RegTech Intelligence 
JWG analysis.
Continuing our Legal Entity Identifier (LEI) series, from when the universal identification of financial entities was a mere idea on the horizon to its steady increase in prominence and complexity, we now mark a new date in the KYC calendar with the arrival of the consultation paper for level 2 relationship data for LEIs, published by LEIROC on 7 September.
Up for discussion are a number of key themes: agreeing on universal definitions of parents (without which the Global Legal Identifier System (GLEIS) would be redundant) and the sources for data collection, data organisation and business models for GLEIS.
But first, back to square one.
What is an LEI?
Following the crisis, the need for much closer monitoring of the financial industry and its participants became swiftly apparent to regulators. The answer to this? A 20-digit universal code for all legal entities involved in financial transactions as a form of top-level identification. The dream was a system where these codes, known as LEIs, provided sufficient data quality and coverage to map the relationships between businesses, owners and their operations across the entire industry, and would be capable of pre-empting the next financial crisis.
And, thus, arose a G20 mandate to bring in a formal LEI system in November 2011 – a system which is now near 400,000 strong in number, with all 30 of the Global Systemically Important Banks registered as LEIs. This is positive and negative – there is still a long way to go before every entity is registered.
Under this system, known as the Global Legal Entity Identifier System (GLEIS), entities must report to their Local Operating Unit (LOU) to register as an LEI, who charge a one-off fee and an annual maintenance fee in exchange for the safekeeping of their records. While there is already a number of existing identification systems in place for market participants, these are based on the ‘good-enough data’ mantra, characterised by its inconsistency and incompleteness. The introduction of an all-encompassing code is hoped, not only to provide the necessary transparency to the financial system, but also to offer substantial efficiency gains by removing duplication of processes and improving the reliability of customer onboarding processes on the KYC frontline.
So far, the focus has been on the collection of level 1 ‘business card’ data – consisting of basic information, such as name and address, where entities wishing to register as LEIs must report this information themselves to the relevant LOUs. This process has been relatively smooth so far with clear benefits. The LEI is becoming a consistent global standard for identification, reducing disparities between previous forms of identification and providing intellectual property free information for all.
It is not without its issues though. Many of these – such as differences in language and inclusion of special characters creating standardisation errors on systems – provide quite large barriers to creating a harmonised framework. An Alacra whitepaper from June highlights the issues of an expanding system without the coordination and infrastructure to remain maintained – 20% of LEIs have now lapsed and still there is not enough regulatory pressure to get the really necessary entities to register. In addition, the previous requirements to have an LEI were focused only on entities conducting specific transactions or on specific regulated institutions (e.g., banks), therefore the need to expand under level 2 to include corporate families elucidates the incompleteness of the current database.
The Global Legal Entity Identifier Foundation (GLEIF) and the Regulatory Oversight Committee (ROC), both set up in order to oversee the creation of the global LEI system, are forced to press on. Time is of the essence, and the cracks in the current system must unfortunately be held together while the initiative continues to its next stage. A few days ago, the ROC published a consultation document focusing on level 2 relationship data for the system, with some complex items up for discussion.
LEIs: Lengthy extensive issues?
Level 2 data is a much more contentious topic. It consists of the relationships between entities involved in financial transactions, tracing their histories and the complex connections between them, aiming to unravel and monitor the structures below that were hitherto concealed. The histories of these relationships are important to track as they can help regulators explore how risks can emerge and grow through these connections.
Having outlined the potential uses of relationship information, from the obvious risk aggregation benefits to the learning potential for academics and statistical uses for authorities, the ROC is quick to get onto the fundamentals.
Definitions, data and differences
The first preliminary decision is to adopt the International Financial Reporting Standard (IFRS) for level 2 data reporting. This outcome stems from the widely agreed, publicly available and, initially global, coverage of this accounting standard.
Despite the widespread uptake of IFRS, there are still disparities across jurisdictions, making the definition of parent organisations (for reporting LEIs) an important topic. LEIROC suggests that defining a parent as an entity that exercises control over another entity (through share ownership, voting rights or more specific reasons) is the most encompassing definition, and has the added advantage of being already adopted by the IFRS.
As is the nature of attempting to standardise a disparate industry with a single code, there will always be differences which get in the way. For reasons of cost efficiency and simplicity, LEIROC hit the ‘play it safe’ button – which we’ll be seeing lots of – by deciding that those that report should be the direct consolidating parents and the ultimate consolidating parents. This means that, in both cases, the legal entity that prepares consolidated statements for the specified financial entity should be the entity to report the relationship data to their LOU.
With regards to data collection and organisation, we see the cautiousness continue. LOUs are to validate the data, as they did with level 1, and the business model for data collection is to be closely adhered to, in order to avoid heavy costs. The safe option of using consolidated financial statements as the main source of data collection was also a suggestion.
While a pattern is clearly emerging, the ROC states their awareness of the different system that will be necessary for level 2 data collection. What seems to be overriding this at the moment is a move towards keeping the engine running and collecting the data as soon as possible using mainly pre-existing methods and while maintaining cost-effectiveness.
Questions still remain: How can we best map relationships between entities if only one of them has an LEI? How do we organise the data in a cost-effective, but comprehensive, fashion? Can we include more reasons that permit an entity not to report?
The answers aren’t entirely there yet but the weight of time is constantly pushing for collection to begin.
What can we draw from this?
LEIROC’s consultation document is a call out for discussion, but the main message is this: we’re playing it safe! For most initial suggestions the safer options have been adopted – using internationally recognised accounting standards (IFRS), a common data format for data storage, requiring parents to collect the information and sticking to the current level 1 business model for level 2 collection – all give the essence of the same approach.
But playing it safe doesn’t always mean a safe result. If a repeat of the level 1 data collection disparities occurs, it will be another example of rushing into phased collection without the adequate preparation or structures in place. While the continual strive for optimisation between quality and cost ravages on, perhaps the industry in general needs to think a little more ambitiously about the compatibility of these plans with a financial system characterised by difference.
Thoughts? Attached at the end of the consultation document is a questionnaire to be returned by close of business on 19 October 2015.
We’ll keep visiting the frontline of the debate, monitoring and discussing new developments, so keep track here and remember that questionnaire deadline. The aim is still to begin phase 1 of the level 2 data collection by the end of 2015, so the clock is indeed ticking.