Rarely am I enthusiastic about bureaucratic standards-building processes. But a recent task force report gives me hope that international support for a system of legal entity identifiers (LEIs) is real and will help bring to fruition a key reform for over-the-counter (OTC) derivatives. Of course, this isn’t the sexy reform that grabs the headlines, but bear with me.
First, we have to thank Lehman Brothers and its spectacular failure for giving the LEI push a much needed urgency. In the aftermath of the Lehmans fiasco, it became clear that nothing was clear.
“At Lehman Brothers [after its failure], investigators couldn’t track where collateral was because it was all paper-based and they didn’t have a way to identify the counterparties because of the different codes,” explains Dennis E. Goodenough III, senior business manager, securities initiatives at the financial messaging services cooperative SWIFT, in a wonderful Q&A with FTF News last year. “The other and more important issue is financial reporting. When corporates report to the regulators on their transactions, they’re using different legal entity identifiers and so the regulators can’t pinpoint which firm is moving the market, or how many transactions are they doing.”
So, a global industry in the 21st Century has multiple ways of identifying the same entity thus creating multiple layers of confusion. Brilliant. Whether or not there is a sinister purpose behind this obfuscation is something the historians and prosecutors will have to sort out. Until then, those left still standing after the Great Recession have to pick up the pieces and fix something that went horribly wrong.
Fast forward to the task force, set up by the International Organization of Securities Commissions (IOSCO) to work with the Committee on Payment and Settlement Systems (CPSS) to develop reporting and aggregation standards for trade repositories (TRs) that warehouse OTC derivatives contracts to improve transparency, mitigate systemic risk and protect against market abuse. The task force, building upon the groundwork of the Financial Stability Board (FSB) and after consulting with authorities and the OTC Derivatives Regulators’ Forum (ODRF), has endorsed minimum data reporting requirements and standardized formats, and methods and mechanisms for data aggregation “on a global basis.”
(It’s interesting to note that there is a very long list of industry bodies now paying attention to OTC instruments. Where, exactly, were they when completely rotten instruments were being created and feverishly sold only to facilitate one of the most precipitous falls in history of a vital industry? Sorry, I digress.)
Not surprisingly, the task force “recommends the expeditious development and implementation of a standard LEI capable of achieving the data aggregation purposes discussed in the report.” That’s good. The report is also pushing for LEIs to be born and raised “under the auspices of an organization with international membership and appropriate governance that develops and publishes international standards for the financial sector.” The task force is also urging ongoing international cooperation, and there appears to be consensus on that front.
“As noted in the report, such further work is in progress. In September 2011, an LEI workshop took place in Basel, Switzerland, under the auspices of the FSB, with more than 50 private sector experts and over 60 representatives from the regulatory community participating,” according to the report.
The task force also cites the support of the G20 Leaders and their November 2011 meeting in Cannes, France, when they blessed the creation of a global LEI “and called upon the FSB ‘to take the lead in helping coordinate work among the regulatory community to prepare recommendations for the appropriate governance framework, representing the public interest, for such a global LEI’ by the next G20 Summit.” As also noted, the FSB in December 2011via the FSB Steering Committee launched “a time-limited, ad hoc expert group of authorities to carry forward work on key outstanding issues relevant to implementation of a global LEI, in order to fulfill the G20 mandate.”
The task force also tackled the issue of minimum data reporting requirements for TRs, urging that “such data include at least transaction economics, counterparty information, underlier information, operational data and event data.” The report pointed to the looming issue of “certain information, such as that contained in master agreements and credit support annexes, will be helpful for assessing systemic risk and financial stability but that at present such information is not supported by TRs.”
The report makes recommendations for bridging these “data gaps” and reminds that the FSB has to help define from the “demand side” the data “needed to bridge data gaps for: (i) assessing systemic risk and financial stability; (ii) supervising market participants; and (iii) conducting resolution activities.”
The task force also took on other issues and this final report is available via the website for the Bank for International Settlements (BIS) (www.bis.org) and IOSCO’s website (www.iosco.org).
But, I think we can finally declare that global support exists for an LEI standard and I hope we can continue to avoid squabbles among the various participants. I also think we can say that it makes great sense to get a global consensus first rather than urge multiple standards from different jurisdictions that then have to be reconciled, which would defeat the whole purpose of an LEI standard.
Lastly, while the march to LEI standardization has many steps to go, I think we can be cautiously optimistic about its progress. But we shouldn’t wallow in contentment for too long. We don’t yet know how the vendors will muck it up.
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