The Global Impact Of LEIs
By Chris Pickles, Bloomberg Open Symbology Team
Identity Management is the most important subject for the financial community to address over the next ten years. So many different industry themes come back to the core topic of identifying the “who” and the “what” of financial services activity. This is critically important largely because financial institutions today are often unable to identify uniquely many of the elements of their business operations. Whether the headline is Cybersecurity or Blockchain or Regulatory Compliance, or simply Operational Efficiency, the topic of Identity Management is fundamental to any and all of the above being feasible.
When Lehman Brothers was in severe difficulties back in 2008 it was selling off high-risk trading positions in order to get itself out of increasing trouble. However, it wasn’t aware that the some of the counterparties to which it was selling off some of those high-risk positions were actually other divisions of Lehman Brothers. Ask a major bank if it has a single consolidated system for managing client and counterparty data, and the reality is that they may have hundreds or thousands of different internal systems for that purpose (two major global banks each said that they have over 4,000 systems for this). Identifying uniquely what they are trading is a further challenge, particularly as investment firms have each developed their own internal identification systems for many of the financial instruments that they have to deal with across all asset classes.
Making change happen in any industry sector is always a complex and lengthy process. Where change requires introducing standardisation across organisations, national borders and vested interests, the process can – and in the financial sector, too often does – take decades. However, one aspect of the financial services sector that today not only enables change but drives industry change is the fact that it is a regulated sector, and regulations have become an increasingly critical driver of industry change.
The global Legal Entity Identifier (LEI) standard and system was created in response to the demand by governments to have regulations that work and that can be policed effectively. This was not “demand” as in “customer demand” but an insistence by governments of major economies that a solution for uniquely identifying legal entities internationally should be generated immediately. Government representatives and regulators committed to including the requirement to use LEIs in future legislation and regulations, so financial institutions could ensure that they can amortise their investment in implementing LEIs across more and more of their business and compliance activities, ie LEIs would help to enable increased operational efficiency overall.
Some key principles of the global approach to LEIs have been different to those used for other standards. Good governance was a key issue from the start, and is often a topic that is easier to address when a new standard is created with no legacy. The Global LEI System was created with pan-industry international governance as well as effective competition as core characteristics. Its governance structure and principles were also created to allow for speedier change and improvement to the overall approach taken, so that as flaws or limitations were found they did not end up being “legacy” that held back the effectiveness of the system.
Data quality of entity identifiers has been a challenge from even before the beginning of the global LEI system. Market participants found that there were flaws and limitations in the approaches of existing national agencies whose function included identifying legal or business entities. In some cases these related to specific issues such as how up-to-date the information was, while in others they related to more general issues of data validation and of data quality management overall. Even under the existing Global LEI System there have been some clear issues related to data quality, and these are already being addressed by the Global LEI Foundation (GLEIF).
Gradually the use of LEIs by regulators is being increased as new national regulations are introduced, such as Dodd-Frank Title VII reporting. EU regulations, as the primary example of regional/multi-national regulations, are beginning to have perhaps the most significant impact on the growth of usage of LEIs. EMIR and MiFID II/MiFIR are both examples of this, but requirements to use LEIs now extend beyond the Financial Markets sector, eg in the EU for EBA reporting.
However, one should not look at LEIs as just an initiative to identify counterparties and clients. The aim of governments and regulators is to avoid a repetition of the 2008 crash, and identifying who is in the market is only one of the building blocks that is required. An ultimate aim of regulators is to have a multi-dimensional modelling environment that regulators internationally can use to monitor risks and what is happening in the financial markets. That modelling environment needs to include data not only about market participants but also about financial instruments that they are using and trading and about the nature of risks themselves. The need is also recognised for greater granularity of data, including identifying parent/subsidiary hierarchies and the relationship between the legal entities that issue financial instruments and the instruments that they issue. Having data of all types in a standardised format that can be fed easily and quickly into this environment is a fundamental necessity.
This is equally true for financial institutions. The world of market infrastructures and service providers today has a plethora of proprietary and uncoordinated data standards that have resulted in investment firms having to create their own internal approaches, processes and systems for identifying entities, financial instruments and risks. The move towards greater standardisation by regulators with real and effective governance of the way that standards are applied and identifiers are issued enables firms to take a more standardised approach themselves to data management. With regulatory requirements for the adoption of data standards already coming into force, now is the time for firms to plan their strategy and direction for how they apply data standards to manage data within their organisation to assure their future.
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