The legal entity identifier (LEI) is a welcome move towards improving the identification of participants to financial transactions.
The legal entity identifier (LEI) is a welcome move towards improving the identification of participants to financial transactions. In March, the Financial Stability Board (FSB) handed off the work of establishing the processes for issuing and managing the LEI to the Regulatory Oversight Committee (ROC) of international regulators. This committee will play a key role governing and establishing the global LEI system going forwards. In parallel, progress continues at the bottom tier of the system with the registration of seven pre-local operating units (LOUs), the organisations responsible for allocating and issuing the LEIs.
There are now seven pre-LOUs that can assign an LEI: in the US, Germany, Ireland, Turkey, Palestine, Russia and France. The most recognisable of these is DTCC’s CICI Utillity, the pre-LOU in in the US that was formed to assign pre-LEIs, called the CFTC Interim Compliant Identifiers, or CICIs, on behalf of the Commodity Futures Trading Commission. WMDatenservice, the pre-LOU in Germany, is the only other pre-LOU that has begun to actually issue pre-LEIs, in this case called the GEI. The others are in the midst of building infrastructure and should soon be joining these two.
At this point it is worth taking a step back to understand exactly why the industry is pushing forward with the LEI and what it could achieve. While the primary driver behind creating this identifier is the need for regulators to improve oversight of systemic risk, there are secondary drivers, which have created support among many financial participants. Financial firms are just beginning to explore the potential of this identifier beyond its initial intended purpose. While the debate may continue about the best way to implement the LEI, most participants have not only resigned themselves to its creation, but are actively supporting it.
As firms think about bringing the LEI into their workflows, there are five steps that must be considered for a successful integration.
First, every firm, if they have not done so already, should take the time to understand what the LEI is, and what it does or does not provide. It is important to understand that the LEI is intended to be an unambiguous identifier for the entities that are participants to a financial transaction. It is intended to replace the ambiguous, freeform name and address fields that most firms and regulators currently contend with. However, the LEI does not identify securities issued by a legal entity, nor does it explain the relationships between entities (for example, parent/subsidiary, affiliates or other hierarchical relationships).
Second, it is critical that each firm reviews the current state of counterparty data within their organisation. Ask yourself how entity data is currently being stored at your firm. Is it easily accessible in a separate entity database, or is it more difficult to extract because it is mixed with other reference data? If separate, is it being held in a central depository or duplicated in separate silos? Understanding where and how your counterparty data is stored enables you to better understand where your systems will have to go.
The third aspect to examine is how and where counterparty and issuer data are used today. Cataloguing current uses such as trade comparison, risk analysis and portfolio management, is essential to prepare for step four, which is defining the use cases for the LEI going forward.
The most obvious use cases for the LEI are driven by regulatory requirements. It is critical when building use cases to first identify the effective dates for compliance with applicable regulations.
Developing other use cases may be as simple as looking at how to improve existing processes by substituting the LEI for freeform entity text descriptions. For others it may be more complex as these use cases may only be partially addressed by the LEI in its current state and may require additional data. For example, it may be necessary to supplement the LEI with additional external data to understand the linkages between issuers and their securities and the hierarchy of an organisation’s legal entities.
The most difficult use cases require discussions about difficult processes never undertaken or previously abandoned because a tool like the LEI did not exist. For example, organisations will be able to analyse bonds based on lead manager, guarantor, obligor or custodian, all entities currently identified in freeform fields, once these entities are identified with an LEI. This will allow them to better assess their exposure to an entity regardless of the entity’s role. Additional use cases may be identified after the establishment of the LEI. It therefore makes sense at this stage to reach out to all the internal business units to identify as many use cases as possible.
The last step in preparing for the LEI is to create a plan. With the above information collected and the use cases created, prioritising each use case is paramount. Regulation will help prioritise some of the use cases, for example, if a regulatory body is requiring use of the LEI by a particular date, then all work needs to accommodate that deadline.
Prioritising other use cases will be decided based on the current criteria your firm uses, whether that is ease of implementation, improvement of service or efficiency versus cost of implementation—keeping in mind that it may make sense to overlap development.
The LEI is not a panacea. It is not meant to be. Rather, it is meant to be a tool, and one that we believe can transcend its initial intended purpose. To fully capitalise on this identifier, though, takes preparation and planning. By following the five steps outlined above, financial firms will be in a much better position to fully tap the potential of the LEI.
