Mandatory Corporate Action

A mandatory corporate action is an event decided by the issuer of a security that affects every holder in the same way and requires no decision from them. The holder's position or cash balance is changed automatically on the relevant date. Examples are a cash dividend, a bond coupon, a stock split, a bonus issue, a redemption at maturity and a change of the issuer's name.

Corporate actions are conventionally divided into three groups according to the degree of choice given to holders. A mandatory event gives none. A mandatory with options corporate action will happen in any case, but the holder may choose the form of the proceeds. A voluntary corporate action takes effect only for holders who elect to participate. The classification determines how custodians and brokers handle the event within corporate action processing.

• Income distributions. Cash dividends on shares, interest payments on bonds and distributions by funds.
• Capital changes. Stock splits, reverse splits and consolidations, bonus or scrip issues made without a cash alternative, and changes of nominal value.
• Redemptions. Repayment of a bond at maturity, full calls, and partial redemptions by drawing or pro rata reduction.
• Reorganisations. Mergers approved by the required majority in which all shares are exchanged for the same consideration, spin-offs, and compulsory acquisition of minority holdings after a takeover.
• Administrative changes. Changes of name, identifier, listing venue or place of incorporation.
• Liquidation. Distributions to holders in a winding up.

Some events come in pairs. A rights issue begins with a mandatory distribution of rights to all holders, followed by a voluntary event in which each holder decides whether to exercise them.

Although no election is needed, the event still passes through a defined sequence at each intermediary in the custody chain.

• Announcement and capture. The issuer announces the terms. Custodians and data vendors record them through corporate action event capture, comparing sources to create a validated event record.
• Notification. Holders with a position, or with pending trades, receive a corporate action notification stating the terms and dates. In the ISO 15022 message set used between custodians, this is the MT 564, and the event is flagged as mandatory.
• Entitlement. On the record date the positions entitled to the event are fixed. The entitlement calculation applies the announced rate or ratio to each holding, including any treatment of fractions.
• Payment. On the payment date cash or securities are credited, old securities are removed where applicable, and a confirmation is sent.
• Reconciliation. Amounts received from the depository or agent are agreed to the amounts expected and to the credits made to clients, as described under corporate action reconciliation.

Records are then updated: cost and tax lots are adjusted for splits and reorganisations, and withholding tax is applied to income according to each holder's status.

The dates that matter are the announcement date, the ex-date, the record date and the payment or effective date. The ex-date is the first day on which the security trades without the right to the distribution; a buyer on or after that day is not entitled. For cash dividends in most markets the ex-date falls shortly before or on the record date, reflecting the settlement cycle. For certain large stock distributions in the United States, the ex-date is set after the payment date and trades in the interval carry a due bill.

Where a trade made before the ex-date settles after the record date, the proceeds go to the seller, who is still the holder of record, although the buyer is entitled. The transfer needed to correct this is a market claim, which depositories in many markets generate automatically.

Mandatory events are high in volume and are mostly automated, but errors still occur. Typical causes are incorrect or late event data, such as a wrong rate or date; positions that are wrong on the record date because of unsettled trades, loans or failed reconciliations; incorrect tax rates; and mishandled fractions. Securities out on loan or held as collateral need separate treatment, since the lender or collateral giver is compensated by a manufactured payment and not by the issuer.

Controls include taking event data from more than one source, checking positions before the record date, reconciling expected against actual receipts on the payment date, and tracking claims until settled. Many custodians credit predictable income such as dividends on the payment date whether or not the funds have arrived, a practice known as contractual income, and bear the risk of late receipt.

Market practice groups and infrastructure bodies have worked to standardise the sequence of dates, the information issuers must announce and the messages used, with the aim that event details flow from the issuer through the depository to investors without re-keying. In Europe, market standards for corporate actions set expectations for the order and spacing of key dates for distributions and reorganisations. Events are increasingly communicated in the ISO 20022 format. Despite this, issuers still announce in differing formats, and interpretation of complex events remains manual. Details of individual event types are given under cash dividend processing, share split processing and spin-off processing, and the first step is the corporate action announcement.