>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> GLOBAL DATA DELIVERING REGULATORY TRANSPARENCY The Challenges Involved in Creating a Universal Financial Instrument Identifier CONTENTS 02 CHOICES FOR FINANCIAL INSTRUMENT IDENTIFIERS 02 REGULATION & THE FINANCIAL INSTRUMENT IDENTIFICATION CHALLENGES 04 A WAY FORWARD — THE FINANCIAL INSTRUMENT GLOBAL IDENTIFIER 05 CONCLUSION 05 APPENDIX DELIVERING REGULATORY TRANSPARENCY The Challenges Involved in Creating a Universal Financial Instrument Identifier The financial crisis of 2007-2008 has led to an At the same time, efforts by regulators to move toward unparalleled regulatory drive to prevent a repetition a more standardized approach for key identifiers have of those events. Much of the global regulatory response produced mixed results so far and, in the case of financial has focused on strengthening the banking system, instrument identifiers, are in danger of producing fragmentation especially those institutions classified as global, rather than the desired level of harmonization. systemically important institutions. Regulators in key markets have also turned their attention to derivatives, ENTITY IDENTIFICATION LEADS THE WAY alternative investments and activities that fall under the One of the aims of reporting trades to repositories was to allow regulatory definition of shadow banking, for example, regulators to see the risks building up in the financial system. repo transactions and securities lending. Many new To do so, they need to identify the exposures that financial firms regulations that cover these areas have been developed, have to one another. The failure of Lehman Brothers in 2008 derived in large part from the recommendations of was a particular driver, as it was difficult for financial-market global regulatory standard-setting bodies such as the regulators to compile a true picture of the possible contagion Basel Committee, the Financial Stability Board (FSB) effect resulting from the investment bank’s collapse. The lack of and CPMI-IOSCO. a single industry standard to uniquely and easily identify all the Lehman entities and all the financial firms exposed to them was A common requirement across the new regulatory landscape highly problematic for the financial system. is greater transparency delivered through increased reporting. Indeed, the output from the 2009 G-20 Pittsburgh Summit In conjunction with the move of OTC derivatives’ trade reporting included 21 references to transparency. to the trade repositories, regulators began to develop a global legal entity identification system. The Basel-based FSB initially The range of new reporting varies across different markets, undertook this initiative, with governance then handed to the but a number of common themes predominate, including the Regulatory Oversight Committee (ROC), which has now reporting of over-the-counter (OTC) derivatives trades to trade evolved into the Global Legal Entity Identifier Foundation repositories. Regulators increasingly want to know more about (GLEIF), a nonprofit organization supporting the implementation the assets that financial groups hold. As markets have moved and use of the Legal Entity Identifier (LEI). The GLEIF is to implement the expanded reporting requirements, especially overseen by the ROC. the trade-reporting mandates for OTC derivatives, issues of data quality have become more prominent. Regulators have The LEI is a 20-character alphanumeric code. In common struggled to digest the information reported, in part because with data best practices, the LEI code contains no embedded of the lack of standardized identifiers for transactions, financial intelligence related to the entity it identifies. Descriptive instruments and entities. Of course, robust identifiers that can reference data elements provide the details of the entity, identify the “who” and the “what” in financial transactions are rather than the code itself. particularly crucial. Transparency cannot be achieved unless the Twenty-six Local Operating Units are authorized by the GLEIF parties involved in a transaction and the assets they have traded to issue and maintain LEIs. The LEI code and associated can be unambiguously named. reference data are an International Standards Organization Historically, the financial industry has not been efficient (ISO 17442) standard. Although an ISO standard was in adopting standardized identifiers, either for entities or already in the entity space (ISO 9362), otherwise known financial instruments. This is not just an issue in terms as the Bank Identifier Code (BIC), this standard had limited of regulatory reporting, but also one that plagues firms coverage and flexibility and was not easily adaptable to themselves within their own data and risk management. become a global LEI. Therefore, a new standard was defined and approved by ISO for use in trade-repository reporting, Many large financial firms hold databases containing customer first in the U.S. and later in European and Asian markets. and inventory information in a variety of formats. Some of these databases use the firm’s own identifiers, while others may use codes provided by a variety of third-party vendors. Some may not even use an identifier, but rely instead on data records made up solely of a number of fields to describe customers and inventory. Many will have combinations of all the above. This situation complicates operations and inhibits effective risk management and regulatory reporting. LEI is now becoming a requirement in other regulatory-reporting REGULATION & THE FINANCIAL INSTRUMENT contexts beyond trade-repository reporting, but adoption still has IDENTIFICATION CHALLENGES some way to go, with about 400,000 entities identified globally. In The range of financial instrument identifiers out there adds the EU, the revised Markets in Financial Instruments Directive and complexity to the operations of financial markets globally. Regulation (MiFID II/MiFIR) reporting regime, when implemented Many of these identifiers are entrenched in their respective in January 2018, will be based on LEI rather than BIC. This could markets or sectors or both, so, until recently, there has easily add an additional 100,000 LEIs to the list, while the move been scant momentum for change. by the GLEIF to include branches in the scheme will give the LEI The regulatory demands for transparency, which led to the a further boost over the coming years. So, even if the adoption development of the LEI, are now a major factor in the evolution and use of LEI have been slower over the past four years than is of financial instrument identifiers. ideal, at least a generally accepted standard fit for the purpose is now available and gaining momentum. Regulators need to receive standardized data if they are to analyze the vast amount of information now required from CHOICES FOR FINANCIAL INSTRUMENT IDENTIFIERS financial-market participants. This is particularly true for If the LEI is taking the entity identification challenge in the right reporting derivatives’ transactions to trade repositories. direction, what about the other half of the equation, financial This requirement started out in the U.S. as part of the instrument identification? Here the picture is more complex. reforms under the Dodd-Frank Wall Street Reform and Aside from the use of in-house codes, the market has a plethora Consumer Protection Act in late 2012, followed by EU of identifiers available for financial instruments. Instrument reporting in 2014 and then similar requirements in a number identifiers include: stock exchange tickers, Thomson-Reuters of Asian markets. In line with the original G-20 mandate for RIC codes, CUSIPs (for the identification of U.S. securities) the reporting of OTC derivatives, it is important that this and Sedols (issued by the London Stock Exchange for UK information be capable of aggregation, not only by country securities). Other identifiers cover only a limited range of or region but also globally. The derivatives need to be financial instruments, such as RED codes, issued commercially clearly identified in a standard way. So, while the instrument by Markit for credit derivatives. Many of the existing codes are identification challenge is not just about derivatives, these specific to a trading venue or country or both. This adds to the products are at the core of most of the international debate complexity of the situation, particularly given the increasing about instrument identifiers, given the difficulties associated cross-border nature of securities trading. with identifying them and the regulatory imperative to find a solution. It was the move to cross-border trading that led to the introduction of the International Securities Identification This has led CPMI-IOSCO to include a Unique Product Number (ISIN). Like the LEI, this is (since 1990) an ISO Identifier (UPI) in its initiatives for standardizing key elements standard (ISO 6166). The ISIN was designed to enable in global derivatives trade reporting. The UPI initiative cross-border identification of securities, with the particular recognizes that greater standardization is needed aim of facilitating the post-trade settlement of those securities. It for instrument identification to achieve the goals of is not used historically in the trading space. The ISIN mainly global regulatory transparency. With a move to greater covers equities and fixed income securities and has a limited standardization (which also extends to unique transaction coverage of other financial