Is the International Securities Identification Number (ISIN) not fit for purpose for identifying certain types of derivatives, as claimed by some partisans for other identifiers or just “concerned citizens” of the derivatives realm? Or is the only possible solution for regulatory reporting requirements a Unique Product Identifier (UPI) based on the descriptive taxonomy developed by the International Swaps and Derivatives Association (ISDA)? Or perhaps the Financial Instrument Global Identifier (FIGI) is the answer, as its originator Bloomberg might contend.
The contentious debate which has been played out in news articles and commentaries, trade show panels, and appeals to standards organizations may be losing steam, due to a meeting of minds between ISIN proponents and supporters of the ISDA taxonomy. At a face-to-face meeting last week of an ISO-sponsored study group (SG) that previously largely worked together by email and conference calls, the first steps toward a collaborative solution drawing on both the ISIN, and ISDA’s taxonomy reportedly drew positive response from the gathered participants, representing financial firms, trade groups and regulators.
The SG sprang into action last year after the pan- European regulatory agency, the European Securities and Markets Authority (ESMA), released its final technical reporting standards for the second version of the Markets in Financial Instruments Directive (MiFID II). The ISIN was named as the mandated identifier for all exchange-traded instruments, including derivatives with any leg or parent contract crossing exchanges.
Separately, the need to report OTC derivative contracts derives from other regulatory mandates, including the European Markets Infrastructure Regulation (EMIR), and calls by the influential G20 for market players to process more over-the-counter deals through clearinghouses to enforce transparency and risk mitigation. MiFID requires fund managers and broker-dealers to report executed trades in all asset classes, while EMIR focuses strictly on derivative transactions.
While the ISIN has been enhanced in recent years to handle some derivatives and is used in some markets for identifying them, its coverage is by no means universal across all derivative types. Its use has also not been universal for regulatory reporting, especially in European countries where the Alternative Instrument Identifier has been accepted by securities watchdogs. As a result, the purpose of the ISO study group is to find a solution for derivatives identification that meets the requirement for ISIN-based reporting. Because of the narrow mandate, the SG did not consider the Bloomberg FIGI as a possibility.
The two co-convenors of the study group who are associated with the Association of National Numbering Agencies (ANNA) and ISDA told FinOps Report that its goal is to devise a solution that works across the full range of derivative types for both operational work and regulatory reporting. A key step to crafting a potential answer was separating the identification of the derivatives contract from its description. This approach reflects the same standards scheme that is globally used across other asset classes through the ISIN and Classification of Financial Instruments (CFI). Both codes are ISO standards. National numbering agency members of ANNA are responsible for issuing ISINs, CFIs, and local identification numbers to help traders, operations specialists, market infrastructures, regulators and even investors keep track of just what is traded.
The SG’s preliminary concept of a hybrid solution calls for the ISIN to be used as the identifier, after some upgrading to accommodate a wider scope of OTC derivatives contracts. The classification or description of the contracts would be derived from the detailed descriptive taxonomy developed by ISDA. That descriptive data would be used in two ways — both as the reference data associated with the ISIN and as the basis for the CFI. Further details on the concept will be provided in a white paper the SG will deliver in May to its parent ISO SC4 committee for capital market identifiers.
What makes the ISIN an acceptable solution in this model, when it has previously drawn so much criticism for not being suitable? “Some of the negative comments on the use of ISINs as identifiers for derivative contracts have been misplaced,” asserts Alan Dean, co-convenor of the study group and head of the Sedol Masterfile, LEI and Corporate Actions for the London Stock Exchange Group, who is also a member of ANNA’s board of directors. “The critics have focused on the current incarnation of ISINs and not taken into account the work conducted by the study group since September 2015. Adapting the ISIN for this breadth of derivatives coverage required more information about what was needed, and we know much more now.”
As Dean acknowledges, ISINs historically have not provided enough granular information about the instruments they identify, because classification codes and other ISO standards served that role. ISDA, in turn, recognized that its descriptive taxonomy was only part of satisfying regulatory requirements. “Relying on the ISIN and CFI with the ISDA taxonomy allows regulators to have both an identifier and underlying reference data,” explains Robin Doyle, managing director of the office of regulatory affairs for JP Morgan and a member of the ISDA symbology governance group. She serves with Dean as co-convenor of the ISO-sponsored SG.
Although the impetus for the SG’s formation was clearly ESMA’s edict, the group has broader aspirations, including aligning with a separate initiative by the International Organization of Securities Commissions (IOSCO) and the Committee on Payments and Market Infrastructures (CPMI) to standardize the process of identifying derivatives products and transactional data. “Many of the outputs from the CPMI-IOSCO workshop held in Washington DC in February have been incorporated into the study group’s initiative and therefore we hope much of the study group’s work will be relevant to the CPMI-IOSCO initiative,” says Jim Northey, principal consultant for Chicago-based technology firm Itiviti and co-chair of the global technical committee for the FIX Trading Community, the trade group promoting the FIX message protocol.
The ESMA and the UK’s Financial Conduct Authority are participating in the SG’s work and more regulators have been invited to pitch in. “We believe working with the global regulators provides the opportunity to create a consistent identifier and classification system. As part of this initiative, FIX is committed to ensuring interoperability with standards from ISDA, FpML and ISO to create a fully integrated solution for both regulatory and industry needs.” FpML is the trading and post-trade message protocol used in the derivatives market, while FIX is the trading message format for equities and fixed-income instruments.
New ISIN Allocator
Still to be determined is how the new ISIN codes for derivatives will be allocated. Currently, national numbering agencies across the globe issue the ISINs, blessed by ISO through the ANNA, which serves as the registration authority for ISINs. However, ISIN’s critics have pointed out that many national numbering agencies may not be able to meet the need for real-time issuance of ISINs for OTC contracts. The current method of obtaining ISINs for equities or fixed-income securities can take several hours or more to complete after a corporate or other issuer requests the code. “By contrast, OTC derivatives contracts are created by financial institutions to meet immediate trading requirements, so ISINs must be allocated in real-time,” says Doyle.
Creation of a new special-purpose numbering agency – one that is fully automated and operates on a real-time basis— is under consideration. ISINs issued by this agency, tentatively called the global numbering agency or GNA, would have a prefix of EZ, unlike the nationally issued ISINs which have a country-code prefix. “Although the two letters don’t stand for anything specific, they will still indicate that the instrument is an OTC contract,” says Dean.
If the GNA is approved, ANNA is expected to look initially within the existing franchise of national numbering agencies for a solution, but ultimately issue an RFP for an external provider to build the system and maintain the records — a scenario similar to how the ANNA Service Bureau operates. Akin to the process of how ISINs are now issued, broker-dealers and other financial organizations could forward identifying information in FpML format to the GNA on any contract to determine if an ISIN has already been allocated. If one is not found, a new ISIN would be issued on the spot. ANNA’s recent calculations that trillions of ISINs can be generated with only minor adaptations of the alphanumeric code have helped dispel any concerns over whether ISINs can support the volume of new ID codes required to accommodate a plethora of contracts.
Just how rapidly could the new solution be implemented? Representatives of the study group are confident that the entire process — including the development of the automated ISIN allocator — can be wrapped in time to be implemented by the industry by January 2018 when MiFID II is set to take effect. “The work of the study group is extensible and flexible and based on the fact we have already done so much, we can meet the deadline,” asserts Dean.
The prompt timetable leaves open the question of whether the industry will willingly adopt this identification scheme. It won’t have much choice if the regulators impose the standard as a reporting requirement. Given that the final ISIN-based solution would be backed by influential associations, agencies and big financial firms, it looks to have a good shot at acceptance. Or the industry could just respond to the solution of a long-standing problem. “Functionality is everything. If it meets everyone’s needs, it will succeed,” says Dean.
So far, the SG’s efforts appear to have quashed some criticism of the use of ISINs as evidenced by the softening stance of one of its participants. Bill Stenning, managing director of clearing, regulatory and strategic affairs at Societe Generale Corporate and Investment Banking in London, who also serves on the study group, felt strongly enough to publish an article in Risk Magazine in February entitled “The ISIN is not fit for purpose for OTC derivative identification.”
However, after the SG’s meeting last week, Stenning told FinOps, “I am very encouraged by the way ISO has engaged in this process and as of now, am increasingly optimistic that we will find a way to a viable solution that both a) represents the products in an orderly way and b) deals the with operational complexities particularly around the timeliness of issue and the potentially very large number of ISINs required.”
Still, as Stenning points out, the study group has “a long way to go.”