OTC Derivatives Players: The ISIN Engine Emerges (Updated)

Editor’s Note: On September 20, ANNA announced that the automated allocation engine for international securities identification numbers for OTC derivatives would also support the derivatives product taxonomy created by the FIX Trading Community as well as other open-standard product taxonomies. The mapping of the FIX taxonomy with the ISO taxonomy is set to be completed before the second version of Europe’s MiFID goes into effect in January 2018. 

Financial firms concerned about how they will comply with regulatory demands to identify over-the-counter derivative contracts when reporting transactions can breathe a sigh of relief.

The Association of National Numbering Agencies (ANNA) has just taken another step closer to providing the financial industry with International Securities Identification Numbers (ISINs) for over-the-counter derivatives as well as a new way to obtain them. Early Wednesday it announced that it had tapped London-headquartered Etrading Software as its technical partner for the engine that will generate ISINs in real-time. Later this month, ANNA will send out a separate request for proposals for the service provision provider that will host and operate the infrastructure for the platform, which will be known as the ANNA Derivatives Service Bureau (DSB).

ANNA’s endgame is to have the twelve-digit alphanumeric code-issuing mechanism in industry production by the fourth quarter of 2017. The timetable gives financial firms enough breathing room to implement and test the system so they are ready to fulfill the transaction reporting requirements of the updated Markets in Financial Instruments Directive (MIFID II) in early 2018. The technological marathon will begin later this year when ANNA, the umbrella organization for national numbering agencies, publishes the technical standards for integrating the DSB into users’ trading systems for fully-automated ISIN allocation. At about the same time, the financial industry will get its first look at the engine, when ANNA offers a preview version for industry discovery and feedback.

Mega banks and broker-dealer players in derivatives, acting as systematic internalizers, or trading platforms that handle OTC derivatives may well jump on the chance to integrate the ISIN allocation engine into their internal systems. Smaller players have another option: obtaining ISINs through a web interface. Web users will complete a template that identifies the exact type of derivative they are trading, while they manually enter the particulars of the contract. Regardless of whether the ISIN registration is done by hand or through direct integration, the ISIN code will be delivered within seconds of the completion of the registration.

“Depending on the type of OTC contract, there could be only a handful or as many as over 50 data fields in the ISIN,’ explains Sassan Danesh, managing partner of Etrading, a financial technology consultancy launched in 2005.”The way these data fields identify a contract is based on descriptive taxonomies of derivative characteristics [such as the taxonomies developed by the International Swaps and Derivatives Association and the European Securities and Markets Authority]. The engine can absorb multiple taxonomies, which can be a great convenience for firms that are used to working with certain descriptive models.” The European Securities and Markets Authority (ESMA) is the pan-European regulatory agency that creates the nitty-gritty rules market players must follow to implement pan-European directives.

Who Does What

The service provision partner for the new derivatives service bureau will be responsible for the overall infrastructure including global communications, data storage and cloud technology, resiliency and advanced security. The DSB will perform the know-your-customer identification and authentication to accept any firms requesting ISINs or seeking ISIN data. The derivatives service bureau will be a distinct subsidiary of ANNA unconnected with the established ANNA Service Bureau operated by CUSIP Global Services (CGS), the US national numbering agency, and SIX Financial Information, Switzerland’s national numbering agency.

“We needed to establish a separate service bureau with more robust capacity to handle the more intense technical requirements and scalability that derivative contract volume and associated data volume require,” says Alan Dean, head of the Sedol Masterfile, LEI and Corporate Actions for the London Stock Exchange who is also a member of ANNA’s board of directors. “This means that key selection factors for the service provision partner include global reach, experience with database hosting and continuity, authentication and cloud-based storage.”

Surprisingly, verification of the data for ISIN allocation will not be required, other than ensuring that data “conforms to the strict definitions of the taxonomy being used,” says Danesh. At that point, the engine will generate the ISIN automatically without requesting further confirmation. This enables no-touch ISIN allocation for user systems connected to the engine. The caveat? Once the data is input and an ISIN is allocated, neither the data nor the ISIN can be changed. So the onus is on the user to use the right information the first time around.

ANNA’s selection of Etrading Software follows Etrading’s role as the Project Management Office –overseer of the process and production — for the study group (SG) operating under the auspices of the International Organization for Standardization (ISO) to expand the scope of the ISIN to include over-the-counter derivatives. The SG was convened in March 2016, after ESMA announced a year ago that the ISIN is the preferred instrument identification code for all financial instruments, including over-the-counter derivatives, for reporting under MiFID II. At that time, ISINs didn’t cover the full range of OTC contracts.

Co-conveners from ANNA and ISDA, the trade group for the over-the-counter derivatives market, lead the study group. ISDA had already been working on the idea of a Unique Product Identifier (UPI) that had no relationship to the ISIN. ANNA had already been seeking industry expertise to assist in enhancing the ISIN to cover more derivative types. Ultimately the SG came up with a hybrid solution that called for the ISIN to be used as the top-level identifier. The ISIN allocation rules were partially based on existing descriptive models for derivative types, but also the work of several sub-groups of derivatives experts who analyzed various derivative types to produce definitions and data requirements.

The ISIN-related reference data would also be used to create the Classification of Financial Instruments (CFI) code for the derivative contract. Both the ISIN and the CFI are ISO-compliant standards devised to help traders, operations specialists, market infrastructures, regulators and even investors keep track of what is traded, cleared and settled. Previously issued only by national numbering agencies, the ISIN was originally created to be a universally understood identifier for cross-border transactions, but is now the most commonly used identifier in global markets.

ANNA is still working on the pricing model for the DSB. Dean says they are considering an annual subscription or membership model, rather than charging a fee for each ISIN registration. The annual fee will likely be volume- related. In contrast, national numbering agencies charge financial firms a fee each time they require an ISIN, as do the agencies that issue Legal Entity Identifiers (LEIs). However, as is the case with LEIs, the overall revenue model will be based on a cost-recovery basis.

Tackling Underliers

While market players work out how to use ISINs for derivatives, they are also figuring out what to do about the identification codes for the underliers. Those are the reference assets on which the derivative contracts are based. ESMA’s technical rules to implement MiFID II require that all the data in the ISINs for OTC derivatives be unrestricted by licensing constraints. Those rules appear to raise an issue with identification of underliers. That is because if the underliers are identified by any CUSIP-based securities identifier, such as the US ISINs, these codes may be subject to licensing restrictions by CGS. For example, CUSIPs nine-digit alphanumeric codes for US securities are embedded within the ISINs for those same securities.

A previous agreement reached between the European Commission and CGS calls for CGS to offer ISINs for US securities on a low-cost basis to firms which sign end-user agreements with the US numbering agency. However, that deal appears to be restricted to Eurozone-based firms, because the EC has no jurisdiction when it comes to firms operating outside the Eurozone. Several European trade associations, including the European Fund and Management Association, Germany’s BVI, as well as market data user groups IPUG and SIPUG, remain unhappy about CGS’ implementation of the EC’s agreement and have taken their complaints to the European Anti-Competition Authority.

Reportedly CGS is in talks with ANNA and others to come up with a solution that would comply with ESMA’s rules for OTC derivative identification. CGS offered the following statement to FinOps Report: “CUSIP Global Services has a long and successful track record of collaborating with market participants, global numbering agencies and regulators to develop widely-embraced global standards for identifying securities. The expansion of the ISIN standard to accommodate OTC derivatives will be no exception. We continue to work closely with ANNA colleagues on a solution for OTC derivatives reporting that will allow critical content to be used in a fashion that fulfills both regulatory and practical requirements.”

The statement concludes with a vehement denial that CGS wants to create any problems for firms needing to use ISINs for OTC contracts that reference underlying US securities. “Any speculation that a national numbering agency would hinder that development in any way is completely without merit.”