FpML 5 has introduced new views and messages to support operational demands related to regulatory reform such as central clearing. In a DerivSource educational insights article, Sapient’s Alicia Szybillo and Henri Pegeron offer background into the evolution of this standard and explains the value of FpML 5 and the challenges ahead for FpML.
On June 9th, 1999, a small group of IT leaders, business developers and technical architects established the framework for modeling OTC derivatives in a standardized way. They decided to utilize a new extensible markup language called XML, which would allow rules and connectivity to be defined across various industry data sources. The standard would continue to be developed internally by various firms
until taking on the official designation of Financial products Markup Language (FpML). The standard continued to gain recognition in the financial community as a viable framework for the then scattered approach to confirmation and reporting for OTC derivatives. FpML eventually caught the eye of the International Swaps and Derivatives Association (ISDA), who had been looking to standardize OTC documentation around various financial products and instruments over the past two decades.
On November 14th, 2001, ISDA and FpML announced that they would work together on the development of the standard and broaden its scope. With the newfound backing of ISDA’s participating players in the OTC derivatives space, FpML began to see rapid uptake and widespread development through Working Group participation. The standard proved to be both practical to implement and operationally friendly due to its human readability and direct tie backs to ISDA documentation. From its 2001 collaboration with ISDA, FpML spent the next 10 years rolling out new functionality and was adopted by asset managers, buy-side firms, vendors, clearing houses and many other financial institutions. This foothold led to the announcement in 2010 that FpML would undergo an architectural overhaul in its move to version 5, allowing it to standardize additional functionality.
Today, FpML covers every major OTC asset class, including non-standard products and bespoke instruments. More importantly, the introduction of FpML 5 has created a clean slate for the coming regulatory reforms and will become a critical tool for supporting functions, such as clearing and trade reporting, in the new OTC regulatory environment.
What is FpML?
According to the FpML mission statement, the task of FpML is to streamline the process supporting trading activities in the financial derivatives domain through the creation, maintenance and promotion of an e-business language for describing these products and associated business interactions based on industry standards. Because the standard is based on XML, it is completely extensible and can take on the form of any logical model—from a simple data dictionary to a request/response transport mechanism to a complex regulatory rules engine. This flexibility is possible because FpML is not a program or piece of software, but rather a clear and distinct list of rules that can be integrated with systems, all kept within the XML Schema framework.
Each “element” in FpML has an ISDA and/or industry established definition, removing the problem of ambiguity of terms. Additionally, every “message” in FpML has a defined business purpose, which, along with a distinct set of available “elements”, creates a standard process. The combination of these two XML features covers almost any possible OTC derivative business flow.
Predominantly, FpML has been utilized by major banks and service providers as an electronic representation of the ISDA legal framework. The vast majority of electronically traded financial OTC trades are done under an established ISDA Master Agreement. Of this, nearly all OTC trades are traded under one of the various ISDA Master Confirmation or Standard Terms documents. Because of the direct tie-in to ISDA, 100% of these documents are currently supported by the FpML standard. As such, the framework is flexible enough to support references to the other documents in place across the various asset classes in multiple jurisdictions (AFB, LEAP and EMTA, among others).
An Open Standard and Process
The FpML standard is currently freely licensed, a wise decision by ISDA, which allows organizations outside of participating firms to contribute to the standard and create other avenues for expansion to the general public. FpML has also collaborated with the International Organization for Standardization (ISO) for guidance on the implementation of business workflows as part of their 20022 standard—a further step toward standardizing complex trade service message offerings.
Today, FpML is governed by a dedicated Standards Committee consisting of over 10 major dealers and 12 alternate entities comprised of major buy-sides, firms custodians and service providers. This group oversees the general direction of development and the projected scope year-on-year. The Standards Committee is also responsible for providing guidance to the release schedule and roadmap. The FpML publication lifecycle is a four-phase process consisting of a Working Draft, Last Call Working Draft, Trial
Recommendation and the eventual Recommendation. A subsidiary Coordination Committee, consisting of FpML Working Group chairs and technology specialists from across the OTC spectrum are responsible for approving each version of the FpML standard.
New Faces in Standardization
Traditionally, FpML (or FpML-based architecture) has only been heavily adopted at major banks and trade repositories due to its direct mapping of ISDA legal terms to XML and for its simplified post-trade event processing model. However, the adoption of global regulation begets the need for new players in the standardized messaging space. In particular, organizations will need to focus on straight-through processing (STP) processing, timeliness and connectivity more than ever as the concepts of “as soon as technologically practicable” and “real time” become commonplace in the OTC market.
• Major Swap Participants (MSPs)—MSPs and Swap Dealers (SDs) will continue to use FpML as a mechanism for trade confirmation and legal frameworks, but will need to build out a verbose internal data library across multiple risk, pricing and valuation systems to meet the strict regulatory requirements. Vendors and middleware providers will seek to simplify this process by housing their own FpML adaptors, translators and rules engines to facilitate this reporting.
• Swap Data Repositories (SDRs)—SDRs will be the end point of connectivity in the regulatory space, but will serve as a critical medium for centralized reporting to the various regulatory bodies. FpML will be used by both SDRs and the monitoring organizations to ensure proper and consistent data. SDRs will look to build open connectivity to upstream entities such as Swap Execution Facilities (SEFs) and Derivatives Clearing Organizations (DCOs). Moving forward, SDRs will be utilized by MSPs and SDs for portfolio and position reconciliation, making the adoption of a unified standard with these entities vital.
• Derivative Clearing Organizations (DCOs)—In addition to needing to provide direct connectivity to both SDRs and middleware providers, DCOs will need to ensure that their business processing flows are consistent with the newly published rules. In addition to the architectural changes required, the clearing landscape will move toward the Futures Clearing Model for most standard OTC trades. Specific workflows have recently been added to FpML to accommodate for the various pricing, margin and broker requirements for cleared trades under this model. The inclusion of the Clearing Broker and Client as two separate entities on the deal is one example of this.
• Swap Execution Facilities (SEFs)—SEFs and Designated Contract Markets (DCMs) have been identified
in the regulation as holders of contractual and execution data which must be reported “real time”, but also as the potential holders of the actual legal confirmation. This, by definition, will mean that SEFs and DCMs may need to maintain a standard legal framework for all transactions that may match and subsequently clear through their platform. FpML will likely see its greatest uptake in this area, as these facilities have traditionally used their own proprietary engines and formats to execute deals. This is also an opportunity for Inter-dealer Brokers (IDBs), custodians and exchanges—organizations that already hold data from both legal counterparties—to utilize FpML and potentially step into the SEF space.
Solutions through FpML Messaging
As a technology-based standard with a legal institutional backing, FpML allows implementers to meet both data management and operational requirements in a single message. FpML 5 has introduced new views and messages to support a broad range of services relevant to the regulatory space.
In 2011, the Depository Trust and Clearing Corporation (DTCC) announced they would implement a core version of FpML 5 to support the effort of creating an SDR for every major OTC asset class. The DTCC will seek to use FpML as an internal data representation as well as a general message connectivity solution for reporting. Clearing organizations, such as the InterncontinentalExchange (ICE), will also utilize FpML for submission of cleared trades directly to the DTCC for regulatory reporting purposes.
The recent finalization of U.S. regulation has made it clear that FpML will need to continue to adapt as rapidly as the industry it seeks to standardize. The Commodities Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) have already begun to participate in FpML and ISDA Working Groups to help shape the standard to meet their needs with respect to trade reporting and transparency. Outside of the US, FpML is seeing a large uptake in both the European and Asian markets as regulation is promulgated across the globe. The pending adoption of the European Market Infrastructure Reform (EMIR) will see many of the same FpML solutions for its respective organizations affected by the Dodd-Frank Act. FpML has also begun to see adoption from clearing organizations, such as London Clearing House (LCH) and Singapore Exchange (SGX), as connectivity solutions in both the EU and Asia are evolving.
Ongoing FpML Initiatives
In 2012, one of the ways FpML has continued to address regulatory initiatives has been the introduction of a dedicated Regulatory Working Group. The purpose of this Working Group is to focus on newly introduced rules from the various global regulatory bodies, such as the CFTC part 17 and 20 Commodity Trader Reporting requirements. The inclusion of the ISDA 2011 Equity Definitions into the standard may also result in a possible revamp of the representation of Equity products in FpML. Both of these initiatives will place a tighter focus on Commodities and Equities rules once the initial enactment of Credit and Interest Rates rules are in place this July.
Additionally, FpML and ISDA have also recently begun work on electronic representations of Standard Collateral Agreements between counterparties to simplify the confusion behind the negotiated framework on Independent Amounts and margining on trades. FpML will support this by providing a representation for the variable terms in the credit support annex (CSA) and/or providing messages to/from services used to calculate collateral requirements based on the new standard credit support annex (SCSA). This is a big step in the right direction and will pave new ground for FpML to serve as a regulatory format.
While FpML itself is well positioned as a standard to meet the demands of clearing and regulatory reporting, consumers of FpML will face challenges following post-enactment of regulatory rules.
Major market participants believe that there are particular concerns surrounding each organization’s ability to keep data in sync with updates as they occur. For example, a Major Swap Participant today may become a Swap Dealer tomorrow resulting in a plethora of trades that must conform to global reporting standards. Additionally, as the uptake of trade standardization occurs, unregulated trades may become regulated with the flick of a pen.
The current ongoing regulatory work will shape the rules of tomorrow, but systems that are unable to make real-time decisions may not be able to cope with the new regulatory requirements. Internal systems that may not have been previously stressed will certainly be put to the test as the required fields for execution and reporting expand. Operational requirements for the data these systems need will also increase exponentially. Periodic updates will prove challenging for many institutions who will be working to implement a standard data model and change their pipeline connections to process FpML in an efficient manner.
Another challenge involves the sheer size of the information being both requested and provided by regulators. The projected volumes for portfolio updates and corrections will enter the millions for some of the more volatile asset classes. In the rates market, amortizing notionals, rate resets and early exercises will need to be kept in sync to the SDR on a daily basis. In the Equity market, stock splits and refactored indices will also result in large volumes of transactions that must be reported in a timely manner. The Financial Information eXchange (FIX) Protocol has taken steps towards increasing its throughput in the trade execution space by creating more lightweight and portable versions of its messages. FpML may find itself in a similar situation as the consumers and generators of FpML, the new faces of standardization, begin to feel the weight of regulatory needs on their infrastructure.