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Taxonomy, UPI and Standardized Products

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)

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Taxonomy, UPI and Standardized Products

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  1. Taxonomy, UPI and Standardized Products In Plain English

  2. 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.

  3. 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

  4. 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

  5. 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

  6. 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 Deriving Taxonomy & UPI FpMLTrade Extract/NormaliseProduct ProductInfoset DeriveAsset Class &Product Type Asset Class &Product Type Extract KeyCharacteristics UPI PackageResults Full Product Description

  7. 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

  8. 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

  9. Deriving Infosets Trade Infoset Trade ValueInfoset Product Infoset Normalize and Separate Values

  10. 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 TradeDetails Product Details Combine identifies Ticker Traded Contract identifies

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