Politics, public opinion collide in EC identifier consultation

In the final weeks of 2023, the European Commission (EC) teed up one last challenge for reference data experts. As the EU prepares to build a consolidated tape for derivatives, it has launched a consultation to choose between two identifiers—the OTC Isin or the UPI—for over-the-counter derivatives transparency reporting. 

Announcing the upcoming consultation, the Commission said that neither the Isin nor the UPI were “entirely suitable unique product identifiers for pre- and post-trade transparency reporting of in-scope OTC derivatives,” giving industry players the perfect forum to air their opinions about both identifiers. 

The consultation, which closed on Tuesday, may seem like a straightforward technical question, but it has divided opinions and exposed the politics at play in the world of identifiers—even two issued by the same organization, the Derivatives Service Bureau, which says it will support whichever option the Commission chooses.

At the heart of the consultation is a recurring question about the relationship between European financial markets and the rest of the world. The UPI has been endorsed by the G20, with the aim that all jurisdictions in the group eventually adopt it to aggregate trades and monitor for the build-up of systemic risk. The Isin, on the other hand, is widely used in Europe and the UK, both for market abuse monitoring and for public price transparency.

Pros and cons

The Commission has stated that while the UPI is not granular enough for transparency reporting on the coming tape, the OTC Isin provides too much information.

In particular, the Isin provides an “expiry date” field, a long-held point of contention. For interest rate swaps, the expiry date changes each day as the asset inches closer to maturity. Each time the expiry date changes, a new Isin is generated for the same asset.

Regardless of the chosen option, there are going to be some impacts on market participants and regulators’ IT systems

Catherine Sutcliffe, Derivatives Service Bureau

“The industry has for many years said that the OTC Isin is the wrong value because of the maturity date,” says a regulatory official at a global systemically important bank (G-Sib). “Part of the reason is you can’t aggregate based on maturity date. … A five-year swap is a five-year swap; it’s not a five-year swap on a maturity date of tomorrow.” The source was not surprised that the Commission couldn’t use the OTC Isin in its current form for the consolidated tape.

Instead, two solutions are being considered. The first is to remove the expiry date from the Isin and replace it with a forward starting term attribute. The second is to use the UPI with two additional attributes—the term of contract and the forward starting term—reported alongside the identifier. The latter option has been dubbed the UPI+.

Expiry date dilemma

The expiry date problem is not insignificant. “If you look at the statistics from the Derivatives Service Bureau, you see that very quickly the amount of OTC Isins overtook the overall available number of securities Isins,” says Rudolf Siebel, managing director of the BVI, a European trade association representing fund companies and asset managers.

Still, Siebel says that since all EU member states have implemented the Isin already, it is likely easier for the industry to continue with the Isin and simply modify one data field. The Isin system, he says, is a “working machine”.

Both options would require changes to the Financial Instrument Reference Data System (Firds), the technology system used for market abuse monitoring by the European Securities and Markets Association (Esma). Currently, Firds uses the Isin to detect market abuse. If the industry were to elect to use the UPI for public price transparency, the system would have to be re-tooled to accommodate a second identifier. This would mean public authorities and market participants making changes to their IT systems, and the data model for the shared database for reporting would also need to be modified.

“Regardless of the chosen option, there are going to be some impacts on market participants and regulators’ IT systems,” says Catherine Sutcliffe, director of regulatory affairs at the DSB. “It’s a case, then, of which is going to have the least impact and be the most effective.”

The pluses of UPI+

Because European markets currently use the Isin for transparency reporting—for all asset classes—some in the industry feel it is more efficient to stay on the current path. But those in favor of the UPI+ solution argue that the OTC Isin has never worked as well as intended.

Roger Cogan, head of European public policy at the International Swaps and Derivatives Association, says that Isda has been skeptical of the Isin for about 10 years. He is not convinced that having one identifier across asset classes would necessarily make life easier for firms. “That efficiency is not real if the identifier doesn’t work for OTC derivatives,” he says.

Moreover, Cogan sees the modified Isin as a new identifier altogether. “You can call it Isin minus, but it would basically be a totally new identifier used only in Europe,” he says.

The US has already elected to use the UPI plus two additional attributes for price transparency purposes. And given that most OTC derivative trades are conducted by globally active investment banks, some argue that the UPI would streamline the reporting process for the biggest firms.

I think the industry is going to split on this. It will be interesting to see some of the outcomes from this consultation, whether indeed even a trade association will be able to come up with a unified position which is agreed to by all its members

Regulatory official at a tier-one bank

“If they could use only the UPI globally, that might be an easier solution for them when it comes to transaction reporting. Usually, though, an investment bank would not do their derivatives reporting for the whole world from one location, but would likely have European reporting completed by their European entity, Hong Kong reporting by a Hong Kong entity, and so on. In turn, the global reporting argument is probably not as strong as it sounds,” BVI’s Siebel says.

Weighing the costs

But whether to use the UPI+ or the modified OTC Isin will ultimately be a question of which solution is easiest and most cost-effective for European firms to implement.

A head of market structure at a second G-Sib says that cost made them change their mind on the matter. “You can see the logic in saying, ‘If we fix the Isin, you have a uniform, cross-asset model in Europe.’ If you asked me the question three months ago, I would have said, ‘No, no—it’s impossible. They should just go for the UPI+’.” The source says switching to the UPI+ would be an extra cost to the industry.

At present, all transparency and reporting in Europe is based on the Isin. Those Isins are already used in internal systems from execution to risk management, the back office, reporting, transparency, and so on.

The bank head of market structure also recognizes the problem with the expiry date, but they are optimistic that by altering that field, this problem can be solved, ultimately making it the cheaper option. “I think the cost advantage is very important. The argument against the Isin was mainly that people believed creating millions of Isins is way too expensive for the industry, but I think there is a solution for that.” The source says that before this change, the UPI solution would have been more logical for the bank.

New fix for old issues?

Some sources say that changes to the OTC Isin answer long-standing problems with the identifier. The BVI’s Siebel says that altering the OTC Isin will “make the Isin usable … in a way the industry would have preferred it to be done when the post-trade transaction regulatory reporting was introduced in the first place.”

The head of market structure at the second G-Sib agrees that the change should have been made earlier. They suggest that there is more appetite for a solution now than there was five years ago. Back then, they say, people were afraid that too much transparency would be bad for the markets; now, they are hungry for more public data sources. Back then, market participants were more likely to appreciate that competitors couldn’t use data; now, they are thinking, “Damn, I can’t use it myself either,” the bank exec says.

The UPI, as the regulatory official at the first bank points out, is also yet to be implemented in Europe. Industry knowledge of the problems with the OTC Isin has emerged over years of use, an advantage that the UPI cannot yet claim. From the position of the regulators, they add, the OTC Isin links to a richer database. By moving to the UPI, a certain amount of data currently available for surveillance would be sacrificed.

Still, the source thinks that given the issues with the OTC Isin, a phased approach to the UPI may be inevitable. “The UPI+ is a great idea … but things change and move on. We’ve gotten better. The question, then, is how do we stop the production [of Isins] at some point in the future and move over to the UPI plus additional fields?” the regulatory official asks.

While the legacy of the 2008 financial crisis still looms large in the industry, distance has brought perspective and time-earned data to reporting requirements. A key consideration as the Commission looks to make a decision will be reducing the reporting burden and easing both the cost and effort of implementation.

“I think the industry is going to split on this,” says the regulatory official. “It will be interesting to see some of the outcomes from this consultation, whether indeed even a trade association will be able to come up with a unified position which is agreed to by all its members.”