SIFMA’s Tom Price translates the industry proposal for a global Legal Entity Identifier system and discusses its potential effects for businesses and regulators.
How will the proposed global LEI system limit counterparty and systemic risk?
The creation of a Legal Entity Identifier (LEI) is very foundational. With the LEI, firms can better react to counterparty risk and regulators can use the LEI for systemic risk analysis. Financial institutions will be able to efficiently aggregate all exposure to their counterparties in a timely and effective way. Having a holistic view of counterparty risks will be an incredibly important effect for institutions, specifically as it relates to risk management. Also, the creation of an LEI system will make it easier for data aggregation, modelling and analysis in risk management. Finally, the LEI system will also streamline regulatory reporting and analysis, giving firms the benefit of being able to report counterparty exposure efficiently in a single format to the regulators.
As it relates to operational benefits, financial institutions will be able to get an integrated view of entities across all their different business lines. The LEI system should also help with processing and settlement efficiencies, as well as new client on-boarding. In addition, it should lead to better corporate actions management and a greater understanding of the hierarchical relationships between their counterparties.
From a systemic risk perspective, it is my view that the regulators will now be able to aggregate information about market participants as it relates to products, markets and positions. They will also be able to aggregate and analyze that data in one central place to identify potential systemic risk in the marketplace, whether that is bubbles, crowded trades, over-concentration, potential liquidity issues or leverage issues. The LEI system will address the concerns of the Financial Stability Board, as it relates to our recent market dislocations.
What mechanisms are necessary to facilitate the coordinated global registration of financial legal entities?
The LEI system could either be run through a federated model or through a centralized model. Federated means that different regions have different models set up to create some sort of identification system for legal entities, or centralized, where you have one issuing agent or international standards body that works with a registration authority. The three necessary mechanisms are:
- A standards body.
- A registration authority that actual legal entities would register with to get the identifier, and someone to make sure the data is clear and up to date.
- Ensuring high data quality is a critical component of this process.
The success of the LEI system is incumbent upon the regulatory community embracing a mandate requiring legal entities to selfregister via a simple process. If I am a legal entity, I register once and I get an identity that I can use in perpetuity. The identity would not carry any intelligence, so a legal entity in Japan that moves to France keeps the same LEI number. The identity number is not bound by geographical region, product or any other attribute.
Will the LEI solution provider develop the solution from scratch or work from an existing standard?
If you go back to the Office of Financial Research (OFR)’s policy statement, there were certain prerequisites spelled out in that document, as well as the lynchpin group document. Some of those criteria for the LEI system were:
- It would have to be an internationally recognized standards body.
- It must be a not-forprofit or at-cost model.
- The entity running LEI should beexperienced and competent in the financial services industry.
We hope that through the Solicitation of Interest (SOI) process, potential solution providers suggest their own recommendations for how they would meet what has been put in the public domain by the regulators, as well as what the industry requires. If there is an existing standard that is functional, and can meet the criteria (as put out by the regulatory community and the industry), then that is fine. Alternatively, if there is something new that can be built from scratch to meet the requirements, then that is also fine – I do not want to prejudge. We are leaving it to the potential solution providers to present how they would do this, after which we will make an evaluation and a recommendation.
What do you say to someone who says that this will just add another layer of complexity to trading firms?
In the context of Dodd-Frank there are many new requirements, but if you take the LEI in isolation, not withstanding all the other issues, the global LEI system will actually create efficiencies for firms. An LEI will actually be a benefit to the industry because it will streamline the way firms do business by creating operational efficiencies out of risk management tools. We have enjoyed substantial industry support in this initiative because there are significant benefits. Not only do the regulators view it this way, but the industry does as well.
How can existing financial standards such as FIX and XBRL and the ISO20022 business model be utilized to assist in the development of the LEI solution?
I do not want to identify any particular current standard, but what we are hoping is that whatever is recommended to the industry and the regulatory community becomes a global standard, and that global standard is adopted and embraced by the world community and is not specific to any one jurisdiction. The framework that is ultimately developed should allow regions and jurisdictions to adopt it as they are ready. That is the main goal. If another standard is fitfor- purpose, I think that would be part of the evaluation process.
What is the timeline for establishing a centralized repository that is compliant with the majority of regional requirements?
There are a couple of components to this. First, the goal is to create a global framework that different jurisdictions can move onto as they receive regulatory mandates within their sovereign borders. For example, in the US, we have a mandate from the Treasury Department, as it relates to the creation of the LEI per Dodd- Frank and the creation of the OFR.There are similar initiatives from the Securities and Exchange Commission and the Commodity Futures Trading Commission as it relates to derivatives. While we certainly have the mandates in the US, other jurisdictions don’t as yet, but they are talking about it. This may slide, but I think that any global LEI framework provider that comes onto the marketplace should be prepared to be up and running in 12 months or so.
After the LEI system is implemented, will regulatory arbitrage be a thing of the past?
Regulatory arbitrage will always exist. As it relates to LEI, market participants are going to seek, by and large, the most liquid, effective efficient markets in the world and the US market is one of those. This is a joint industry initiative; it is not a SIFMA process and it is not a US process. The goal is to create a global legal entity identifier framework.
