06.01.2012
By Terry Flanagan

Industry Rushes To Set Up Trade Tags To Reduce Risk

System of Legal Entity Identifiers aims to identify counterparty exposures.

Development of a global system for uniquely identifying counterparties to financial transactions is taking place through a coalition of industry service providers and international standard-setting bodies.

“One of the gaps that was identified as a result of the financial crisis was our industry’s inability to aggregate and assess exposures to an individual entity,” said Tim Lind, global head of strategy and business development, enterprise content, at data vendor Thomson Reuters.

“Given the variety of asset classes and the complexity of legal entities, the process of aggregating and assessing exposure to an entity across asset classes following a credit event takes days.”

Until now, a key piece of reference data had been missing, making it difficult for regulators to have a clear picture of the exposures that financial institutions have to each other.

The Legal Entity Identifier (LEI) is a global program designed to create and assign unique identifiers to every financial organization that engages in a financial transaction.

“Today there’s no universal key to identify an entity,” said Lind. “When we exchange information with customers, or they exchange data with their customers or counterparties, we rely on fuzzy matching of name and address.”

Regulators will use LEIs to better gauge systemic risk, and risk managers at financial institutions will use LEIs to better understand and aggregate counterparty exposures and risk.

“There is no technological reason why slicing and dicing of the aggregate balance sheet could not be done with the same simplicity as searching the web,” said Andrew Haldane, executive director for financial stability at the Bank of England, in a March speech.

The G20 leaders, at their November 2011 meeting, declared support for the creation of a global LEI and called upon the Financial Stability Board (FSB), the G20’s regulatory arm, to take the lead in coordinating work among the regulatory community.

In response to this mandate, at its December 2011 meeting the FSB created an ad hoc expert group of authorities to carry forward work on outstanding issues relevant to implementation of a global LEI standard.

“The implementation of standards such as legal entity identifiers, designed to provide a common language to identify legal entities, can provide a higher level of accuracy that can be applied to reduce levels of capital adequacy,” said Darren Marsh, business manager, risk management and compliance services at Interactive Data, a provider of financial market data.

Building Blocks
As the finance industry’s selected facilities manager for the project, the Depository Trust & Clearing Corporation (DTCC) will collect requirements for new LEIs to be created, validate the information, maintain and store reference data associated with each LEI and maintain public distribution of the LEI database.

DTCC will operate the core LEI utility as the central point for data collection, data maintenance and LEI assignment.

“The building blocks are being established right now,” said Lind of Thomson Reuters. “In June, DTCC will go live with the first phase of publishing LEIs. Right now there are 15,000 LEIs that have been assigned in a sample file that’s been distributed, and which we have matched to our own internal database.”

The FSB has requested that the International Organization of Standardisation (ISO) remove the role of registration authority from the new LEI standard ISO 17442.

In the opinion of the FSB, removing the registration authority function from the ISO standard will simplify the governance model of the global LEI system and eliminate potential conflicts between ISO and FSB, two separate governance systems.

Even in the absence of a registration authority, Swift—the leading worldwide financial messaging service for international money transfers—will have a role as part of the central utility responsible for allocating, validating and distributing LEIs.

“This is a change in terminology rather than functionality,” said Paul Janssens, LEI program director at Swift. “The tasks of allocating LEIs and validating and distributing data do not change. In function of the operational model and the implementation phasing that is being defined, it will be determined which functions are central and which functions are federated.”

A revised draft version of the ISO 17442 standard has been distributed to ISO members for a 30-day ballot.

Taxonomy Tussle
In the U.S., the Commodity Futures Trading Commission has proposed a universal international standard consisting of unique identifiers to facilitate data aggregation by regulators across counterparties, asset classes and transactions.

“If ISO 17442 is not fit and ready for purpose, the CFTC has indicated that it will set its own standard for counterparty identification purposes,” according to a March report by Aite Group. “Hence, it is waiting for a decision by the FSB before it mandates the standard.”

In order to enhance its ability to conduct effective market surveillance (and thus mitigate systemic risk and prevent market manipulation), the CFTC has specified data conventions such as Unique Swap Identifiers (USIs), Legal Entity Identifiers (LEIs) and Unique Product Identifiers (UPIs).

“We welcome the CFTC’s efforts to provide more structure to the reported data through the introduction of USIs, LEIs and UPIs,” said Robert Pickel, chief executive of the International Swaps and Derivatives Association, a trade body.

“These unique identifiers are crucial for linking data together and enabling data aggregation across counterparties, asset classes and trades.”

A number of useful applications could come out of the creation of this unique identifiers infrastructure.

“Apart from enhancing the ability of regulators to monitor activity and risk in the system, these developments are likely to revolutionize the financial services industry and will, most likely, lead to the creation of another cottage industry specializing in applications from these data,” said Pickel.

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