By Matthew Stauffer, managing director and head of Institutional Trade Processing at DTCC
The aftermath of the 2008 global financial crisis brought a swath of regulatory reforms aimed at increasing the transparency and resiliency of the financial system. Looking back with 10 years’ of experience, it is safe to say some of those reforms were better executed than others, while some remain incomplete today.
Arguably, the legal entity identifier (LEI) was one of the most significant of those reforms, designed to advance financial stability in two ways. First, it was created to help regulators and financial firms quickly and accurately identify parties to financial transactions and obtain an accurate view of their exposures across asset classes – a challenge that proved daunting, if not impossible, following the collapse of Lehman Brothers.
Second, it was designed to help companies improve their internal risk management processes associated with collecting, standardising, aggregating and reporting their data while improving efficiency thereby reducing costs. This has become increasingly important in today’s environment where LEIs could decrease the touchpoints that drag on the trade lifecycle.
Unfortunately, the LEI stands as an example of an incomplete reform. In fact, the use of LEIs is only one of several broader, post-financial crisis, enterprise data management initiatives that financial institutions continue to implement.
While progress has been made in this area, significant work remains to be done to enhance the enterprise data management practices of financial services firms to improve their ability to quickly and accurately aggregate their risk exposures, especially in times of economic volatility and market stress. Completing this effort will help to realise the full benefits of LEIs and other post-crisis data initiatives.
Progress with LEI adoption varies widely by region, with a direct correlation to regulatory mandate, with European regulators going farthest toward mandating the use of the LEI as set out in numerous regulations. The LEI is a regulatory requirement for trade and transaction reporting under the Markets in Financial Instruments Directive II (Mifid II), the European Markets Infrastructure Regulation (Emir), the Securities Financing Transaction Regulation (SFTR), the Alternative Investment Fund Managers Directive (AIFMD), and Solvency II, among others.
The US has so far seen the Federal Reserve System, Commodity Futures Trading Commission (CFTC), and National Association of Insurance Commissioners (NAIC) require LEIs in various reports submitted by the industry regarding bank holding companies, swap transactions, and insurance investments. Additionally, the US Securities and Exchange Commission (SEC), Municipal Securities Rulemaking Board (MSRB), and CFTC have recommended – though not required – LEIs be included in credit rating disclosures, money market funds’ monthly submissions, private fund managers’ reports, and futures clearing merchants’ ownership reports. There are also SEC and Consumer Financial Protection Bureau (CFPB) proposals pending that would require LEIs to appear in swap transactions and home mortgage disclosure submissions.
In parts of Asia-Pacific, LEI issuance remains extremely low as numerous regulatory efforts have stalled. However, this is not true for Japan and Australia where reporting requirements for over-the-counter derivatives trades using LEIs recently took effect.
There are also extraterritorial implications to take into account. Some market participants such as specialist brokerages in Asia which do not have any presence in the EU may be less familiar with the LEI mandate and may need to rely on their institutional clients to learn about Mifid II and its LEI requirement, while others are reluctant to share their data with European regulators to whom they have no reporting obligation.
In recognition of the persistent issues, the Financial Stability Board (FSB) is looking at ways to encourage LEI adoption globally. In August 2018, it announced a peer review seeking to (1) gather global input on the approaches and methods used by FSB members to implement LEIs, including its adoption for regulatory requirements; (2) assess whether current rates of LEI adoption are sufficient to support the ongoing and future needs of FSB member authorities; and (3) identify the challenges in further advancing the implementation and use of LEIs, and make recommendations to address common industry challenges.
The industry’s use of LEIs has progressed significantly, with the total global LEI population currently at nearly 1.3 million. DTCC is actively working to expand this use through its GMEI utility, which having issued over 407,000 LEIs, is the largest issuer regulated by the Global LEI Foundation. Beyond regulatory concerns, LEIs – especially when used with standing settlement instructions (SSI) – could also reduce the friction that slows post-trade processing by seamlessly connecting transactions and counterparties across the trade lifecycle. However, the full benefits of this system – for the public and the private sector – can only be achieved if it is adopted universally.
Therefore, to complete this critical reform of the post-crisis era, we need to further expand the mandatory use of LEIs for reporting purposes across all jurisdictions and financial markets through regulatory requirement.
Matthew Stauffer is managing director and head of Institutional Trade Processing at DTCC, which includes responsibility for DTCC’s Global Markets Entity Identifier (GMEI) utility.