A recent International Standard is helping bring new clarity to the complex world of finance and investment.
ISO 4914 provides a new way of identifying and understanding specific types of financial products known as OTC derivatives, and brings much-needed clarity to the sector. Finance expert Emma Kalliomaki explains.
In the plainest terms possible please: what is an over-the-counter (OTC) derivative? Typically, who uses them, and to what ends?
Emma: An over-the-counter derivative is contract agreed between two parties which is not conducted over a regulated exchange or trading venue. A derivative is a financial instrument whose value is derived from the performance of the underlying asset, such as a shares, currencies, interest rates, and commodities.
Derivatives are used by firms as a risk management strategy, used to hedge business risks, with the aim to protect a company’s finances from risks it may be exposed to. They are also used for speculation, which involves attempting to make a profit on educated estimates on market activity.
What does the new ISO standard do with regard to these? Why is that needed, and what kind of problems can it help avoid?
Emma: Following the financial crisis of 2007-2008, a lack of transparency in OTC derivative markets was identified as one of the key issues. G20 Leaders agreed at the Pittsburgh Summit in 2009, as part of a package of reforms to the OTC derivatives markets, that all OTC derivatives transactions should be reported to trade repositories. Trade reporting, by providing authorities with data on trading activity, is key to identify and address financial stability risks from OTC derivative markets.
The Unique Product Identifier (UPI) is being introduced as a mechanism to identify OTC derivatives products to assist G20 regulators to aggregate global OTC derivatives data by either product or UPI reference data element, together with the Critical Data Elements (CDE) and Unique Transaction Identifier (UTI). This will provide regulators with an improved, consistent view and common understanding of systemic OTC derivative risks.
What’s the impact of the new ISO standards for OTC derivatives from a consumer perspective?
Emma: Aggregation of the data across trade repositories can enable authorities to obtain a comprehensive view of OTC derivative markets and activity, aiding supervision and oversight to facilitate a more stable and efficient environment for all market participants as well as domestic and global economies.
How is this technology blazing trails in the finance industry?
Emma: The UPI will be delivered by the Derivatives Service Bureau as part of an identification framework where the technology has been designed to enable a hierarchy to exist between the Classification of Financial Instrument (CFI), UPI, and International Securities Identification Number (ISIN) for OTC derivatives. Assigned through a single platform, the technology will ensure harmonization and alignment of these identifiers based on the principles determined by the relevant industry representation groups.
Are further ISO standards anticipated in this area that will build on this and further improve confidence?
Emma: There are a number of ISO standards working in concert with the aim of improving the quality of data used in financial data reporting, improving the ability to monitor financial risk, and lowering regulatory reporting costs through the harmonization of these standards across jurisdictions. The ISO standards working with the UPI are Legal Entity Identifier (LEI), Unique Transaction Identifier (UTI), Critical Data Elements (CDE), Classification of Financial Instrument (CFI), and International Securities Identification Number (ISIN). Additionally, through the ISO development processes, these standards continue to evolve as the stakeholder use evolves ensuring the standards remain fit for purpose.
Disclaimer: PECB has obtained permission to publish the articles written by ISO.