UK: Legal Entity Identifiers - A Global Opportunity

Adopting Legal Entity Identifiers across the value chain

One thing that became clear during the financial crisis was that many financial services organisations did not have an effective process for understanding their counterparty exposures or the exposures of their counterparties' counterparties; thus impairing their ability to effectively manage risks and challenging the confidence of investors and counterparties.

The problem was largely due to the inability of organisations to capture and aggregate their legal entity level exposures accurately, which in turn hindered their ability to assess their counterparty risk. Across the industry, organisations were unable to quickly and accurately report their exposure making it impossible for supervisors to determine either: the systemic risk posed by relationships between organisations; or the risk posed by particular counterparties.

In response, the G20 has endorsed the Legal Entity Identifier (LEI) initiative. This initiative will lead to the creation of a unique identifier for any entity involved in a financial transaction. The Financial Stability Board (FSB) is tasked with taking forward the planning and development work and has published a number of principles and recommendations1 that outline the benefits LEI delivers and how the LEI system should be implemented.

The global regulatory community has already begun to pledge its support2 for the LEI initiative and, with a target launch date of Q1 2013, organisations need to take immediate steps to assess the impact on their risk and regulatory reporting processes.

The use of LEI will undoubtedly improve the ability of supervisors to monitor systemic risk. However, LEI is also a 'building block' to improved risk management within organisations and supervisors will expect3 LEI to be used by risk functions to monitor risk across the business.

A critical element is a consistent method by which counterparties are identified such that data can then be matched and aggregated across products, business lines and geographies combined with the latest technology that allows this to be done efficiently and effectively (see Deloitte's recent paper 'Aggregated risk on demand'4). In addressing such issues, LEI adoption can bring additional benefits such as improved customer take-on processes, increased revenue through cross-sell and up-sell, enhanced pricing and strengthened finance processes.

Scope of LEI and G20 endorsed implementation Principles

The expectation is that LEI will be used when reporting transactional information to supervisors. It will uniquely identify all parties involved in the transaction such that the supervisory community can aggregate data to monitor risk concentrations.

National supervisors will be responsible for the detail of when and how LEI will be implemented. The Commodity Futures Trading Commission (CFTC) has been the first to formally adopt the principles of uniquely identifying entities and has chosen DTCC and SWIFT to provide the CICI5 (CFTC Interim Compliant Identifier). The CICI will be used for CFTC's swap data reporting regulations until it transitions to the global LEI. Organisations have been able to register for a CICI since August 2012 in advance of the October reporting deadline. In Europe, the European Market Infrastructure Regulation (EMIR)6 strongly supports the use of a common identifier for legal entities as part of its trade reporting requirements. In this regard, it supports the use of a LEI if globally available and it meets the CPSS-IOSCO principles for data aggregation. However, authorities recognise that a global LEI might not be in place by the time the full EMIR trade reporting requirements kick-in (most likely to be July 2013) and acknowledge that an interim solution might need to be developed.

In the meantime, the FSB is coordinating the implementation of the LEI to a timetable and set of principles and recommendations agreed at the G20 summit in June 2012. This includes a deadline for establishing an independently functioning LEI system by March 2013.

The thirty-five FSB recommendations (see Figure 2) cover governance, funding, standards and validation and set out expectations as to what data should initially be captured and made available by the LEI system.

Impact and opportunities

The immediate impact of the LEI will be on supervisory reporting as supervisors follow the CFTC and adopt LEI for supervisory returns. However, while not explicit, the implication of a global identifier has much broader impact.

Whilst regulatory compliance may be a short term imperative, those organisations that look to adopt LEI across the organisation are likely to see significant competitive advantage.

Organisations with a group-wide consistent and accurate view of their clients and counterparties could improve the sales and on-boarding process, improve risk management, and reduce the operational costs associated with the downstream impacts of inconsistent and inaccurate data. A strategic approach to data management has been explored in more detail in a previous Deloitte paper7.

In fact, the impact of LEI on the ability of an organisation to manage risk has recently been flagged in the Basel Committee on Banking Supervision (BCBS) paper8 'Principles for effective risk data aggregation and risk reporting'. This paper notes that 'The Financial Stability Board has several international initiatives underway to ensure continued progress is made in strengthening organisations' risk data aggregation capabilities and risk reporting practices, which is essential to support financial stability... including a public-private sector initiative to develop a Legal Entity Identifier (LEI) system'.

In adopting LEI organisations will have to ask themselves a number of questions:

  • Which parts of the business are most affected by LEI?
  • Which business processes could be affected and what are the costs and benefits of LEI adoption?
  • What are the knock-on impacts of LEI adoption in one process but not the other?

For many organisations it is becoming clear that replacing existing internal identifiers with LEI across all business processes would avoid the need for yet another reconciliation. However, a 'big-bang' approach is impractical for many organisations and a phased approach starting with regulatory reporting and risk management processes in the investment bank will often be most suitable.

Whilst full adoption seems sensible in the long term, organisations should plan carefully for the consequences. For example, once published, LEI hierarchies may provide new information on current clients potentially pushing exposures above existing limits. Planning for how to deal with such scenarios is critical to a successful LEI adoption programme. The table in Figure 3 outlines where the impact of LEI on existing processes will be greatest across business lines and functions.

LEI clearly entails significant business process and technology change across all business lines, even to meet nearer term regulatory reporting requirements. The fragmented nature of legal entity data and its usage means that there are few areas that are not affected. Enabling change whilst maintaining 'business as- usual' (BAU) is therefore incredibly challenging.

Organisations will need to:

  • Understand what being 'compliant' means for them;
  • Determine their approach to achieving compliance;
  • Prioritise and execute significant change activities (across data, technology, process and organisation) in line with their agreed approach, whilst maintaining BAU.

Those organisations that are better able to manage the large volume of change required to do this strategically will gain the greater benefit, extending well beyond just compliance. Embedding LEI in product and front line systems reduces the operational risk and associated need for reconciliation and manual intervention.

This leads to greater straight through processing and reduced cost. It also allows for improved data quality and consistency, resulting in better informed and more timely business decision making. Furthermore, functions (particularly Risk and Finance) are able to focus on their core activities rather than becoming proxy data management functions. In an environment where the regulatory landscape is changing, it provides a foundation for more cost effective compliance with future demands. Conversely, those that take a more tactical 'sticking plaster' approach will find that the cost and complexity will increase over time.

Next steps

Most financial services organisations will have a requirement to use LEI for reporting. However as noted above, LEI has the potential to make a positive impact across an organisation. It is therefore essential to gain cross-firm sponsorship for an LEI programme. Only by doing so will an organisation effectively position itself to capitalise fully on the opportunity that LEI presents.

Key elements of an LEI programme include:

  • Assessment of current initiatives affected by LEI;
  • Assessment of systems holding client and counterparty data;
  • Impact assessment of LEI adoption, particularly across risk management;
  • Operating model for BAU integration of LEI;
  • Development of a process to consolidate, match and deduplicate existing client and counterparty data; and
  • Matching and integration of LEI against existing client and counterparty data.

Conclusion

The financial crisis has been the tipping point for renewed focus on data standards. With G20 support, the LEI is expected to be the first such standard ready for use by the regulatory community.

Given the significant impact on supervisory reporting processes, organisations should be advancing their plans for LEI adoption. In doing so they should recognise the wider benefits that LEI can bring to both risk management and also other business processes starting with client on-boarding.

LEI presents a significant opportunity that goes well beyond enabling organisations to fulfil their supervisory reporting obligations. Organisations that embrace this opportunity will gain a deeper understanding of their clients and counterparties, improve revenue and become more agile.

Footnotes

1 A Global Legal Entity Identifier for Financial Markets http://www.financialstabilityboard.org/publications/r_120608.pdf

2 Towards a common financial language, Bank of England: http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech552.pdf

3 Basel Committee on Banking Supervision, Principles for effective risk data aggregation and risk reporting http://www.bis.org/publ/bcbs222.pdf

4 Aggregated risk on demand: Why shareholders need what regulators want http://www.deloitte.com/view/en_GB/uk/industries/financial-services/0c49ec9b1d336310VgnVCM2000001b56f00aRCRD.htm

5 CFTC Announces Website for Market Participants to Register for CFTC Interim Compliant Identifiers (CICI) http://www.cftc.gov/PressRoom/PressReleases/pr6331-12

6 Draft Technical Standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories http://www.esma.europa.eu/system/files/2012-379.pdf

7 Growth, risk and compliance: Taking a strategic approach to managing reference data http://www.deloitte.com/view/en_GB/uk/services/audit/enterprise-risk-services/ers-in-industries/financial-services/ a82567c5033f6310VgnVCM2000001b56f00aRCRD.htm

8 Risk, data and the supervisor: The clock is ticking... http://www.deloitte.com/view/en_GB/uk/industries/financial-services/6e9890d93552a310VgnVCM2000003356f70aRCRD.htm

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