Anyone involved with the trade repository reporting for OTC derivatives will be aware of the LEI or “legal entity identifier”. Others may have heard about it, but as yet it is unlikely to be impinging on day-to-day responsibilities. Still it is worth paying some attention to the LEI, because it has the potential to deliver fundamental changes in financial market operations.
With my co-author Ka Kei Chan of Derby University, and support from the Alfred P. Sloan Foundation of New York, I have been investigating the potential impact of the LEI, drawing on a series of interviews with data management professionals in some of the major firms. Let me outline the basic information about the LEI that I think all financial market professionals should know (and of course, I would be delighted for anyone who has time to read our paper ‘The Global Legal Entity Identifier System: Will it deliver?’ in order to learn more)
The LEI is a live issue in derivative trade reporting because Dodd-Frank and EMIR require counterparties to be identified at legal entity level using a standard “LEI compliant” identifier. The most widely known of these is the CICI (or CFTC interim compliant identifier) jointly developed by DTCC and SWIFT and used for meeting the Dodd-Frank reporting requirements). It is not the only one. There are now six other different units issuing interim LEIs around the world, with more yet to come, and to date around 104,500 identifiers have been issued globally of which 88,800 are CICIs (information taken from www.p-lei.org a useful website monitoring LEI issuance)
Nothing too exciting there then: just another compliance hoop that firms have to jump through?
Well, yes, but from this first application, the global LEI could well develop to become a game changer for financial market operations. There are obvious and substantial efficiency gains to be had from using industry-wide standard identifiers, for counterparties, instruments, trades and other “elements” of financial operations. But the industry itself has never succeeded at overcoming co-ordination problems and establishing such standard identifiers. This regulator imposed solution could finally achieve this end.
A few further points to bear in mind about the global LEI:
- Preparation is taking some time, because the system must operate at a global level (under the auspices of a new Swiss-based body known as the ‘Global Legal Entity Identifier Foundation” and with regulatory oversight from the inspiringly named “Regulatory Oversight Committee” or ROC) but yet also be flexible enough to allow the process for issuing of LEIs – and validating associated reference data – to be tailored to the needs of individual markets and jurisdictions;
- When the global LEI system is properly launched, the CICI and all the other interim identifiers being used for Dodd-Frank and EMIR trade reporting will become part of the system. These LEIs will be unique and also portable, so an entity reporting trades in say both London and in New York will use the same LEI in both jurisdictions;
- Once established as a “passport” to entry in global financial markets, the LEI promises very substantial efficiency gains to firms, notably by removing duplication of processes and improving the reliability in customer on-boarding and associated Know Your Customer and Anti-Money Laundering processes. On the basis of our interviews, and other information, we have estimated that the full adoption of the LEI will offer the industry savings in the order of $10bn per annum.
- While regulators have not yet made further announcements, it is clear that the LEI will eventually be used in many other aspects of regulatory reporting, for example securities trading or corporate credit exposures such as interbank exposures, commercial mortgages and syndicated lending. A complete representation of counterparty and corporate creditor and debtor LEIs could well become a requirement in recovery and resolution plans. In short, the regulatory reporting case for embracing the LEI will only grow over time.
These benefits and applications, while substantial, are not the end of the story. We foresee at least the possibility of very much greater social benefit from LEI, over the next decade or so, as it becomes the accepted universal standard for counterparty identification in all business processes. Standardisation, ultimately, promotes transparency, interoperability and competition, and hence is good for customers. It will also help regulators better achieve their ultimate goal of ensuring systemic financial stability. But the immediate gains alone should be enough to ensure the widespread uptake of the LEI and that it becomes a basic tool in every aspect of financial processing.