The godfather of European financial market regulations seems to be making trading venues an offer they cannot refuse. The only way to comply with a compulsory reporting requirement in the second Markets in Financial Instruments Directive is to sign a contract sources describe variously as “terrible” and “unacceptable”.

Mifid II and its accompanying regulation, Mifir, enters into force in the European Union on January 3, 2018. The revamped rules introduce new measures to help regulators set liquidity thresholds for pre- and post-trade transparency, and sniff out market abuse in the over-the-counter derivatives market. Central to regulators’ ability to identify individual instruments is a unique identification code, known as the International Securities Identification Number (Isin).

Trading venues comprising regulated markets, multilateral trading facilities and organised trading facilities will have to disclose the reference data – including Isins – of every financial instrument they admit to trade on their venue in transaction reports, which must be sent to local regulators at the end of each trading day.

The registration authority, the Association of National Numbering Agencies Derivatives Service Bureau (Anna DSB), is responsible for generating Isins for OTC derivatives, and is the only entity capable of doing so. For trading venues to be able to request the creation of Isins for OTC derivatives, they must sign up with the bureau. The service has been open for business since October 2, but with just over a month until Mifid II enters into force, venues refuse to join.

Alex McDonald, chief executive of the Wholesale Markets Brokers’ Association (WMBA), a lobby group for interdealer brokers, says he is not aware of anyone who has signed up to the service so far. Three European trading venues told Risk.net they have not yet on-boarded with Anna DSB.

“It is a pretty terrible document,” says a source at one of the venues. “The problem is we are obviously running out of time for the start of Mifid II. My understanding is not a single venue so far has signed up to Anna DSB for Isins. Eventually we will be forced to sign up to it, but reluctantly.”

McDonald and the three venue sources all say the commercial terms in the contract are “unacceptable”, because they include open-ended charges that make the overall cost of the service unknown.

There have been challenges generally around the fee model and not having a 100% level of certainty on the fees until the beginning of next year

Emma Kalliomaki, Anna DSB

A managing director at Anna DSB based in Sweden, Emma Kalliomaki, acknowledges there have been challenges. But she says firms have not signed up to the service because they are not yet prepared at a technical level.

“The pattern has been that the execution of the agreement and transition to [Isin] production has really been based on the level of readiness of firms to move in that direction,” says Kalliomaki. “The testing environment has been operational since April, and that doesn’t require any contract in place or fees. Therefore, the firms who have that connectivity and are ready to do that transition are the ones that have been more likely and [swifter] to move into the production environment.”

She continues: “There have been challenges generally around the fee model and not having a 100% level of certainty on the fees until the beginning of next year; it creates some challenges with regards to firms signing off internally. I think those same challenges have occurred across the board, but some have been able to act more swiftly for those matters.”

No choice

The venues, however, have no choice but to join. Anna DSB is the only source for them to request the creation of Isins. If they do not join the service, they will essentially be unable to comply with the reference data reporting requirements in Mifid II and consequently receive fines from their local regulators.

“It is the most bizarre terms of service. It is a cash cow. They are going to be making a lot of money from Mifid II and there is nothing we can do about it,” says the source at a second European trading venue.

A third source likened the situation to having a gun levelled at their heads and being told to sign the contract.

All three venues that spoke to Risk.net stated they will eventually have to sign the contract with Anna DSB before the start of Mifid II. Two of those confirmed they had set themselves an internal date for signing the contract, with one source stating they will sign at the end of November.

If there is one entity with 10 trading venues, then they would have to pay 10 fees. There is no discount, because it would mean those with fewer venues as well as other users will then have to pay higher fees

Emma Kalliomaki, Anna DSB

Anna DSB announced in a press release on November 9 it had 29 users signed up to the service. Since then, the authority’s Kalliomaki says more users have registered but did not give a precise number. According to an article published by Waters Technology on November 16, a representative of Anna DSB stated they had 30 registered users.

The press release, however, states the 29 firms represent “the majority of top-tier US and European swap dealers as well as some buy-side and trading venues”.

Anna DSB will charge fees to three of its four categories of users: power, standard and infrequent. These users will be able to create new Isins and conduct real-time searches for issued Isins in the database. The fourth user category, referred to as registered, will not be charged to use Anna DSB but will only receive an archive of Isins at the end of each day and be able to do manual real-time checks.

Kalliomaki confirmed the 29 users signed up to the service are power users.

The power user category is an attractive option for investment firms because, despite not necessarily needing to create Isins, the category allows them to integrate their own systems and processes with the Anna DSB’s Isin engine.

This will then allow them to attach Isins onto post-trade reports or send the information to counterparties to help them complete reporting requirements.

“Venues are trying to get answers on certain issues, such as the arbitrary limit on how many Isins the Anna DSB would permit to be created at 50,000 per week, an artificial cap apparently created to generate a private income stream

Alex McDonald, WMBA

The initial user fee for the 2017–18 period is estimated at €82,500 and the annual fee is estimated at €65,000, says Kalliomaki.

At first glance, €82,500 seems small. However, there are parts of the contract under which fees can quickly escalate, with the second venue source estimating they could pay just short of £1 million a year.

If that estimate is correct, that venue alone could be paying an eighth of the operational costs of running Anna DSB, which estimates the costs of running the service at €8.8 million a year. That includes the amortisation of start-up costs over a four-year period.

The first variable component of the charge is applied per trading venue needing to connect to Anna DSB. This means if a market operator has multiple MTFs and OTFs to sign up to Anna DSB, they will have to pay €82,500 for each of their venues. For large market operators, the costs could sharply increase the more venues they run.

“If there is one entity with 10 trading venues, then they would have to pay 10 fees. There is no discount, because it would mean those with fewer venues as well as other users will then have to pay higher fees,” says Kalliomaki.

In Kalliomaki’s example, if a market operator were to run 10 venues, the initial cost for them would be €825,000 to receive Isins.

This charge is also applied if the market operator wishes to register any reporting facilities they have. Some trading venues will also run approved publication arrangements or approved reporting mechanisms.

Investment banks are allowed to register with Anna DSB at their group level, but if they have separate businesses such as asset management, custodial arms or private wealth managers, they would all have to sign separate agreements.

The cap doesn’t fit

Costs will rise if a venue breaches a 50,000 cap on the number of Isins it needs Anna DSB to generate per week and a 100,000 cap on the number of search requests. After the cap is breached, Anna DSB then applies a series of tiered charges increasing with every 10,000 Isins issued to users every week.

“Venues are trying to get answers on certain issues, such as the arbitrary limit on how many Isins the Anna DSB would permit to be created at 50,000 per week, an artificial cap apparently created to generate a private income stream,” says McDonald of the WMBA.

The caps ensure there is no mismatch between fees and usage and all users are paying the same flat fee irrespective of the number of Isins they need to generate

Emma Kalliomaki, Anna DSB

At first glance, again, the 50,000 limit seems reasonable as it offers a large amount of Isins for a venue to create and seemingly provides plenty of headroom for venues to create Isins before breaching the limit.

But venues say they will need more than the limit offers almost every week because the code uses the maturity of an instrument as a field to distinguish between different financial instruments. This will mean derivatives that rely on tenors to determine the end date of a contract, such as interest rate swaps, will have to be reissued with Isins every day because the maturity will change from one day to the next.

This could result in venues requesting tens of thousands of Isins each day alone, says the source at the second trading venue.

“The caps ensure there is no mismatch between fees and usage and all users are paying the same flat fee irrespective of the number of Isins they need to generate,” says Kalliomaki of Anna DSB. “This ensures we have a fair policy across users, which means there cannot be a disproportionate use of DSB’s resources across one user versus another. Actually, for the majority of users this has not been an issue. The number of users who have signed up indicate the thresholds are considered acceptable.”

However, if the 29 users are mostly investment banks, the cap for requesting Isins to be created should not affect them. Under Mifid II, investment firms are obliged to send to local regulators transaction reports at the end of each trading day and publicly disclose instruments they trade before and after they transact those – depending on if the trade is below size thresholds and the instrument has a liquid market.

However, investment firms only have to fulfil those obligations if the instrument is traded or admitted to trade on a venue – in which case, the venue will already have created an Isin the investment firm has to report. This means dealers should only be affected by the higher cap to search for Isins, and not the cap on creating Isins. Venues will be affected by both caps.

The costs are unknown, so you are having to sign up to something you don’t know how much you will have to pay for

Source at one trading venue

The result of these provisions in the contract means trading venues have no fixed idea as to how much the overall cost of the Isin service will be.

“The costs are unknown, so you are having to sign up to something you don’t know how much you will have to pay for,” says the source at the first trading venue.

Anna DSB responds by saying it is difficult to calculate exact fees as they don’t have a complete picture of how many users there will be. They estimate between 100 and 200 to register as power users and Kalliomaki of Anna DSB is confident they will reach those estimates.

“As an industry utility trying to ensure there is a fair distribution across all firms, it is a challenge; I think it is definitely difficult to do when you don’t have the basis of knowledge of how many users you are going to have,” says Kalliomaki.

Game theory

Anna DSB will work on a cost-recovery model, which means the fees paid by users will be used to cover the costs incurred by running the service.

Anna DSB has been set up as a not-for-profit utility by Anna specifically to create Isins for OTC derivatives. The governance of Anna DSB is dictated by requirements set by the International Organization for Standardization (ISO) on the operations of numbering agencies, which includes pricing of services on a cost-recovery basis. Anna is contracted by ISO to serve as the Isin registration authority and ISO is responsible for oversight of Anna DSB.

A group of four investors – Euroclear, Herausgebergemeinschaft Wertpapier-Mitteilungen Keppler, S&P Global and Six Financial Information – also sit on the board of Anna DSB.

These investors provided the funding to develop Anna DSB. According to a final fee model report published on June 28 by Anna DSB, the funding will be repaid over a period of four years at €1.4m each year. On top of that, Anna DSB will pay the investors €320,000 each year in interest payments for four years.

Power users are supposed to contribute to a larger share of the cost. If more users sign up to the service, the costs will be revised and the fee per user will decrease; any surplus will be used to reduce fees in subsequent years. But if fewer users sign up to Anna DSB, they could increase the fees for 2018.

The third source says this also makes them uneasy, as the contract stipulates Anna DSB can unilaterally alter the fees in the middle of the contract.

The second venue source believes the fee structure discourages venues from signing the contract early, because if they wait until after their competitors join the service, it may mean they will be able to negotiate for the revised fees.

We have this first-mover disadvantage because if there are more trading venues that connect to Anna DSB then the price dramatically decreases

Second venue source

The fee model report also provides an example of the change in fees depending on whether they have 100 to 200 power users on board. If there are 100 power users they will charge €65,000 and if the number of users increases to 200 then the initial charge decreases to €38,000.

“We have this first-mover disadvantage because if there are more trading venues that connect to Anna DSB then the price dramatically decreases. You end up in a situation where you are thinking to yourself: ‘do I wait until they have more users to avoid the more expensive version; or do I apply now to get to 100 users and pay out up front?’ If you pay out up front then your competitor will join later on and never have to subsume the extra cost for being the first mover,” says the second venue source.

Kalliomaki of Anna DSB disputes this, as they will use January 5, 2018 as a cut-off date before revising fees for 2018 on January 15. This means they will not revise fees before January 5.

“If they don’t sign before January, then those numbers aren’t included in the fee determination, so the fee would be higher than if they were to join before the January 5; the more users we have then the lower the fees are. So by not joining before January 5, everybody is being disadvantaged because those numbers don’t get counted in the fee determination using the actual numbers,” says Kalliomaki.

But most venues are still negotiating the contract and consider it a stand-off. If they wait until the last moment, Anna DSB may be tempted to revise the fees so as to ensure it reaches the target of 100 power users.

The second venue source also questions whether the contract being offered to them matches the rationale of a cost-recovery model. Venues face the extra costs for using the service more frequently, and yet they have in theory already paid for the cost of building the infrastructure in the initial fee.

“The plumbing and wiring has already been done. A cost-recovery model does surely not mean the more the wiring is used the more expensive it is to run. It doesn’t seem to make sense. There is something not right,” says the second venue source.