. The clearing and settlement model in the US have been built to net trades and payments amongst counterparties, and it would be quite challenging for DTCC to perform FATCA withholding on gross proceeds payments (sale of a US security) on a trade-by-trade basis to a non-participating foreign financial institution. We raised this concern with the IRS and Treasury, which resulted in a preferential treatment for DTCC on gross proceeds. For DTCC, the gross proceeds from a sale or disposition are limited to the “net amount paid” or “credited” to a member’s account that is associated with a sale of property.
How do you think corporate actions have changed over the last decade?
The complexity component has certainly shifted. And as various markets expand globally, we’re seeing more and more of these events happening, so the overall volume of complex events is growing. I think there’s a lot more focus on market and global market practise, and trying to leverage concepts to deal with other market issues. I also think there’s more communication between markets on corporate action processing and market standards. As a result of that dialogue, I think there are massive benefits to markets.
The main thing we hear from our customers is they want us to reduce cost and reduce risk. There are a number of major issues across DTCC where we’re going to help to do that. Things like LEI (Legal Entity Identifier) and the global trade repository for OTC derivatives are things I believe are going to be a significant beneficial change for the industry. We’re also hearing, from a collateral standpoint: “how can DTCC help the industry minimise capital requirements and maximise collateral?” and we’re looking at a number of different ways we can do that. Finally, from an asset servicing perspective, we’re always looking at ways in which we can create a utility-type function that helps do one thing for many clients that saves them money and improves efficiency. It’s a good, low cost approach to helping the industry solve some problems.
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