Standards And Regulatory Reporting
Chris Pickles, Open Symbology Team, Bloomberg examines reporting standards and initiatives.
Whichever country you operate in, the demands and complexity associated with regulatory reporting have been gradually increasing over the last ten years. That includes transaction reporting to local regulators as well as trade reporting to the market as a whole, irrespective of asset class. As a result, the urgent need to agree and adopt standards that will help regulators to monitor markets and help financial institutions to achieve regulatory compliance more cost-efficiently has become more and more apparent to all involved.
Three key areas that market participants are addressing together with regulators and industry associations are: the process of identifying what has been traded, identifying the nature of the trade and establishing how to communicate all of this information to regulators consistently.
You might think it’s simple for firms themselves to identify what they have traded – but even that isn’t as easy as it seems. Each different area of financial markets currently has different ways of identifying what is being traded. Each country has its own system for identifying equities and bonds, and those domestic identifiers are at the heart of the ISO International Securities Identification Numbering (ISIN) standard.
However, regulators have recently started to recognise that ISINs are little-used outside of the securities (equities and fixed income) sector. Derivatives exchanges have historically generally used their own in-house identifiers with no international standardisation, with OTC derivatives frequently having no recognised identifiers at all. And when it comes to other asset classes, such as commodities, foreign exchange and money markets, and other financial products, such as loans and mortgages, standardising the identification of financial instruments is still in its infancy.
Work is ongoing in the USA and across Europe to agree on how to standardise Unique Product Identifiers (UPIs) and Unique Trade Identifiers (UTIs) for the OTC Derivatives sector. Regulators in Europe are separately proposing the use of non-standardised “Alternative Instrument Identifiers” (AIIs) to identify exchange-traded derivatives. These regulators have started to recognise the vast number of instruments for which there have been no standardised identifiers, saying firms will just have to describe those instruments to the regulators when they report transactions. As yet there is no clear agreement on the approaches to be taken.
While one solution could be to “glue together” lots of different data fields that describe the instrument in question, that approach contradicts basic principles of data management – principles that the Global Financial Markets Association (GFMA) emphasised when the global Legal Entity Identifier (LEI) system was being designed. For an identifier to be unique, persistent and unchanging, it must contain no information about the object that it identifies.
To put all of this into perspective, the ISIN standard was created some 25 years ago and so far around 30 million financial instruments have been allocated ISINs. In parallel, Bloomberg has confirmed that it now has to be able to identify over 220 million instruments and that, on average, the firm is now having to identify an additional 5 million instruments each month.
In the financial markets sector, it would be easy to think ISINs are the norm when, in fact, they identify less than 15% of the instruments that a given financial institution can be involved with. One result of this is that in October 2014 the Object Management Group (OMG), a global standards body, adopted a new standard for Financial Instrument Global Identifiers (FIGIs) that has now been applied by Bloomberg to allocate FIGIs to all of the instruments that it covers.
The second key area being examined is about identifying the nature of a trade and how that impacts the basic information that relates to that trade. Without details of the nature of a trade, information about that trade could be interpreted wrongly. For example, the same identical financial instrument could be traded in two different ways and at two different prices: without knowing how the trade occurred, pricing information about that instrument could be used incorrectly to make investment and trading decisions. Understanding the nature of the trade is where the Market Model Typology (MMT) becomes invaluable.
It’s a natural tendency to expect that financial markets in all countries function in the same way as in your own country – but that’s very often not the case. Just taking one example of this, stock exchanges can operate a market in three ways that are fundamentally different – quote-driven, order-driven matching and order-driven auction – and each of those different market structures can result in different prices for the same equity. A single organisation can operate multiple exchanges and multiple market segments within those exchanges, and each of those can be operating in competition to other exchanges and non-exchange systems, such as Multilateral Trading Facilities (MTFs) and Electronic Crossing Networks (ECNs). All of these can be operating in multiple countries. Achieving a consolidated view of prices across the overall market may be relatively simple, but understanding what those prices mean and how they were arrived at is much more complex.
In the European Union, where there is now a legal requirement to implement one or more systems for providing a consolidated view of the markets in equities across the region (European Consolidated Tape), it became clear some years ago that this would also require a clear definition of the data relating to equity prices. Trade reporting is a regulatory requirement for publication of pricing data to the market as a whole, but that is only of value to the market if the reported information can be clearly understood. The Federation of European Securities Exchanges (FESE) initiated the work on the definition of a “Market Model Typology” (MMT), later expanding this work by including participants from investment firms and relevant industry associations, including the FIX Trading Community. In order to ensure that the MMT is considered and managed as an open standard developed by and for the industry, the coordination of work internationally on the MMT has now been handed over fully to the FIX Trading Community.
At this stage we can therefore see that FIGIs provide a basis for unique identification of financial instruments across all asset classes and the MMT provides a basis for understanding the pricing information about those instruments. The third key area currently being addressed is how to communicate all of this information to the different regulators. Until very recently, regulators have dissociated themselves from industry standards, arguing that regulators are not part of the financial industry and issues surrounding industry standards therefore fall outside their remit. However, practical experience over the last ten years has proved that standards can make a major difference to regulators’ own work as well as to the compliance work of the institutions that they regulate.
As well as an individual country potentially having more than one regulator, financial institutions that have a broad range of activities and that operate in multiple countries frequently have to carry out regulatory reporting in more than one country. Added to that complexity is the fact that regulators want to be able to exchange information meaningfully with each other in order to regulate global financial markets to better effect. There is clearly a vital international requirement for the standardisation of how the market communicates with regulators and how regulators communicate with each other, both in terms of data standards and protocol standards. The European Securities & Markets Authority (ESMA) is one regulatory body actively examining this area. In March this year it gathered responses from market participants about which protocol and data formats they would find most helpful and appropriate to use for regulatory reporting. One of the options given was the use of FIXML, the XML version of the FIX Protocol.
The importance of FIX to the day-to-day operations of investment firms across Europe is clear, but not only for pre-trade activities through to trading: FIX is an ideal standard for use in trade reporting and transaction reporting as well. Being an open industry standard, FIX allows for the use of both ISINs and FIGIs, thereby ensuring that FIX can be used to report all trades and all transactions in any of the 220+ million instruments that financial institutions are involved with today. FIX also enables the MMT to be applied in regulatory reporting so that the information that is delivered has meaningful value to market participants and to regulators internationally.
Regulators are beginning to understand better the importance of standards to efficient and well-regulated markets. It’s now very much up to market participants to take the next important step and emphasise that free, open and non-proprietary standards such as FIX and FIGI are the most appropriate approach for regulators to adopt as well.
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