Abhishek Malik, Consultant, TCS BaNCS for Capital Markets

The valuation of a portfolio gives an overall picture of the client including assets/liabilities and forward positions. The positions of a portfolio can be valued at the latest available market rates and aggregated to arrive at the total portfolio value in the base as well as other performance currencies. Various market forces affect asset prices worldwide. One such event which affects the valuations of portfolio securities is Corporate Actions (CA), which is designed to have some effect on the share price. This effect may be purely mathematical, I.e., if the number of shares is doubled in a subdivision, then the market price is halved, or it may follow market sentiments depending upon how a corporate action is perceived in the eyes of an investor. This change of market price is immediately reflected in the valuation reports of the investor’s portfolio. However, quoting the current market price alone in the valuations without considering the adjusted cost basis will be erroneous. This is because investors won’t be able to report actual gains or losses when filing tax returns and may miss accounting for unrealized gains or losses. This task becomes more complicated when stocks are purchased over a period and several CA’s such as mergers or splits have happened over them.

Traditionally, financial institutions like broker dealers and wealth managers have been looking for solutions that evaluate the impact of corporate actions on assets to generate correct valuations. But in today’s competitive scenario, these services are increasingly becoming popular among custodians in a bid to provide better value-added services to their customers.

The solution to correct asset valuation lies in effectively tracking and updating the client’s positions records with adjusted cost price. Hence, part of the process would rely on the:

1) Ability of the positions management system to maintain the cost price of all the asset positions (at the tax lot level).

2) Ascertaining of all corporate action types which can impact securities cost.

3) Determining procedures to adjust the cost basis for each such corporate actions. The principle of all procedures remains the same i.e. the total book cost of the portfolio securities would remain same before and after the execution of CA. Few examples here illustrate this:

  • A stock split of 1:2 would mean that the number of shares in the customer portfolio will double hence the cost price of each position would be halved.
  • Rights issue –distribution of the rights intermediate instrument is done free of cost; hence the cost price of the intermediate security position would be zero.
  • Consolidation of the stock is another CA in which two or more shares are replaced with a single share. This would increase the cost price in the same proportions as the consolidation. 
  • The final step would be the ability of the CA system to post the adjusted cost basis information in the security movements.

Further, as newer laws require the financial institutions to track client’s asset cost more closely, the importance of accuracy in reporting is increasing. Hence, correctly adjusting the cost price would be one of the crucial steps towards realizing this aim.

Disclaimer: Views or opinions represented in this blog are based on the author’s own research and do not represent TCS BaNCS.

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