Cash & Liquidity ManagementPaymentsSWIFTTowards STP in Corporate Actions

Towards STP in Corporate Actions

Introduction

SWIFT message traffic increased by 95 per cent between 2001 and 2004, yet corporate actions messages still only represent just 5.7 per cent of total traffic. On 10 February 2005, SWIFT’s board approved the establishment of a service bureau operating on the SWIFT network dedicated to providing the opportunity for SWIFT users to automate the corporate actions function of withholding tax processing.

Executive Summary

The principle of this service bureau is to provide custodians on the SWIFT network with access, on a subscription basis, to an added value service offering that removes the need for an internal withholding tax processing function.

Key attributes:

  • Leverage SWIFT investment;
  • Convert the withholding tax processing function, or parts of it, into STP processes;
  • Save up to 65 per cent on costs;
  • Improve delivered service quality and scope to clients;
  • Maintain service branding.

Diagram 1 shows the user process model using the withholding tax service bureau operating on the SWIFT network, which contrasts with the complexity (aka cost and risk) of Diagram 2 representing the current process template used by most custodians. Such bureaus are increasing in number and are proving to be an increasingly cost effective way to manage complex custodial operations.

The service bureau model effectively outsources the manual processes which would otherwise stop custodians from enabling STP in corporate actions processing.

The model described leverages SWIFT technology, uses existing messages as well as new SWIFT services such as FileAct, to create an automated, interactive tax processing function that enables custodians to retain their service branding to clients while reducing costs by up to 65 per cent and improving the quality and extent of service significantly.

Daigram 1: Complex and Manual processes convert to simple STP processing

Source: Author’s own

Background
Diagram 2: Tax Processing as it is today

Source: International Withholding Tax – A Practical Guide to Best Practice & Benchmarking. Publ. Euromoney 2003

Diagram 2 shows the current function of withholding tax processing which clearly is not an STP process. Any custodian who provides tax processing services to its client base, or for its own proprietary funds, may well have automatic processes initiated by the receipt, typically, of a SWIFT message MT564, providing notification of a corporate actions event. The consequence of such a notification includes calculating the effect of the notification for the clients who may have an eligibility to receive a proportion of any income notified in the message and most custodians have already leveraged links between their proprietary systems and SWIFT to make this STP.

In withholding tax operations however, there are a number of consequential and parallel processes which require manual interventions. These include account set-up, documentation management and also the processes of creating, filing and following up on applications for exemption, relief at source and remedial reclaims with third parties such as agent banks, local and foreign tax authorities. There are only two ways in which this type of function could be effectively incorporated into an STP strategy resulting in reduced transaction costs and increases in efficiency and quality. Either:

  • each element of the process itself must be automated or,
  • the process must be outsourced using an automated data feed so that, from the user’s perspective, the manual elements of the process become transparent.

To date, only a small fraction of withholding tax processing functions have been found to be susceptible to internal automation. Some of these elements are internal, such as documentation and some external such as the information flow between custodians, agent banks and tax authorities that are the basis of the back end of the process.

The second alternative, outsourcing, the object of the latest service bureau approval, provides automated links between user and service bureau removing internal manual processing and paving the way, by example, for the development of automated transmission of withholding tax messages and submissions between agent banks and tax authorities.

Tax Processing Service Bureau
Diagram 3: Service Bureau model for STP in tax processing

Source: Author’s own

Diagram 3 shows the principle of the service bureau. A separately managed user BIC address allows tax processing to be outsourced to a secure managed centre leaving the subscriber with a fully automated function supporting a much simplified vertical relationship between foreign withholding agent, user and client.

The service bureau subscription is established in three steps:

  1. Apply for an additional destination BIC.
  2. Apply for membership of the message user group for MT574.
  3. Ensure SWIFT FileAct is implemented at the user institution.

In essence, the additional destination BIC means that users of the service bureau are able to send SWIFT messages and files to, and receive messages and files from, their own BIC addresses. These messages and file transfers can be initiated automatically from the receipt of MT564 notification or initiated manually.

MT574 messages, using repeatable blocks, are used by users to send beneficial owner information securely to the service bureau where, combined with transactional data sent in either MT566 or FileAct files, it is used to monitor and establish eligibility for relief at source, exemptions or remedial reclaims. MT574 (IRSLST) was originally created to automate a single jurisdiction tax processing issue (US S.1441NRA withholding tax regulations). The Corporate Actions Securities Maintenance Working Group has already approved the necessary expansion of the scope of this message subject to ratification by the UK National Member group for inclusion in SR2006.

Since all the otherwise manual and semi-automated processes are undertaken by the service bureau, the user is able to maintain its client facing tax processing service based on the sending and receipt of SWIFT messages and files representing beneficial owner and transactional data outbound and receivables posting data, status reports and tax refunds inbound.

Diagram 4 shows the simplicity of set-up. Tax processing requires both data and documentation to be effective. Bulk data transfers (existing accounts and ongoing amendments) are made via MT574. For supporting documentation, the service bureau uses a sophisticated document imaging and management system to acquire and manage supporting documentation for existing accounts and a web based account set-up system for new account documentation.

Diagram 4: Set-up of Data required by Service Bureau

Source: Author’s own

Features

Branding

The service bureau concept is not intended to compete with custodians but to be a service to them. Its aim is to provide a more efficient service model allowing custodians to retain their own service branding to clients whilst reducing costs and improving service quality and scope.

Fit

Fit enables the user to marry its internal processes to those outsourced so that there is no cost or quality impact. In this case, since inbound and outbound communications are both via SWIFT, the processing can easily fit into existing automation strategies. Partial outsourcing allows testing of the concept by users while at the same time providing a competitive advantage by extending a users service offering to areas where no service is currently provided e.g. omnibus account structures or on specific securities issues such as depositary receipts.

Reducing Costs

Research in pre-sales indicates that the use of this particular service bureau for tax processing could reduce costs by as much as 65 per cent, representing several million dollars a year for the average custodian. Clearly each potential user is different and has addressed withholding tax processing internally in a different way, as is every service bureau in terms of its cost/benefit offer. The actual degree of cost saving will therefore depend on a number of factors. The cost structure for the service bureau is based on the volume of tax reclaim events, account monitoring, documentation management and relief at source events being free.

Improving Quality

For many custodians, there are limitations to the scope of tax processing offered. Some of these are market driven, others structural or cost related. The service bureau model can successfully improve service quality by leveraging its processing volumes to provide tax processing benefits that would otherwise be excluded from a service offering. Four examples are given below:

  1. Omnibus Account Processing. One of the most common limitations of tax operations is based on client structure where no service is offered if the client has an omnibus or multi-level structure. This is sometimes imposed due to the complexities or cost of processing and sometimes due to the absence of underlying beneficial owner information. The Service Bureau offers the potential for custodians to extend their service offering (and therefore competitiveness and ranking) into such areas as omnibus processing at no incremental cost.
  2. Thresholds. Also a common limitation in tax processing is the concept of thresholds. If the value of a reclaim is below an amount that a custodian has calculated as the cost of processing, the reclaim is often not filed. This is a different issue from whether the client’s account is credited with the value of the reclaim. Some custodians do not process and do not credit. Some do not process but do credit – as a client retention strategy. In either case, the cost per transaction efficiencies that can be delivered from a service bureau that is processing over a million reclaims a year means that many subscribers will be able to offer reclaims on all transactions and remove thresholds entirely.
  3. Tax interpretation is, as most custodians know, both expensive and often theoretical. Experience of exotic or complex tax reclamation based on relationships with tax authorities is a fundamental benefit that subscribers buy into. So, clients for whom it may have been thought impossible to gain treaty benefits, can be brought into receipt of tax entitlements as a service extension with no incremental cost.
  4. Contractual Tax. Performance is also a key attribute of any tax operations function. While clients may find gross funds credited at paydate desirable, custodians can only provide such a service profitably if they have sufficient processing volumes in any given market to statistically predict recovery times and build the cost of financing into their contractual tax service. With over a million reclaims a year, the service bureau can provide much better and more accurate statistical data to finance such competitive offerings.
The Future for Tax Processing

The service bureau described, is notably focused currently on the automation of withholding tax at the front end of the process because, in today’s processing environment that is all that can realistically be achieved. The automation achieved is “virtual” in as much as the manual processes are not eradicated per se, they are merely removed from the user to the service bureau so that from the user’s eye view, processing can be automated.

This begs the question of how and when the actual manual processes themselves (of both relief at source and reclamation) can be replaced with electronic ones. True STP in this area is conditional on several factors – the political will of the tax authorities, the regulatory frameworks to allow electronic signatures in the investment chain, the implementation of secure and electronically based documentation, and the development of a suite of SWIFT messages that are designed to fit and improve the process model are just four. While the cost benefits of such an industry wide initiative would be truly enormous, it is likely to be some years before this kind of automation initiative has enough inertia to become the de facto standard.

On the positive side, some tax authorities are now accepting “electronic” submissions although there is no international standard in place and formats and procedures differ widely from bar-codes to spreadsheets. The secure platform already exists in the SWIFT network to create a single ISO15022 standard, albeit much work remains to be done to develop a contiguous message suite for this area of corporate actions. The European Union and USA already have regulatory structures in place (Electronic Signatures Regulation 2002 for the EU and The Electronic Signatures in Global and National Commerce Act in the USA) although many other markets do not have analogous regulation.

As a focus for increasing volumes of tax processing events on behalf of its subscriber base, the service bureau concept is likely to be at the forefront of the development of such initiatives.

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