a Uncovering systemic risk Regulators push for global Legal Entity Identifiers by Paul Janssens Regulatory concerns Regulators too have taken a specific The recent financial crisis has underscored the need for additional interest in LEIs. In the USA, the Dodd- transparency and regulation in financial markets. Globally, regulators Frank Wall Street Reform and Consumer are conducting systemic risk analyses aimed at understanding Protection Act (DFA) created the Office of Financial Research (OFR) with the the aggregate risks of entities and their counterparties across asset specific task of collecting large quantities classes and regions. Precise and accurate identification of legal enti- of pricing, position and trading information ties engaged in financial transactions is important to private markets and analysing it to uncover systemic risks. and government regulators alike. Other US regulators will need to perform similar tasks. An essential component of enabling Most financial firms have developed In Europe, meanwhile, the European regulators to conduct such risk analysis is their own LEI solutions in-house, an Securities Market Authority (ESMA) and the creation and maintenance of a global, approach that creates inefficiencies. the European Systemic Risk Board (ESRB), standard Legal Entity Identifier (LEI), the Tracking counterparties and calculating which held its inaugural meeting in January core record attributes which comprise it, exposures across multiple data systems 2011, have been set up to collect transactions and a utility to support it. In other words, is complicated and expensive, and it can reporting and analyse global systemic risks. the adoption of a reliable, internationally result in costly errors. Precise identification of financial firms is accepted LEI solution. ISO technical com- necessary to evaluate whether a firm poses mittee ISO/TC 68, Financial services, has a systemic risk. This involves assessment formed a dedicated group to develop a strat- LEI creation should of the relationships among firms operating egy for identification standards, including adhere to industry across a range of markets and financial legal entity identifiers. best practices. instruments. In addition, securities regulators LEIs are not new to the financial services must often identify parents and affiliates industry. They are used by financial insti- of broker-dealers manually and by name. tutions to identify customers and trading Maintaining internal identifier databases Multiple identifiers for participants in partners. This enables them to trade, know and reconciling entity identification with securities trading make it difficult to create their customers and conduct internal risk counterparties is expensive. Complete a consolidated order audit trail. analysis and stress-testing. Commercial automation of back-office activities remains This means that regulators cannot LEI vendors exist, but there is no widely elusive, in part because of the lack of a adequately analyse systemic risk unless a accepted LEI standard in the marketplace. universal identifier for legal entities. On common, widely adopted LEI is established In the absence of a universal system for occasion, the straight-through processing containing basic information that uniquely identifying the legal entities that participate chain is broken and transactions fail to identifies all the entities involved in reported in financial markets, private firms and regu- settle because counterparties have not been transactions. Jean-Claude Trichet, President lators have created a variety of identifiers. properly identified. of the ECB and newly appointed Chairman ISO Focus+ April 2011 © ISO Focus+, www.iso.org/isofocus+ 13 a Special Report of the ESRB, recently announced, “ The that is established and implemented by pri- • Persist over the life of an entity, CSDB [Centralized Securities Database vate industry and other relevant stakeholders regardless of corporate actions or other of the European System of Central Banks] through a consensus process.” business or structural changes would be best complemented by a public The Office also believes that partici- • Include minimal information about the reference data utility providing standard- pation of International Standard-setting entity in the identifier itself ized information on instruments and entities bodies would be beneficial in developing • Accommodate growth in the num- that would be operated on the basis of an the standard. If an LEI is established to the ber of legal entities that need to be international agreement.” satisfaction of the Office by 15 July 2011, identified in the full range of reporting it plans to issue a regulation mandating its systems, and to potential industry and use for data reported to the Office. Initiatives in the USA regulatory innovations In late 2010, the Commodities Futures • Be available for all eligible market Trading Commission (CFTC), Securities A consistent overview participants, including, but not limited and Exchange Commission (SEC), Office of of systemic risk will to, all financial intermediaries, all Financial Research (OFR) and a consortium require engagement from companies that issue stock or debt of US regulators known as the Linchpin listed on an exchange, all companies group (the US Treasury Department, the the industry. that trade stock or debt, infrastructure Federal Reserve Board of Governors, the providers, all entities subject to finan- Federal Reserve Bank of New York, the cial regulation, and firms affiliated The Office has also set out what it sees as Federal Deposit Insurance Corporation, the with such entities the main characteristics of an appropriate Financial Industry Regulatory Authority, and LEI. It should : • Not be contractually restricted in use the Securities and Exchange Commission) • Where possible, be compatible with all issued proposals for public comment • Be based on a standard developed and existing systems, work across various that included the LEI concept. maintained via an international “vol- platforms, and not conflict with other The Office of Financial Research, for exam- untary consensus standards body”. numbering or identification schemes ple, issued a statement of LEI policy with a The Office cited ISO in this regard request for comment at the end of November • Be unique for each legally distinct • Be readily accessible using secure and 2010, where it declared its preference, through entity, where each legal entity is open standards rule-making, to adopt “ a universal standard assigned only one LEI which cannot • Be reliable and secure against corrup- for identifying parties to financial contracts be reassigned tion or misuse 14 © ISO Focus+, www.iso.org/isofocus+ ISO Focus+ April 2011 a • Be capable of becoming the single International Standard for unique identification of legal entities in the financial sector. The Office notes that LEIs should be issued by an entity with expertise in imple- menting standards for the financial sector “ organized and operated as a not-for-profit body and have a formally documented governance structure with balanced rep- resentation for relevant stakeholders ”. A recent discussion paper issued by the Divisions of Research and Statistics and Monetary Affairs of the Federal Reserve Board, “ Creating a linchpin for financial data : toward a universal legal entity identifier ”, argues that a universal LEI would likely provide a “ public good ” in that it could allow cheaper and more efficient analysis for all interested parties. The paper identifies a number of standards used in industry today to ensure quality and accuracy in identification assignment. Regardless of the methodology selected, it argues, LEI creation should adhere to industry The two industry utilities have proposed Authority for ISO 9362:2009, Banking best practices in identification assignment to to work jointly in creating a LEI service to – Banking telecommunication messages ensure high quality and accuracy. assign, maintain and distribute new LEI – Business identifier code (BIC), provides Several organizations have expressed an codes. Initially, the focus would be on the US it with a highly informed perspective on interest in providing a global LEI service requirements since these regulators appear to the adoption of a universal LEI standard. for the financial industry. These include be making their decisions first. The partnership SWIFT is also the Registration Author- Depository Trust & Clearing Corporation could involve additional players as regulatory ity for ISO 10383:2003 Securities and (DTCC) and SWIFT, organizations that requirements emerge around the globe. related financial instruments – Codes have cooperated to study and develop an The wealth of experience that SWIFT for exchanges and market identification optimal solution to the LEI challenge. has gained in its capacity as Registration (MIC), Part 1 and 2 of ISO 13616:2007, Financial services –International bank account number (IBAN), Part 1 and 2 of ISO 15022:1999, Securities – Scheme for messages (Data Field Dictionary), and the six-parts of ISO 20022, Financial services – UNIversal Financial Industry message scheme. About the author Paul Janssens joined SWIFT, the member- owned cooperative supporting standardized financial information, in 1988. He has held the positions of Group Treasurer and Euro Programme Manager, and is now heading the Legal Entity Identifier initiative. ISO Focus+ April 2011 © ISO Focus+, www.iso.org/isofocus+ 15.