The pressure from regulators to assign a unique code to every counterparty to a financial transaction is the gift of Lehman Brothers to the world. In derivative trade reporting it is, along with unique transaction and product identifier, the key to making sense of the data. It is not yet clear whether multiple issuers are part of the problem or part of the solution.
One obligation no derivative counterparty obliged to report to a repository can escape – even in the United States – is the Legal Entity Identifier (LEI). These ISO 17442-compliant 20 character alphanumeric codes, which provide every party to a financial transaction with a unique, machine-readable identity, are at the heart of the ambition of global regulators to monitor, understand and mitigate systemic risk in the international financial system.
Since derivatives counterparties need one for each legal entity, this has proved a particular problem for fund managers, because each and every fund is a separate legal entity – and there is nothing optional about acquiring one for every fund either. The European Securities and Markets Authority (ESMA) has mandated their use in the regulation of derivatives under the European Market Infrastructure Regulation (EMIR).
The Commodity Futures Trading Commission (CFTC) developed its own temporary version of the LEI. This is the CFTC Interim Compliant Identifier, or CICI. These codes are issued by a web-based CICI utility, which was set up in 2012 by the Depositary Trust & Clearing Corporation (DTCC) and Brussels-based messaging network SWIFT. By the beginning of 2014, the CICI utility had issued more than 95,000 CICIs. Luckily, they are all re-usable as LEIs.
“The CICI numbers were issued in compliance with ISO 17442, which is the standard adopted for the global roll-out of LEIs,” explains Richard Young, head of regulatory affairs at SWIFT in London. “We are now moving away from calling them CICIs in favour of pre-LEIs. If you have a CICI already, and are now under an obligation to report under EMIR, you can re-use it as a pre-LEI. So CICIs are now re-usable for reporting in other jurisdictions. ”
In Europe, according to openleis.com, 98,372 LEIS were issued by the time trade reporting started on 12 February 2014. That was thought to represent less than a tenth of the estimated one million thought to be required. There was also a worrying degree of variation by country, with Germany securing far more LEIs than important financial centres such as the United Kingdom and Luxembourg (see Table 1, page 19). At least some of the chaos which ensued is attributable to the failure of many counterparties to obtain LEIs in good time.
The Global Markets Entity Identifier (GMEI) utility, as the joint offering from DTCC and SWIFT is now known, is only one of a number of so-called pre-Local Operating Units (pre-LOUs) that create and assign LEIs. In fact, no less than 22 organisations have applied to issue LEIs (see Table 2, page 20), and all but six are operational. LEIs issued in Europe when reporting started The Regulatory Oversight Committee (ROC) of the Global Legal Entity Identifier System (GLEIS) - a body set up by the Financial Stability Board (FSB) to standardise LEIs – judges whether a LOU is technically competent to do the job. 58 central banks and securities market regulators drawn from 36 countries plus the European Union and four global regulatory bodies – the International Organisation of Securities Commissions (IOSCO), the Committee on Payments and Settlement Systems (CPSS) and the Committee on the Global Financial System (CGFS) as well as the FSB – have become members of the ROC. Another 16 central banks and securities regulators from 15 countries sit on the ROC as observers, alongside three more supranationals: the International Bank for Reconstruction and Development (IBRD, or World Bank), the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD). All of which is a measure of the importance regulators everywhere (and nowhere) attach to LEIs. Given this, it is curious that they are prepared to endorse so many LOUs. “The regulators want competing issuers,” says Richard Young. “Because local markets have local flavours, they also wanted a system of local providers to issue these numbers, although once you are endorsed by the ROC, you are endorsed globally.
The GMEI Utility has issued pre-LEIs to entities in 160 different countries and the European Union (EU) represents 32 percent of the total records.” To avoid duplication – LEIs must, after all, be unique – LOUs will have to share information with each other. “Each of the authorised issuers has to do a daily reconciliation with each other to make sure they have not issued the same LEI to different entities or different LEIs to the same entity,” adds Richard Young. Over time, the ROC plans to build a central hub, to which all of the LOUs will connect and report. For now, they reconcile with each other bi-laterally. “In the interim, you have got the spokes without the hub, as it were,” says Richard Young.
Selecting an LOU to issue an LEI is expected to be largely a matter of local choice, especially for the corporates that transact few derivatives trades and fund managers that do not run many funds. The price is not high. The registration and issuance fee is set at no more than US$200, with an annual maintenance charge of US$100 to cover the cost of keeping up to date records of the name, address, and legal form of the entity that underlies the LEI, and conducting independent checks of its validity from public sources.
The LEIs will eventually find uses far beyond reporting swaps to trade repositories. Already, the European Banking Authority (EBA) has suggested LEIs be used by banks to report compliance with capital and liquidity regulations under the fourth Capital Requirements Directive (CRD IV). Theoretically, LEIs might even be useful to fund managers and their bankers. “LEIs offer them a standardised system for discovering and managing exactly who their counterparties and customers are,” explains Richard Young.
There is still work to be done on LEIs. At the moment, the codes capture names, addresses and legal forms only, and not what is most important – namely, who actually owns who. Since the use of an LEI in counterparty risk management depends on understanding that, this is not simply a nice-to have.Lehman Brothers, to take an obvious example, did not always trade under the name of Lehman Brothers. “It is a tricky one, because you need that information to understand where risk is being built up, but it is actually confidential in many markets,” says Richard Young. “The regulators are working on how to collect and disseminate that information.”