The LEI is well on its way to establishing more transparency around financial transactions and markets. Its implementation will highlight some specific data management challenges, but its benefits for financial institutions and firms are wider reaching than simply reporting to regulators.

The problems financial institutions had to deal with in 2008 included the understanding that they faced full exposure to one another. Underscoring the need for additional transparency and regulation in the financial markets is the ability to uniquely identify financial interconnectedness. When the Lehman Brothers collapsed, both financial regulators and the private sector were unable to assess quickly the extent of market participants’ exposure to Lehman, or to fully trace how the vast network of participants were connected to one another.

Subsequently, regulators identified the failure of risk management processes and controls as a significant contributory factor, and focused on developing the macroeconomic tools required to monitor systemic risk. As a result, the demands for transparency on firms and understanding exposure across the business have increased.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the
industry today

Over the years, industry bodies such as the International Standards Organisation attempted to establish a global entity identification system, but efforts could not achieve the level of coordination needed to launch a single global solution. Neither was there the regulatory impetus in place required to drive broader adoption. While there are currently many ways to identify entities in financial transactions, there is lack of a unified global system to identify and link data to enable financial regulators and firms to better understand the true nature of risk exposures across companies, markets and jurisdictions.

Initiating a LEI
Post 2008, the G20 nations tasked the Financial Stability Board (FSB) – a supra-national regulatory coordination body – to prepare recommendations for a global LEI governance and implementation framework. Coordinated worldwide commitment has helped overcome previous impediments to developing a global LEI system, which is expected to be a significant achievement in responding to the vulnerabilities of the financial system, and provide meaningful long-term benefits for regulators and market participants alike.

The LEI is designed to be a unique and persistent entity identifier enabling risk managers and regulators to consistently determine parties to financial transactions instantly and precisely on a global basis. It will be a common pervasive code to supersede the many proprietary vendor and internal codes already in existence. Aside from an initial registration fee and an annual maintenance fee paid by the firm requiring a LEI, it will be free of licensing conditions to encourage adoption.

Within scope are legal entities, subsidiaries and fund structures, banks, fund managers, corporates, partnerships, trusts, municipal corporations, government departments and charities which all require LEI. Individual persons, branches and operating divisions, however, are out of scope and therefore do not.

When industry adoption of the global LEI reaches critical mass, data reported both externally to supervisors and internally for risk management purposes will be more reliable. The global LEI will enhance the ability of regulators to monitor and analyse threats to financial stability and the ability of risk managers to evaluate their companies’ risks. It promises to facilitate improved risk analysis, supervision and regulation, reduce cost for industry in collecting, cleaning, and aggregating data, and in reporting data to government regulators. It also mitigates operational risks of private firms and improves their internal risk processes, and enhances the industry’s market discipline.

The LEI system is an alphanumeric code and associated set of reference data items to uniquely identify a legally distinct entity that engages in financial market activities. Following a robust International Organization for Standardization (ISO) process, ISO Standard 17442 was created as the new LEI standard, and made publicly available in May 2012. This global standard is endorsed by the G20 as a 20-digit code with associated ‘business card’ information.

Successful operation of the Global Legal Entity Identification System (GLEIS) – which was officially launched in March of last year – will require support from the global regulatory community, private sector firms, and industry associations. The endorsed recommendations define clear roles for public and private sectors. The system is based on two components, a governance model and an operational model.

For the governance model, the GLEIS is overseen through a Regulatory Oversight Committee (ROC), which was established in January 2013. The ROC has a plenary of members and observers from more than 70 authorities as well as a regionally balanced executive committee taking its work forward. Its standing committee and a secretariat in Basel, Switzerland, support it on evaluation and standards.

The Central Operating Unit (COU) will be the principal operational arm of the global LEI system. The private industry will participate and consult on the development and operations of the COU. Established as a not-for-profit foundation, it will also be based in Basel, but is not yet fully functional. In particular, the COU is responsible for ensuring the application of uniform global operational standards and protocols.

It will guarantee that all parties implementing the GLEIS will adhere to governing principles and standards, including reliability, quality, and the uniqueness of the LEI.

Local implementation will be conducted through a federation of Local Operating Units (LOUs), which will benefit from local knowledge of infrastructure, corporate organisational frameworks, and business practices. LOUs will register and validate applications for LEIs, issue LEIs, and maintain the associated reference data.

Progress of the LEI system to-date
Considering the scale of the initiative there has been significant progress since the G20 mandated the FSB in November 2011. Over the last year, there have been several developments towards full operational deployment. The ROCs implementation of a clearly defined governance framework laid the foundations for the use of pre-LEIs allocated by endorsed pre-LOUs in regulatory reporting – until the COU has been established all endorsed LEIs have ‘pre’ status as do the LOUs that allocate them.

The momentum has been further strengthened by the European Banking Authority (EBA), stating that all EU credit and financial institutions apply for pre-LEIs by the end of 2014 for supervisory reporting. Similarly, in the US, the Securities Industry and Financial Markets Association (SIFMA) has called on the Financial Stability Oversight Committee to encourage the adoption of LEI among regulators for financial reporting.

As of April this year, 13 pre-LOUs have endorsed status and this interim system of pre-LOUs and pre-LEIs will continue until the COU is set up and the GLEIS becomes fully operational. At this point, pre-LOUs will convert to LOUs, pre-LEIs will transition to LEIs, and LOUs will begin issuing LEIs. Initial adoption of pre-LEI has predominantly resided among firms that trade OTC Derivatives.

Dodd-Frank in the US and EMIR in Europe both require pre-LEIs in trade reporting, while regulators in Hong Kong (HKMA), Singapore and Australia are also introducing rules to use pre-LEIs. In addition, their use has been mandated for Solvency II reporting by EIOPA, the insurance and pensions regulator in Europe. Looking forward it is expected that the LEI will also become a requirement for AIFMD and Markets in Financial Instrument Directive II (MiFID), which will broaden across asset classes.

As the number of use cases increases, it is safe to assume the number of institutions applying for and utilising LEIs will increase significantly. Eventually it is expected that LEIs will be included in every financial transaction concerning a financial instrument as a
matter of course.

There are challenges however, as the practice of issuing and tracking LEIs becomes more complex once LEI operations have begun. With pre-LEI portals continuing to emerge in several markets, data management professionals will have to cope with the on-boarding and maintenance of LEIs from multiple venues. Without cross reference to alternative identifiers, firms need to manually map pre-LEIs into systems and apply corporate actions on an ongoing basis to maintain data provenance.

As regulatory mandates overlap, firms need to establish a holistic approach to data management to facilitate aggregation of risk exposures. This is done by connecting the disparate data held on counter parties, clients, obligors and issuers. As an identifier with a limited set of reference data, the LEI alone will not resolve all of these challenges.

The full benefits will be realised only when the LEI is packaged with additional content, such as broader entity hierarchies and linkages to the securities master, to provide transparency of organisational structure and risk exposure.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the industry today. It is that mapping and deployment across the enterprise that will yield the true benefits.

Within this model, the LEI could significantly reduce the amount of time to aggregate entity data across different systems, for a view of enterprise-wide risk exposure to a single name issuer or group of issuers by way of the securities held in an investment portfolio or fund.

From the collapse of Lehman Brothers, it is clear how important this structure is to regulators, firms and to the market as a whole. The LEI may primarily be intended to provide regulators with the tools to monitor systemic risk, but in light of its obvious benefits it is worthwhile for all market participants to accept its challenges.