Emma Kalliomaki, managing director at Association of National Numbering Agencies (ANNA) and the Derivatives Service Bureau (DSB), offers an explainer of how these two industry bodies are leading efforts for the facilitation data standards and data harrmonisation across the OTC derivatives trade lifecycle, including central clearing.
The DSB provides objective, standards-based reference data to market participants and public authorities to enable the identification of and transparency in Over-the-Counter (OTC) derivatives markets, to support public authorities’ – notably national competent authorities, ESMA and the ECB, enabling these authorities to monitor financial risk and market abuse. The DSB operates as an industry utility service under the principles of the International Organisation of Standardisation, (ISO), providing services on a cost recovery basis and ensuring access to data is on a Fair, Reasonable and Non-Discriminatory basis.
The DSB’s origin and role
The origin of the DSB was triggered by a decision in September 2015 by European regulators that the International Securities Identification Number, known as the ISIN, would be the preferred identifier for new regulatory reporting mandates coming into effect, specifically under the MiFID II, MiFIR and MAR frameworks. The DSB was therefore established in 2017 to deliver an identification framework specifically for OTC derivatives where unlike other financial instruments, the OTC markets lacked a standardised, uniform identification framework – accentuating the challenges in transparency and market oversight.
The DSB UPI and ISIN
The DSB’s role has further evolved following its designation by the Financial Stability Board, FSB, as the sole service provider for the forthcoming Unique Product Identifier, referred to as the UPI, which will join the ISIN as part of an OTC derivatives identification hierarchy. It is important to highlight that ISINs have been used in capital markets globally for over 40 years and are implemented in more than 100 jurisdictions, enabling cross border trading and a streamlined processes for clearing and settlement of the broad range of equity and debt securities issues, as well as securitised derivatives, exchange traded derivatives and since 2018 also for OTC derivatives.
The ISIN and OTC derivatives
The ultimate goal of the ISIN is to provide a standardised approach to identification of financial and referential instruments via a unified system, making the ISIN and the associated reference data accessible, and available to all stakeholders and authorities. We continue to work with all regulators in improving the quality of data and the timely submission by industry to authorities. So, why this focus on over-the-counter derivatives? The gross market value of OTC derivatives – which is an indication of the potential risks involved – stands at $12.4 trillion in 2021. The derivatives clearing market in Europe alone represents some €735 trillion. At this level of magnitude, there can be little doubt that derivatives play a pivotal role in the EU economy. But they also bring certain risks. These risks were highlighted during the 2008 financial crisis, when significant weaknesses in the OTC derivatives markets became evident.
Standards have never been so important
Much progress has been made in making derivatives’ trades safer. The European Markets Infrastructure Regulation (EMIR) came into force in 2012 improving the transparency of OTC derivatives markets and reducing the risks associated with those markets. 10 years later, the EMIR REFIT draft technical standards were issued in support of alignment with international standards and harmonising the reporting regimes, in particular between EMIR and MiFIR. However, the recent London Metal Exchange case of nickel market prices underline how important market surveillance needs to evolve in the OTC space. In early March 2022, nickel prices erupted to $20,000 per tonne with an initial margin of only $2,300 per tonne, resulting in the LME suspending trade in the metal for 8 days. The OTC nature of the trades and their clearing was seen as being a contributing factor. Regulators rely on monitoring and despite the introduction of EMIR following the 2008 financial crisis, this example is indicative that blind spots remain in OTC markets.
EU regulatory framework – OTC derivatives surveillance
This is why the DSB warmly welcomes the European Commission’s consultation on the future EU regulatory framework for derivatives clearing. Much work, however, remains to be done in the OTC derivatives area to facilitate the role of regulators in removing these ‘blind spots’ through better surveillance, to expand the scope of OTC commodity derivatives in the rules and provide buyers and sellers with more transparency on prices, quantity, and asset class. Critical to this ambition, and perhaps overlooked in the EC consultation, is the need to greatly improve the quality of data generated by derivatives’ users and intermediaries, and ultimately feeding into the national and EU supervisory reporting mechanisms. This point has been repeatedly underlined by ESMA, the ECB and the EC as fundamental to authorities’ abilities to undertake their supervisory functions.
Data Alignment and Harmonisation
Market stakeholders also have similar interests on data alignment and harmonisation – which remains a key focus of the DSB and its industry representation groups. In particular, when interpreting the requirements to define the products for identification of OTC derivatives, we need a standardised, harmonised approach to generate consistent and accurate data, increasing the ability to automate and improve timeliness and accessibility to data. Harmonisation also includes having a common definition of OTC derivatives, at both trading and clearing levels – and also central clearing requirements, across all relevant EU legislative packages – as the Commission has suggested.
DSB recognises the risk of duplicative reporting requirements between EMIR and MiFIR and welcomes the need to harmonise the 2 reporting regimes, with a view to maximising data alignment for the benefit of improved data quality being reported. We back the aim of the EC’s consultation’s active consideration of amendments to better harmonise and align the requirements applicable to entities active in OTC derivatives beyond EMIR and MiFIR – to embrace the Capital Requirements Regulation/Directive (CRR/CRD), UCITs directive, AIFMD, Money Market Fund Regulation (MMFR).
In short, the DSB supports emphasis of the revised regime to be focused on developing supervisory reporting requirements, including OTC definitions, formats, and processes – that are unambiguous, aligned, harmonised and suitable for automated, streamlined reporting. Another focus is on cultivating a requirement for prompt timing of disclosures by users of derivatives and making double reporting and over-reporting a phenomenon of the past. And making full use of available international standards for consistent and accurate identification and classification of financial instruments, including OTC derivatives. Enabling supervisory data to be reported in machine-readable electronic formats so it is easy to combine and process – facilitating the use of RegTech tools for reporting and Supervisory Technology tools for data analysis by authorities. Above all, transforming the identification framework of derivatives transactions as user-friendly to all end users across the OTC derivatives ecosystem, removing the risk of settlement mismatches and more generally promoting increased data quality through the trade lifecycle.