The identification codes needed to tag accurately the derivative instruments being traded are proving hard to manufacture, not least because the European regulator has not offered firm guidance. This accounts for much of the difficulties repositories have encountered in reconciliation.
To report successfully, a Legal Entity Identifier (LEI) to identify the counterparties (see “LEIs: what they are, who needs one, and where to get one,” page 18) and a Unique Trade Identifier (UTI) to identify the transaction (see “UTIs: what they are, who needs one, and where to get one,” page 22) they have agreed are not enough. The trade repository also has to know what instrument they have traded. This is where a Unique Product Identifier (UPI) would be useful. “The idea is that, when a trade is reported to a repository, you have got each of the counterparties identified via an LEI; you have got the identity of the particular trade via the UTI; and you have got what has been traded via a UPI,” explains Joe Halberstadt, head of FX and derivatives markets at SWIFT. Unfortunately, the European Securities and Markets Authority (ESMA) has published even less guidance about UPIs than it did about UTIs. Though it explained that it had received “no formal request to endorse a UPI framework,” it did release an “interim taxonomy” for use when existing identification codes are not available. At present all parties reporting under the European Market Infrastructure Regulation (EMIR) are using this interim taxonomy.
It permits counterparties to rely on the International Securities Identification Number (ISIN), which consists of a two letter country code, a random nine digit identifier and a twelfth digit derived by an algorithm from the other 11 digits. Where an ISIN is not available, the Alternative Instrument Identifier (Aii) can be used as a product identifier and a Classification of Financial Instruments Code (CFI) number to identify the type of derivative being traded (see Table 4,).
It permits counterparties to rely on the International Securities Identification Number (ISIN), which consists of a two letter country code, a random nine digit identifier and a twelfth digit derived by an algorithm from the other 11 digits. Where an ISIN is not available, the Alternative Instrument Identifier (Aii) can be used as a product identifier and a Classification of Financial Instruments Code (CFI) number to identify the type of derivative being traded (see Table 4,). The Aii (see Table 5, page 28) consists of the ISO 10383 Market Identifier Code (MIC) of the regulated market where the derivative is traded; the Exchange Product Code, which is assigned to the derivative contract by the regulated market where it is traded; the Derivative Type, which identifies whether the derivative is an option or a future; the Put/Call Identifier, which is mandatory where the derivative is an option; the Expiry Date, which is the exercise or maturity date of the derivative; and the Strike Price, which is also mandatory where the derivative is an option. If neither an ISIN nor an Aii is available, the ESMA “interim taxonomy” permits counterparties to report according to a simple formula it has published (see Table 6, page 30).
Experience after 12 February 2014 suggests this lack of clear guidance is problematic, especially in terms of reconciling trades reported to different repositories. “The lack of standard UPIs for use by all clients caused a lot of problems in terms of reconciliations between trade repositories once reporting began on 12 February,” says Daniel Jude, director of client development and sales to asset managers at the CME Group in London. “Until there is some guidance from the regulators, it is going to remain a problem.” A similar problem is created by dual reporting, even if both parties report to the same repository. “One client may say, `I am going to use the ISDA taxonomy,’ but someone else may use a different taxonomy,” explains Jude. “That is why the lack of a standard UPI is causing problems in inter-trade repository reconciliation as well.”
Even cleared derivatives, which can be found on Bloomberg and Reuters, often have different identifiers for their own products. ISIN and CFI are not available on all the European central counterparty clearing houses (CCPs) that clear futures and options, and CCPs outside the European Union have of course no requirement to produce a product identifier at all. The Futures and Options Association (FOA) has advocated creating UPIs from a combination of the Aii and a derived CFI. It contends this combination offers full coverage of all exchange-traded derivatives, and can be derived from existing data, obviating the need to go to the trouble and expense of asking for new information.1 Although CFI requires establishment and maintenance of static data, so does the interim taxonomy proposed by ESMA.
The International Swaps and Derivatives Association (ISDA) is also working on Unique Product Identifiers (UPIs). It has developed separate OTC derivative taxonomies for credit, interest rate, commodity, foreign exchange and equity swaps. These provide a mute testimony to the variety and range of instruments traded across these asset classes, and illustrate the scale of the challenge of standardising understanding of exactly what financial product is being traded.
The commodity taxonomy, for example, has to take account of seven different base products (metals, energy, index, agriculture, environmental, freight and multi-commodity exotics) which are further divided into precious and base metals, oil and gas and coal and electricity, grains, dairy, livestock, forestry, soft commodities, weather and emissions, and then into forwards, swaps, options and loan leases. The credit taxonomy identifies 115 sub-products and even an asset class as straightforward as interest rate swaps manages a dozen.
However, ISDA has had some joy with its taxonomies. Regulators in Japan, the United States, Australia, Hong Kong, Singapore and Canada have approved them for use, and in some jurisdictions they are already being used for trade reporting. ISDA says it is in “ongoing dialogue” with ESMA to obtain its endorsement of the taxonomies as the source of the UPIs for EMIR reporting. Even if ISDA succeeds in its ambition of securing the endorsement of ESMA, not every trade or every derivative counterparty is governed by ISDA documentation. The ISDA taxonomy is also proving hard to use in practice. “There is a very high level taxonomy, but very little progress has been made in resolving UPIs,” explains Joe Halberstadt. “Working out whether it is an FX forward or an interest rate swap is relatively straightforward. It is much harder to uniquely identify a 30 day FX forward in the dollar-euro currency pair.”
Daniel Jude agrees. “There is still a huge area of ambiguity about the population of the fields,” he explains. “The greater the level of granularity, the greater the problem. It is fine to say, ‘Okay, this is a credit product’, or `This is a commodity product,’ `or `This is an energy product.’ But when you try and break it down further, even though some of the 85 fields enable you to give some of the data required to achieve the requisite degree of granularity to report to the repository, it is not clear to all clients how to populate those fields. That is the problem with the lack of standardisation in the UPI space.”