Complexities Expand in Market Data Licensing
By Oksana Soutus, Data Licensing Analyst, Jordan & Jordan
In the last few years, significant changes have been made to how the financial industry consumes and manages market data. Substantial improvements in technology have enabled financial firms to process data with greater complexity and efficiency, thus allowing firms to take on new roles in the industry, produce new types of products, and create new technologies that increase the value of their products and the market data they utilize. In turn, exchanges have kept abreast of the increased demand and evolution of market data consumption and have adjusted their commercial and licensing models which govern their market data products. Implementation of increasingly specific and granular policies has slowly become the industry standard, resulting in elaborate commercial and licensing models that are unique from exchange to exchange. As a result, it is more crucial than ever to note changes and trends in the industry in order to prevent exposure to increased audit liability.
As an example, over the last decade exchanges have worked to establish and modify Non-Display policies to appropriately reflect how financial firms utilize market data in Non-Display applications. These changes have resulted in complex new policies, additional licensing requirements, and increased fees. Now similarly, exchanges have begun to shift their focus towards establishing and expanding their understanding of “Derived Data” creation in order to better protect their interests and to ensure that their policies better reflect how financial firms manipulate market data to meet various business requirements. As there are no industry standards on how exchanges create and organize their polices and since every exchange has their own nuances as to how they conduct their business, firms have increasingly become frustrated at the difficulty associated with understanding the requirements and the restrictions of Derived Data creation.
Derived Data, also referred to as “Original Created Works” or “New Original Works,” is generally defined as new works that are created from proprietary data that cannot either be readily reverse-engineered or used to create new data that is substantially similar to the proprietary data. Some definitions include additional restrictions and specifications, such as not displaying or incorporating raw proprietary data. Exchanges also often reserve the sole right to determine which products fall within the meaning of Derived Data creation. Ultimately, this broad definition of Derived Data was enacted to address concerns associated with allowing unfettered modifications to market data and the creation of new products which may be used internally or by third parties. One issue is balancing the interest of exchanges in protecting their intellectual property rights in their market data with the conflicting interest of financial firms in manipulating data to create their own analytical figures and products in an industry that is continually becoming more competitive. Exchanges must protect their proprietary data from being used to create a product that would serve as a substitute for their proprietary data, which would diminish the market value of the data. Another issue for exchanges, which results from the industry’s competitive nature, is charging fees that reflect the demand for their data. As the use of market data is no longer considered an afterthought, more resources are needed to manage the distribution and monitorization of data. Exchanges are cautious about ensuring that the commercial value of their data is fully captured. While exchanges could enact a blanket ban on any Derived Data creation to protect their interests, most exchanges understand the needs of the industry and instead put certain protections into place. These protections include limiting Derived Data to Non-Display data only, requiring separate Derived Data licenses, charging additional fees, and restricting who may receive the Derived Data created.
Non-Display Usage Licenses Including Derived Data Creation
Non-Display usage policies were first introduced by most exchanges after the first MiFID was implemented in 2007. The standard categories of Non-Display usage in these policies typically included Automated Trading, Index Calculation, and Derived Data Creation/New Original Works. Where exchanges included Derived Data creation under their Non-Display policy, the creation of new products was typically limited to Non-Display applications and prohibited in display applications. For many exchanges, this is still how their Non-Display policies are set up and how they address Derived Data creation. Other exchanges, while still considering Derived Data creation as a category of Non-Display usage, have begun to implement changes, include distinguishing between internal distribution (where the Derived Data creation is not fee liable) and external distribution (where the Derived Data creation is fee liable) and requiring an additional licenses for Derived Data creation.
General Derived Data Policy
As an alternative to categorizing Derived Data creation under Non-Display policies, many exchanges created separate Derived Data polices. While these policies utilized the same definition of Derived Data under Non-Display policies, they typically allowed for greater Derived Data creation since they allowed unlimited product creation from both Non-Display applications as well as display applications in addition to listing clearer fees. Most of these policies also provide additional clarification on which types of products the exchange considers Derived Data by including a non-exclusive list of Derived Data examples such as:
- risk management
- profit/loss calculation
- portfolio valuation
- quantitative analyses
- fund administration
- net asset value calculation
- portfolio management
- indicative pricing
Although these policies contain specific examples of Derived Data, they also provide greater leeway for exchanges to determine which products fall under the definition of Derived Data and whether any additional fees can be charged for created products by exclusively reserving the right to determine whether something is considered Derived Data. Not surprisingly, this causes uncertainty for firms and opens the door to unexpected fees and penalties.
Recently, some of the larger exchanges have implemented policies that go one step farther than the standard separate Derived Data polices that allow for the creation of all types of Derived Data. Instead, these exchanges have policies with multiple categories of Derived Data creation that provide greater clarity as to which types of financial products fall under their policies, but which ultimately are separately fee liable. One such policy consists of the following six separate categories of Derived Data creation while may others have similarly defined categories.
- Indices, Benchmarks, and Underlying Strategic Product Creation: Category for the right to process, develop, create, or otherwise calculate an index and/or the Underlying Strategic Financial Product linked to the index. Some exchanges distinguish between internal index creation and creation for an external third party by creating two separate categories with different fee structures where some exchanges consider internal creation of indices as being fee liable while others do not.
- Exchange-Traded Products: Category for the right to use data in the calculation of indicative optimized portfolio values, net asset values, or similar products. Typically, this category would fall under the previous one, but may be required to be separately licensed where the product is not linked to an underlying index, or if the index is not owned by the financial firm creating the Derived Data.
- Certificates and Warrants: Category for the right to process, create, or otherwise settle certificates, warrants, and other similar structured financial products
- Spot, indicative, or amalgamated price and value: Category for the right to process, create, or otherwise calculate prices or values.
- Contracts for Difference (CFD): Category for the right to process, create, or calculate prices or values for CFD’s, spread bets, binary options, and other products that offer similar leveraged exposure.
- Other: Category for the right to create any financial product not expressly listed under the other categories. This is a catch-all category for all the products that fall under the broad definition of Derived Data and for any new types of Derived Data products that may be created in the future.
While currently, only a small number of exchanges include a detailed list of products that are considered Derived Data, it is likely that over the next few years, more exchanges will follow suit, implement new changes, and revamp their Derived Data policies.
Financial firms not only have to understand the changes in exchange policies but also the corresponding changes in exchange fee structures. With every policy change, exchanges have implemented more granular user or instrument-based fees which have resulted in complex pricing models. Some exchanges have implemented separate Derived Data licenses with their own fee schedules, which adds to the complexity as firms have to review multiple contractual and policy documents to understand which market data products they need, which licenses are required for their use cases, and how much it all costs.
A present challenge for financial firms is exchange policies that use a user-based or instrument-based unit of count for Derived Data. Most entitlement systems used by firms are not set up to report such granular usage, as exchanges typically only charged flat fees on a per application or enterprise basis. In cases where firms are unable to precisely track which data is used for which specific Derived Data product, firms are charged for every possible use or creation of Derived Data and not based on their actual use.
Ultimately, the changes to Derived Data policies being implemented by exchanges is in response to today’s environment where financial firms can consume and create more derivative works from market data. With the global spend on financial market data in 2018 surpassing $30 billion for the first time, exchanges are trying to balance their interest in generating revenues and protecting their intellectual property rights with financial firms’ interest in growing and providing the best possible products to their clients.
Oksana Soutus is a Data Licensing Analyst in Jordan & Jordan’s Market Data Services practice. Oksana assists clients by comprehensively reviewing client data usage to identify licensing gaps and remediate reporting rules. Oksana received her Juris Doctor from Fordham University School of Law in 2019, where she concentrated in Business and Financial Law as well as Litigation and Dispute Resolution.
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