Codes to label trades between counterparties are essential to enable trade repositories to match counterparties, and reconcile trades with other repositories, but the European regulator did not publish advice until it was too late, and even then left ample scope for interpretation.
If derivatives users were slow to adopt Legal Entity Identifiers (LEIs), and some of the pre-LOUs are struggling to produce them fast enough (see “LEIs: what they are, who needs one, and where to get one,”), there is at least a methodology in place for generating the alphanumeric codes and multiple issuers to choose from. The same cannot be said of Unique Transaction Identifiers (UTIs), which are required to tag particular transactions between two counterparties, so duplication is avoided and the same alphanumeric code can be used by multiple trade repositories.
In Europe in particular, UTIs are essential. “The UTI is extremely important in Europe because, unlike the United States, in Europe both parties have to report,” explains Joe Halberstadt, head of FX and derivatives markets at SWIFT. “In order to avoid double counting, you need to make sure that the repositories involved can link the two sides of the trade. Given that there are multiple repositories in Europe, there is a distinct likelihood that one counterparty will report to one repository and the other counterparty to another, creating a reconciliation challenge between two separate organisations. But even if they both report to the same repository, the repository needs to be able to link the two sides of the trade together. The only way they can do that is by using the UTI. So having a common UTI for each trade is absolutely critical to swap reporting in Europe.”
That criticality was insufficient to persuade the European Securities and Markets Authority (ESMA) to lay down a prescription for UTIs until 11 February - the night before reporting began. In its guidance, the regulator said it expected either the trading platform (in the case of an exchange-traded derivative) or the central counterparty clearing house (CCP) to assign the UTI or the counterparties to the trade (in the case of an OTC derivative) to assign it (leaving open the question of which counterparty should generate the UTI and which should endorse it). As to how counterparties should choose which of them generates the UTI and which consumes it – to avoid the risk of duplicating UTIs - ESMA proposed a decision-making “hierarchy.”
That hierarchy proposes that UTIs for centrally executed and cleared trades be generated by either the trading platform at the point of execution, or by the trade confirmation platform at the point of confirmation, or by the central counterparty clearing house (CCP) at the point of clearing, or by the clearing broker after the trade has cleared. Otherwise, ESMA thinks financial counterparties should generate UTIs for non-financial counterparties, and bigger non-financial counterparties for smaller non-financial counterparties. If it is an intra-company transaction, ESMA says the seller should generate the UTI. For those derivatives that are traded on electronic platforms (such as a swap execution facility or FXAll) or confirmed electronically (via, say, MarkitSERV), it is relatively easy for the infrastructural intermediary to ascribe a UTI to the trade and send it to both parties. In the United States, the trading platforms are charged by the regulators with doing it, but in Europe they merely offer it as a service.
In any event, there is not yet much infrastructure in the swaps markets – especially in Europe - or in the giant foreign exchange market, where bi-lateral voice trading is still commonplace. “In those cases, there is nobody in the middle to create the UTI and provide it to both parties,” says Joe Halberstadt. “That means the two parties need to agree a protocol specifying which of them will create the UTI, ensure whatever they create is globally unique, and then work out how it is going to be shared.”
Generating the actual alphanumeric code of a UTI – which ESMA has agreed can have up to 52 characters – is also open to a variety of approaches. ESMA has sanctioned four separate methods (see Table 3, page 25). For derivative contracts that are also reportable under the provisions of the Dodd Frank Act, the European regulator allows the Unique Swap Identifier (USI) created by the Commodity Futures Trading Commission (CFTC) to be used as the UTI. ESMA expects the counterparties to agree which form of identification they will use before reporting the derivative contract to a repository, including the determination of which of them will actually generate the UTI.
Anticipating this degree of latitude would cause problems, the International Swaps and Derivatives Association (ISDA) worked with its members and other market participants to develop a global standard for generation and communication of UTIs. The result is a 40 page document entitled Unique Trade Identifier (UTI): Generation, Communication and Matching,1 which puts forward a decision-making hierarchy not unlike that of ESMA. It says UTIs are best generated by execution platforms, followed by confirmation platforms, but accepts that email and the telephone will sometimes be necessary.
The ISDA document includes complicated “tiebreaker logic,” which is used to determine which party in a variety of asset classes and instruments is responsible for generating the UTI. In the foreign exchange market, for example, its default is that, if no UTI is assigned by a trading platform or confirmation engine, the seller of risk (as with an FX option) or (where there is no seller of risk, as with an FX forward) the seller of the alphabetically lower currency will by default create the UTI. “For most investment managers and corporates, that is the worst of all worlds,” explains Joe Halberstadt. “It creates a mix and match with a huge number of bi-lateral agreements. It has the potential to create a huge mess.”
Despite its shortcomings, ISDA is working with regulators around the world in the hope of getting their support for the adoption of its approach as the global standard. The trade association believes this is vital to avert the risk of a variety of jurisdiction-specific or regulator-specific UTIs emerging, since that would inhibit the ability of counterparties to to create and report a single UTI for multi-jurisdictional trades.
The net result is that, for now and for some time to come, UTI generation in the swap markets is rich in complexity, creating a risk of confusion. Matters are not much clearer in exchange traded derivatives, where even in listed futures and options the trade identifiers are neither uniform in terms of methodology nor unique across CCPs. Sometimes they are re-used. The Futures and Options Association (FOA) EMIR Trade Repository Working Group has argued for CCPs to generate UTIs, and pass them on to clearing brokers, which will in turn distribute them to their clients.2 Of course, not all derivative users are bound by the rules and best practice recommendations by either ISDA or the FOA.
At CME Group, the European Trade Repository has found corporate clients conducting inter-company business, and buy-side clients with counterparties outside the scope of EMIR reporting, coming to it for advice. “We have clients coming to us asking whether they should be the generator of UTIs or the consumer of UTIs,” says Daniel Jude, director of client development and sales to asset managers at the CME Group in London. “The choice can depend on your internal structure.
If you are facing the Street for all of your trades, you can usually go to the brokers to get them to produce the UTI for you. But if you have got internal company transactions – which is common for corporate clients – you have got to find a way of producing them yourself.”
Market participants of all kinds would undoubtedly prefer a single process, whether a derivatives trade is executed bilaterally or through a trading platform. But however the UTI is generated, both parties know it is critical that it is included in the confirmation of the trade. In large and liquid markets with multiple participants, such as the foreign exchange market, it is the only way to ensure that counterparties share UTIs in a timely fashion. The difficulties experienced in matching trades and reconciling them between trade repositories in the weeks after 12 February 2014 illustrated exactly that point.
A variety of “interim” UTIs were put to use, some of them demonstrably nonsensical. “Somebody just sent us a random series of numbers as the UTI for an equity option,” reported one trade repository official in mid-March. “It is easy to do. So long as you know the construct, you can put your own bid in for what should be used as the UTI.” Ultimately, a clearer assignment of labour to the counterparties is almost certainly necessary. Either the broker-dealers must create the UTIs, or the fund managers and corporates on the other side of the trades must do so.