Until the world has a definitive LEI, we are going to have to recognise that piecemeal adoption brings with it significant hidden costs in validating, enriching and mapping for regulatory purposes.
LEI watchers have been encouraged to see Saudi Arabia and Italy joining the fold in the past month. They might be just in time, as OTC reporting requirements are kicking in and we have a long way to go to be able to have a reliable identifier to spot systemic risks.
According to the font of all knowledge, Openleis, as we open the reporting floodgates for Europe we still have some way to go. WM Daten have issued over 34,000 LEIs, whilst the LSE have issued a mere 11,000. The French INSEE are just shy of the UK count, whilst the Dutch Chamber of Commerce drop in at slightly under 3,000.
Clearly, if the total number of registered market participants is meant to include all the corporates that trade FX forwards, we are far short. Some would suggest we are short by millions. All the usual caveats about last minute rushes and rumours about queues around the block for registrations aside, something is seriously wrong with this picture.
One could blame the regulators. Have they really made it impossible to survive WITHOUT an LEI? No. Have they clarified to all concerned that ignorance and inaction are not to be tolerated? No. Are there still other things that could be stuck into reporting fields instead? Yes.
However, the regulators don’t bear all the blame on this one. Recent academic research shows that there is up to $10 billion in cost savings to be gained from the LEI. We have been testing the assumptions behind this and are officially raising an eyebrow.
Take the conclusion of the EBA, in its recent decision to ignore industry concern and push ahead with LEI adoption deadlines of 31 March for some and 31 December 2014 for all institutions under their supervisory remit:
“Even after considering the costs arising from the indirect factors above, the overall additional cost (direct and indirect) from the implementation of LEIs would still lead to negligible cost in relation to the overall operational cost.”
Like many statements about the ‘obvious’ value of the LEI, this is fuzzy thinking. While it is true that there will be some operational efficiencies within large firms, it is not clear that the addition of another ‘mapping column’ will achieve benefits that outweigh the costs of its implementation and ongoing maintenance.
The costs of validation, enrichment and quality assurance should not be underestimated. Ensuring data quality is a labour-intensive task that requires skilled people who understand the issues within firms’ systems to reconcile the differences in reporting techniques. For example, KYC systems will need to be modified to require LEI capture, new workflow will need to be introduced to account for expired LEIs and extensive data quality programmes will need to be implemented. Figure 1, outlines the wide scope of costs associated with the LEI implementation.
Figure 1: LEI implementation cost drivers
|Data quality management||
The average price across pre-LOUs for registering an entity for an LEI is approximately €133, plus the additional costs associated with its maintenance. But, this is merely the tip of the iceberg.
The number of entities required to register for risk reporting is a considerable increase over the number required for EMIR, i.e., trading entities. Some estimates place this increase in the region of 900%, i.e., a firm that is required to register 500 LEIs for EMIR would need to register 5,000 for risk reporting. And a firm registering and maintaining 5,000 entities for 5 years will spend €2.16 million doing so. Whilst negligible in terms of total operating cost, it is a massive uplift in the current spend on reference data.
Yet this external fee pales in significance to the internal costs. For example, considerable effort is required for the internal procedures described in the second cost category. Some estimates have placed the work required for this, in the short term, at approximately one full time equivalent (FTE) day per LEI registration. From this we can estimate the one year cost of implementing 5,000 entities to be an additional €5.7 million. Over the next 4 years, whilst less time is consumed in maintenance, an additional €2.9 million will be spent making a total of €8.6 million. From this analysis, we can see that the external registration cost is a mere 20% of the internal cost.
The costs of the internal systems changes identified in Figure 1 are substantial. Scores of source systems, data warehouses, risk analytics systems, management information and reference data management systems will need to be updated. As mentioned above, these risk systems will need to be kept in synch with other systems that are using the LEI as well (e.g., trading, AML). For a large firm, this could cost millions.
Without an accurate cost/benefit analysis to benchmark against, it’s likely that firms will continue to treat the LEI as ‘yet another’ regulatory requirement rather than push for enterprise adoption. The challenge in defining a business case is the need for caretakers of that code to engage with multiple stakeholders to determine its value. Each business process that consumes the LEI will derive some efficiency or effectiveness gains from it (e.g., fewer trade breaks, fewer people, lower pay grades, better service levels, etc.). There is real work required to model and quantify where the benefits outweigh the costs (i.e., licences, hardware, physical space and, most importantly, labour).
Obviously, there is a benefit to the adoption of the LEI that could well make a positive business case for it, but this advantage needs to be visibly identified and off-set against the costs of its implementation. And, clearly, we need real, meaningful and thought-through plans to make this happen.
 5,000 entities multiplied by the average cost of registration and maintenance for 5 years is €433: €133 for the first year and 4 years of maintenance totalling €300
 Cost of a blended day required for 1-time registration, maintenance and senior management involvement multiplied by 5,000 entities, plus 0.5 days in subsequent 4 years