New Year’s Message: Pay More for OTC ISINs?

Update 12/30/2017: This article has been updated to include more details about the DSB’s €8.8 million figure for overhead.

Data, operations and vendor procurement managers whose buy- and sell-side firms need international securities identification codes (ISINs) for over-the-counter derivative contracts could end up with some bad news come January 15.

Financial firms might discover they will be paying additional fees to the Association of National Numbering Agencies’ Derivatives Service Bureau (DSB). The reason: they could need to make up for the company’s shortfall in revenues for 2018 because the DSB fell short of its predicted number of users. The new bills would be in addition to the preliminary charges they already paid for their first 15 months of creating ISINs through the DSB, which became operational in October 2017.  The additional payments, if necessary, would be due in March 2018.

How serious is the shortfall? Pretty serious. The DSB missed its projections for two categories of paying users — its highest paying power users and second-highest paying standard users by a longshot. The DSB had projected signing up 100 power users and 100 standard users. As of December 7, it had contracts with only 66 power users and five standard users. DSB officials would not provide updated figures as FinOps Report went to press.

Most of the largest trading venues, who would have fallen under the highest paying category of power users, have signed up only some of their multiple venues with the DSB. Officials at the DSB would not identify any of the holdouts which reportedly include major interdealer brokers such as Tullett Prebon, NEX and Icap. All three declined to comment for this article.

The DSB has been set up as an automated utility to allocate ISINs for over-the-counter derivative contracts requested by trading venues, fund managers and broker-dealers to comply with their reporting requirements of the second incarnation of the Markets in Financial Instruments Directive (MiFID II). Based on usage, the DSB breaks down users into four categories, three of which pay fees for creating ISINs or requiring real-time connectivity to the DSB.

Because the DSB’s fees are based on a cost-recovery model, all of its users are required to prepay their contracts so the utility can meet its operating costs through the year, while recovering its estimated €8.8 million in overhead. The €8.8 million figure, disclosed in the DSB’s second fee model consultation document published in May 2017, includes an additional €2.158 million in costs unrelated to the DSB’s previous initial estimate of operating costs. Of the €2.158 million, €1463 million represents the amortization of start-up costs over the first four years of the DSB’s operations. Start-up interest costs for loans to be repaid over four years amounts to about €320,000 for the first year. The first year’s contribution to a contingency fund to cover unplanned costs during the first few years of operation comes to €375,000.

The interest costs, says the DSB’s consultation document, are based on start-up loans made by the company’s investors. The document did not identify the investors, but an article published by FinOps Report in April 2017 cites Euroclear, CUSIP Global Services, WM Daten, and SIX Information Services as being among the investors.

The initial fees, charged to the DSB’s users when their contracts were first submitted, were based on the DSB’s best estimates of the number of expected users in each category. Firms which fall under the category of power users – the only category programmatically connecting to the DSB and usually creating the highest number of ISINs — would pay the highest rate. The other two paying groups are the standard users and infrequent users.

The DSB will make its final fee calculations early next year, based on the actual number and type of users signed up by January 5. If the new fee calculations indicate that the existing users have overpaid, they will receive a refund or credit from the DSB. If the opposite occurs and the DSB needs additional funding to recover its overhead, the user firms will be invoiced for their share of the additional funds.

So far, short of a last minute surge of signups, it stands likely that fund managers, banks and broker-dealers who already signed up to use the DSB will have to shell out more money. The DSB says it could not have anticipated the low turnout, because there are no historical numbers to work with. It could make only a best estimate.

According to Emma Kalliomaki, the DSB’s managing director, the stronger interest in the power user category was a surprise, albeit not a bad one because a power user’s annual fee is three times that of a standard user’s. However, she cautions, the overall reduction in expected users threatens to raise the costs for everyone, if sign-ups don’t pick up.

Kalliomaki would not estimate how much more fund manager, bank, broker-dealer and other users of the DSB might have to pay if the DSB doesn’t reach its projected number of power and standard users. “We continue to sign up new users so the number is growing,” she says, adding that there is no way to know for certain the total number of trading venues that might need to sign up. Her explanation: the European Markets and Securities Authority (ESMA), the European regulatory body, has not yet published its list of approved organized trading facilities — a new category of trading venues. The other category is multilateral trading facility.

Kalliomaki declined to comment on why the trading venues haven’t signed more contracts with the DSB. Based on what the Wholesale Markets Brokers Association (WSBA), the London-based lobbying group for interdealer brokers trading in OTC derivatives, has publicly said, the trading venues don’t like the DSB’s fee model. They are angry they have to sign contracts before knowing what they will be paying. Trading venues also complain that they may be carrying most of the DSB’s overhead, because each parent trading venue firm has to pay a separate feel for each subsidiary trading venue connected to the DSB.

The trading venues’ beefs suggest they may have wanted a fee discount or cap on fees based on the volume of ISINs they generated. Instead what they got were hefty bills. How much? According to the published fee model, the preliminary fee for each power user is €65K, which would add up for firms with multiple trading venues. Of course, the ultimate fee will not be known until the DSB’s does its recalculation in January.

In response to a request for comment from the Financial Stability Board about the potential governance of unique product identifiers (UPIs) for OTC derivatives, NEX didn’t refer to the ANNA’s DSB by name. However, it backhandedly criticized the current model of receiving ISINs saying that trading venues are footing 75 percent of the bill.

The DSB has publicly said that ISINs could easily be adapted into UPIs to be used for global regulatory reporting purposes, rather than only for EU’s MiFID II. In a recent announcement, the DSB appears to contradict any speculation that trading venues would be responsible for a majority of the DSB’s income. The DSB reported that bank fees currently represented 60 percent of the DSB’s income, and venue fees only 25 percent.

What does the DSB plan to do to motivate the trading venues to sign up? Nothing, because there is nothing it can do, according to DSB officials. The rules set up by the International Organization for Standardization (ISO), which the DSB must follow, require fair and equitable access to the DSB.  Therefore, the DSB cannot offer any users special agreements which may disadvantage other users. That means the DSB has no leeway to offer the trading venues a discount or cap on fees, if that is what the venues are looking for. The WSBA declined to respond to FinOps Report’s questions on what concessions its members want from the DSB.

What now? The lack of participation from the trading venues won’t hamper the DSB’s operations — technically speaking. The DSB, says Kalliomaki, will continue to accept new contracts at any time. However only new contracts submitted by January 5 will affect the ultimate 2018 fees. The more users, the lower the fees are for all of them — and the more likely that the users won’t be getting an invoice in January to fork over more money.

Even if trading venues don’t succeed in winning any concessions when it comes to their 2018 fees, they could have one small consolation. Kalliomaki says that the DSB will “revisit” its fee model next year.

“We will know much more about the user base and how they are using the DSB, so we can adjust the fee model as the facts warrant it,” she says. What that might mean practically speaking is anyone’s guess. What is certain is that, whoever is paying, the total revenues will have to cover the DSB’s overhead – a fact that only leaves so much wiggle room.