The merger of IHS and S&P Global will create (another) powerhouse in financial services data. But perhaps one of the most interesting aspects of the deal is that the European Commission (EC) required that S&P divest CUSIP Global Service (CGS) – which since 1968 has managed the assignment of the CUSIP security identifiers on behalf of the American Bankers Association (ABA). After a relatively short process – Factset (FDS) emerged as the buyer of CGS, for a whopping $1.925bn – signaling perhaps the perpetuation of a business model that reaps outsize profits due to the monopoly position granted to the original business over 50 years ago.
The amount paid is the most Factset has ever committed to a single acquisition – although at face value the deal has clear rationale:
- Revenue Synergies: CGS has a large client list, and there are likely significant cross sell and upsell opportunities.
- Whoever controls this service reaps many other indirect ecosystem benefits - FactSet CEO Phil Snow said: “CGS is a unique asset with tremendous market recognition providing deep alliances across the financial industry.”
- Other Accounting Synergies: Apparently a reported $200m tax benefit.
- Accretive to earnings: FDS is trading at over 40x trailing earnings – helped by recent strong performance in the stock. The detailed financials aren’t available for CGS – but revenues were disclosed at $175m pa. This compares to FDS of $1.6b (trailing 12m to Nov 2021) or about 9x revenues and 30x EV/EBITDA. The CGS was priced at 11x revenues, but most likely closer to 20x EV/EBITDA even after assuming a hefty annual payout to the American Bankers Association (ABA) which controls the CUSIP (see below).
Source: IEX Cloud, New Constructs, Blue-Sky Thinking. Trailing 12m
Many find it ironic that the release states: "As part of FactSet, CGS will continue to carefully steward the CUSIP system in close partnership with the American Bankers Association (ABA) to ensure both a seamless transition and continued innovation. As a result, CGS will continue to reliably serve the global securities market as it evolves and grows".
Others feel that the stewardship of the CUSIP has been non-existent, and that the current business model is to the detriment of innovation and competition across financial markets. Factset is a fine company - and has a stance around "Open". But at the end of the day, it competes with smaller Fintechs - firms that have traditionally been targeted and taxed by the CUSIP Global Service.
The reality is that the drive for growth and return to shareholders (and the ABA) has resulted in a significant tax on the whole financial services industry – and it’s a tax NOT represented by the relatively paltry $175m in annual revenues – but the cost to the industry of managing with and around the strict licensing regime that CGS has imposed on the industry to protect and grow the business.
The opportunity cost to the industry is probably measured in the billions – through an implied tax on innovation – as many fintech’s can’t afford to handle the CUSIP. If they do – they risk the “knock on the door” followed by an audit and back dated fee which in some cases gets into the millions of $s!
Background: CUSIP and the Paperwork Crisis
According to Wikipedia: “The acronym CUSIP typically refers to both the Committee on Uniform Security Identification Procedures and the 9-character alphanumeric security identifiers that they distribute for all North American securities for the purposes of facilitating clearing and settlement of trades.”
Source: CGS Newsletter October 2021
The CUSIP was essentially founded in response to the ““Paperwork Crisis in the Securities Industry” – a crisis that arose from the monster bull-market of the late 1960s. In 1968 markets had to close Wednesday’s to clear the backlog of trades – which in those days averaged 10-15m shares a day (vs 6bn these days!). The creation of a new security identifier was to be part of the solution – and so the Banking and Securities Industry Committee (BASIC) was formed with the mandate to devise a unique identifier that had the following attributes:
- a universal numbering system, one that would give a unique number to every class of security still in circulation, and to every new security going forward;
- the CUSIP number would be imprinted on all new stock certificates;
- the “uniform” part of CUSIP - was to assure that the numbers would be imprinted in basically the same area of the stock and bond certificates, and in bold enough type, so clerks could find them readily; and
- the CUSIP numbers ought to be “machine readable” (even though machines were few and far between at the time).
The CUSIP distribution system is owned by the American Bankers Association and is operated by Standard & Poor's. The CUSIP Service Bureau acts as the National Numbering Association (NNA) for North America, and the CUSIP serves as the National Securities Identification Number for products issued from both the United States and Canada”. US ISINs are extended versions of 9-character CUSIP numbers and are formed by adding a two-digit country code at the beginning of the CUSIP number and appending a check digit at its end. However, the CUSIP is a standout across other NNAs (contributors to the ISIN superset) in the ways and methods it collects revenues!
And so for more than 50 years CUSIPs have enabled the smooth settlement and trading of a wide range of securities – its original stated purpose. But overtime, as markets have become more sophisticated, and downstream use cases have proliferated, the use cases and value of the CUSIP has grown significantly. And so CGS evolved and adapted to take advantage of these new and previously unanticipated needs that went way beyond the original remit granted to the ABA and S&P.
Prior Regulatory Action Has Been Limited
Despite the importance of the CUSIP identifier, and some of CGS’s questionable licensing practices, todate CGS has attracted relatively little attention. Back in 2011 an antitrust review by the EC charged S&P CapIQ with abusing its position as the sole provider of US ISINs (CUSIPs). Under the settlement S&P agreed to provide a low cost “low value” (unusable?) feed as part of the settlement. Unfortunately that investigation focused on pricing, frustrating various industry bodies that other tactics and strategies aimed at protecting the broader revenue stream were not considered. A customer quote from a recent Waters Technology article about the divesture says it all: “What a deal. You charge somebody to issue a CUSIP and then when they use it, you say they have to pay a licensing fee. … Those who license CUSIP and pay for CUSIP hate them. It’s a red-hot hate”.
Another source of frustration is that the data is already in the public domain. There is a large school of thought that the CUSIP and any related public reference data is not subject to copyright at all. Word has it that on at least two occasions this has been tested, and that S&P backed down - perhaps fearing a declarative judgement that would once and for all determine that the data is not subject to copyright. Also, the landmark settlement in April 2021 of the Oracle America vs Google copyright infringement case potentially creates some precedent for the identifier space. The supreme court basically ruled that even though Google developers did use copyrighted Oracle code, that it fell under the “fair use”. The opinion stated that “Google’s copying of the Java SE API, which included only those lines of code that were needed to allow programmers to put their accrued talents to work in a new and transformative program, was a fair use of that material as a matter of law.” If you want to know more about Fair Use – the US Copyright office has some great materials. Perhaps this will help a brave firm to step forwards and challenge CGS in court, and to get that declarative judgement the industry needs to move forwards.
So what should happen next?
The original EC ruling requiring disposal of CGS related to overlapping assets at both companies - implying the deal would reduce competition. On the face of it, the sale of CGS to Factset ticks that box. BUT IT DOESN’T. The very nature of this sale in no way changes the competitive dynamic in the market. As mentioned above, the EC has shown an interest in CGS – but primarily relating to pricing of the CUSIP in Europe and when embedded in the ISIN superset. Hopefully the EC (and the US regulators – DoJ/SEC) will sit up and take notice and impose additional conditions for the sale of the business. There is some precedence from prior M&A approvals in the space: when Thomson and Reuters came together, TR was required to sell copies of their fundamental, estimates and research products to help the likes of Factset and S&P enter those markets! In the identifier space, they were also required to provide a cross referencing service to help clients migrate away from the Reuters Instrument Code (RIC) – though few firms took advantage of the service. So additional remedies could include:
- Allow alternative identifiers to be assigned and recorded as part of the registration process alongside the CUSIP. Issuers (their bankers) would also be required to provide the same reference data they provide to CGS. The SEC would need to approve this.
- A historic cross reference file to be provided by CGS to allow new providers to seamlessly interoperate between the identifiers for already issued securities.
Bloomberg would immediately participate with OpenFIGI, benefitting their large customer base. I would also expect LSEG/Refinitiv to contribute PermID to the file. Of course both these firms would continue to charge for basic reference data, but new providers would also emerge, built on new future proofed technologies and more affordable and reasonable charging regimes (think blockchain, smart contracts etc). These may be operated as standalone commercial entities, or potentially backed by trade organizations or consortia. The Global Legal Identifier Foundation (GLEIF) is an example of how this model has worked well in the past.
Alternatively – the SEC could take back control of this data set (it’s hardly complex!). The data already resides on Edgar, it just needs to be better organized and databased. API access would enable cross reference and access to basic terms and conditions. Now that would be a game changer!
