Taxonomy, UPI and Standardized Products In Plain English

Introduction The Dodd Frank act introduces several new concepts to derivatives processing Taxonomy: Identifies the type of product that has been traded (e.g. a simple equity option) UPI: Identifies product that has been traded (e.g. a 5Y USD LIBOR interest rate swap) – not necessarily a specific contract Standardized Product: A derivative product that has standard terms and is listed on an execution platform. All of these are related but are being considered in isolation.

How Derivative Trading Is Changing Increased use of clearing to reduce risk Clearing works better if the products are fungible and more easily netted LCH survey showed that over 50% of cleared swaps are unique Standard products would make this easier But some standardised derivatives are more fungible/nettable than others Similar interest rate swaps can have different term structures Some derivatives have already become highly standardised Especially credit and commodities products Will be traded more like a security Fewer economic characteristics need to be captured

Short Term vs Long Term Impact Any solution to regulatory reporting must work for the current and future market There currently exists a very large pool of existing long dated derivatives which will not change but must be reported e.g. Bilateral 30 year interest rate swaps In the future more trades will be of standardised products and cleared But there will always be some bilateral trades that are custom or not able to be cleared

Product Taxonomy Tells you what kind of product you have E.g. IR Swap:Fixed-Float Every category needs to be very precisely defined to allow price comparison IR Swap:Fixed-Float One fixed interest stream One floating interest stream Constant notional, fixed rate and spread Not inverse floating or index swap No stub periods Bucket categories for ‘exotic’ products that don’t match a specific case

Deriving Taxonomy & UPI FpML Trade Given a source of structured trade data the taxonomy codes and UPI can be derived e.g. an FpML based trade Standardised products can use the same technique but start with a product infoset The product taxonomy determines the attributes that will form the UPI The full product description combines the taxonomy, UPI and product details Extract/ Normalise Product Product Infoset Derive Asset Class & Product Type Asset Class & Product Type Extract Key Characteristics UPI Package Results Full Product Description

UPI: Compound or Opaque? The UPI makes it possible to differentiate between similar products 3M IBM PUT option vs a 6M HP CALL option Products with differences in attributes that are not significantly price affecting should have the same UPI e.g. accrual basis, calendars, date roll convention Could either be either: A compound identifier formed from the key product characteristics Parse and add defaults based on ‘market convention’ to recreate the product description An opaque identifier allocated from a incrementing counter or a one-way hash function applied to the product description MUST always look up the product details via a reference data service to obtain the full description Cost to create industry service and changes to client systems to use them will be hugely expensive

UPI: Specific or Generic? How detailed will a UPI be? What attributes will be trade specific and what will be part of the product Is the strike part of the UPI or the trade? The more specific the UPI the greater the number of related UPIs e.g. LIFFE lists 28 contracts (put/call) for the Dec ’11 option on ARM stock with 14 different strike levels Ticker

Deriving Infosets Trade Infoset Trade Value Infoset Product Infoset OTC Swap Trade Effective Date Termination Date Notional Amount Notional Currency Floating Calc Frequency Roll Convention Floating Index Floating Index Tenor Spread Floating Reset Freq Fixing Offset Fixed Calc Frequency Fixed Rate Compounding Method Payment Frequency Payment Offset Accrual Basis Date Roll Convention Holiday Calendars Trade Values Effective Date Termination Date Notional Amount Notional Currency Roll Convention Spread Fixed Rate Price Affecting Non-Significantly Affecting Term Notional Currency Floating Calc Frequency Floating Index Floating Index Tenor Floating Reset Freq Fixing Offset Fixed Calc Frequency Compounding Method Payment Frequency Payment Offset Accrual Basis Date Roll Convention Holiday Calendars Normalize and Separate Values

Relationship With Ticker Tickers identify real traded contracts Have quotes and price history If a product is general then need trade facts to identify a specific contract Product: 5Y USD/LIBOR-6M Swap (identified by its UPI) Trade: Buy next month swap on 10-Nov-2011 Contract: DEC 2016 USD/LIBOR-6M swap Ticker: L6M-DEC16 Products with same UPI could be listed on different exchanges with different tickers Trade Details Product Details Combine identifies Ticker Traded Contract identifies