On June 10, 2015 the Swaps Data Repositories (SDRs) of DTCC, ICE and CME collectively responded to the SEC’s Final Rule on Security-Based Swaps Reporting (SBSR). This collective response focused exclusively on the details of UIC’s (Unique Identity Codes).<1>
Then on July 20, 2015 ISDA presented a public document on the fifth anniversary of the Dodd-Frank legislation, again echoing the need to develop and adopt standardized product and transaction identifiers, as well as reporting formats.<4>
These codes, properly implemented, have the power to transform financial transaction flows, bring regulators in line with their oversite mission, and permit the concept of straight-through-processing to become a reality. Most importantly the issues surrounding UICs need to be resolved quickly as billions of swaps transactions are sitting in SDRs with ill-structured and poorly designed codes and data tags. Computers are unable to access them in any uniform manner or aggregate them. It has left swaps regulators blind to the contagion of systemic risk.
The SEC, CFTC and Office of Financial Research asked in 2010 for such codes and passed the coordination of the first code and its implementation to the G20’s Financial Stability Board (FSB), the global standards body created in the aftermath of the financial crisis. The FSB issued requirements for a series of unique, unambiguous and universal identity codes starting with the legal entity identifier (LEI) for financial market participants. They later took on the definition of contracts and instruments (the unique product identifier – UPI), and transactions (the unique transaction identifier – the UTI). With the use of these codes further drill down to codes for desk, trader, and branch could be developed. These codes collectively are referred to as UICs.
The LEI has been the first out of the gate. They are being used in reporting swaps to 25 SDRs across the globe, including three in the US. The issue of the LEI and the other principal UICs is that billions of transactions are accumulating in these SDRs with attached LEIs, UPIs and UTIs but there is no means to reconcile them nor aggregate them for risk analysis.
That these codes are not unique, unambiguous and universal is now well recognized. In their present forms they are not fit for the FSB’s intended purpose of collecting information on all financial transactions conducted by all financial market participants in all financial products for use in systemic risk analysis. However, with current technology demonstrating that data collection of financial transactions on such a massive scale is possible<5>, the UICs become the prerequisite pillars of this capability. Without them they will leave regulators and industry far short of their goals for observing contagion building up in the financial system.
The LEI initiative, with nearly 380,000 codes issued to date for swaps participants, has only now acquired the capability to reconcile duplicates and conform LEI registry data to a standard data format. How many duplicates or improperly coded records will be uncovered using this new capability is not yet known. Already 70,000 have been “lapsed” due to the failure to ‘recertify’ them annually. Many of these were the result of being issued prematurely and indiscriminately before final rules were promulgated by the FSB.
This summer, a public consultation will be conducted on how to establish the ultimate parent for each LEI, one of the requirements for UICs for swaps data reporting. The public consultation will also solicit interest in understanding how to provide hierarchies of ownership and control of LEIs embedded in financial transactions for data aggregation.<6>
The LEI is obviously still a work in progress. There are no assurances that given further enlightenment from the consultation that LEIs will not be sent back to the drawing board. In effect this is the request for all UICs made by the three US SDR’s and by the “Joint Association” – to revisit the UICs structure and governance.
What has not been given a fair hearing to date is that such a universal system of identification already exists – it is found in the barcodes of commerce and in Internet naming protocols and coding conventions. However, these two global coding conventions had been dismissed earlier in discussions with industry trade associations’ as not a relevant model for finance. The three SDRs and the Joint Association group are looking for other solutions, mostly favorable to their existing operating models, while the solution the regulators have been asking for, self-registration, is in plain sight.
The model of self-registration is the model used in the commercial barcode and the Internet’s coding conventions. However, regulators approved a host of data intermediaries to insert themselves into what was intended to be both the self-assigning and self-registering of codes by financial market participants directly. In the case of the LEI these ‘third parties’ are assigning codes and validating data using after-the-fact second or third level sources even though a ‘second- eyes’ certifying agent at the originating source (such as an auditor <7>) could be used.
The UTI is still intended to be self-assigned by market participants but, unfortunately not yet with universal definition nor an agreed upon code structure. It has not worked well in either the US or the EU even though they are assigned by each financial market participant (or their agent). Different reasons for their lack of conformity surfaced regardless of whether UTIs were placed on each of the two sides of a submission to SDRs required in the EU or on only one side as submitted to SDRs in the US. The UTI has no universal definition and hence, multiple versions of the UTIs are flowing into SDRs. The UPI with no universal definition is likewise problematic.
The three SDRs in the US argue for holding back on enforcing the UIC provisions in the SBSR rules for the reasons noted above. They also note that the rule is difficult to implement in regard to who corrects errors in the codes on the one sided submissions required by regulators in presenting swaps transaction for posting in SDRs– the SDRs or the market participants. Finally, the SEC has still to gain clarification on what procedure must be followed to register a LEI by one legal entity through a third-party agent for another legal entity that is part of a single organizational structure<8>.
Finally, if we had started on this journey by designing what the framers of the legislation had asked for -- common reference identifiers for participants and products<9> -- we could have extended such a common code structure to include all UICs such as those constructed within a common framework in the successful implementation of the barcodes of commerce<10>.
What now needs to be done, as is being requested by the three US SDSRs and the Joint Association, is to pause and conduct a comprehensive study on the entire range of required UICs to determine the best code structure and governance framework that is fit for all their intended uses globally. We may find that an integrated framework of code construction already exists in commerce and on the Internet that can be applied to finance.
The problems that have arisen in the use of UICs in swaps data reporting should be considered a pilot or beta test, and taken as a needed pause for studying the issue on a more macro basis. Creating the Barcodes of Finance cannot be done through silos of markets, sovereign jurisdictions or regulators. This must be a global solution to a global issue.
<1> See DTCC Data Repository (US) LLC, et al “Comments on Proposed Rule: Regulation SBSR - Reporting and Dissemination of Security-Based Swap Information” at https://www.sec.gov/comments/s7-03-15/s70315.shtml
<3> Joint Association letter “Key Principles to Improve Global Trade Reporting and Data Harmonization” at http://www2.isda.org/attachment/NzY1OA==/Joint%20Trade%20Association%20Data%20Harmonization%20letter.pdf
<4> The Dodd-Frank Act: Five Years On, July, 2015 at http://www2.isda.org/attachment/NzcxMg==/Dodd-Frank%20Briefing%20Notes%20FINAL.pdf, page 10
<8> Financial InterGroup Holdings Ltd, May 18, 2015 “Comments on Proposed Rule: Regulation SBSR - Reporting and Dissemination of Security-Based Swap Information” at https://www.sec.gov/comments/s7-03-15/s70315.shtml
<9> SEC, Regulation SBSR – Reporting and Dissemination of Security-Based Swap Information, Federal Register / Vol. 75, No. 231 / Thursday, December 2, 2010 / Proposed Rules, Dec. 10, 2010, http://www.sec.gov/rules/proposed/2010/34-63446.pdf, page 204
<10> Comments by GS1 and Financial InterGroup to SEC on Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, February 14 2011 at http://www.sec.gov/comments/s7-34-10/s73410-57.pdf, pages 14-26)