The adoption of OTC clearing and the subsequent use of clearing houses has created the need to mandate standardised OTC derivatives identifiers (IDs), in order to enhance the movement of trades and manage market and price risk while also supplying transparency for regulatory oversight requirements. However, we’re seeing this occur in broad strokes in a globally fragmented manner.

ESMA, despite vocal industry opposition, has reaffirmed the use of the International Securities Identification Number (ISIN) as the standard identifier for reporting derivatives under MiFID II. The International Standards Organization (ISO) just finished reviewing initial industry working group recommendations by asset class.

Why would the creation of a standard ID, supported by ESMA along with IOSCO and ISO, if so required for the efficiency of the OTC market, be an issue? Because the discussion has morphed into a product-agnostic, geographically-specific need related to one type of regulatory reporting, losing sight of the fact that ID standards are a global operational support issue.

Standards should, where applicable, be sought as universal on a product level and then brought to fruition, driven primarily to alleviate operational issues facing the entire industry. Indeed, the initial debate focussed on a method to provide optimised operational support for the matching, settlement, pricing, clearing, collateralisation and portability of bilateral and cleared OTC derivatives, as well as enabling the most accurate regulatory reporting to mitigate and proactively manage risk. ESMA is taking the industry down a road where the effective assumption is that, for every product, one-size-fits-all.

The ISIN would be unnecessarily robust for some products, as you’d end up with blank or unnecessary characters, and it wouldn’t be robust enough for others. There’s also the issue of a lack of uptake, as some other financial products with standard IDs do not use the ISIN structure.

Attempting to lasso the entire OTC market with a single standard is neither practical nor the best approach for risk mitigation support, either now in the future. Establishing a standard is about the value of that process and the value of the information you’re receiving in that process. It’s about reporting information the right way from day one, and working in such a way that the identifier gives insightful information to market participants and regulators to reduce risk and avoid institutional and market collapses.

We need the largest buy and sell-side firms to collaborate and agree on standards and submit those for consultation with the various regulatory bodies in a coordinated manner. For each combination of asset class and product type, with sufficient liquidity and maturity, a unique standard should be created and driven to adoption. Previous successful examples of these include OPRA codes for listed equity options, or RED codes for credit default swaps.

Beyond the ISIN, other options include Bloomberg’s FIGI (Financial Instrument Global Identifier) and the International Swaps and Derivatives Association (ISDA) proposal to adopt a Universal Transaction ID (UTI) in combination with a Universal Product ID (UPI). Outside of currently low utilisation and industry adoption, the FIGI benefits from being free and more flexible, as well as from Bloomberg’s desire to evolve the offering based on industry feedback and grow adoption. The ISDA taxonomy makes sense in application to bilateral trades and bilateral reporting.

This is important to understand; with cleared trading and reporting we have the advent of standard contracts and compression methodologies that result in many transactions attributed to a single position and related opportunities for collateral and portfolio optimisation through the portability of trades between FCMs and CCPs. While this positional ID for cleared trades could have a transactional ID as a suffix so as to align with the bilateral structure, it should be inclusive of whatever the position is and specific to whatever the product is.

Ultimately, multiple new ID formats are needed. Each should differ in structure, given the uniqueness of the OTC market and the adaptability of asset classes and imaginable products therein. The OTC market is bespoke so it can provide infinite ways of allowing financial institutions to hedge their risk in special ways for unique client portfolios. This will not decrease in time as our world is only getting more complex and investment vehicle options and managers will become increasingly diverse.

Joshua Q Israel Satten is director of business consulting at Sapient Global Markets, based in San Francisco