IFR Editor-at-large Keith Mullin
THE DEBATE AROUND legal entity identifiers and product identifiers has been swirling back and forth ever since we got through the shock-horror phase of Lehman Brothers’ collapse. I’ve kind of been following the conversations, but I must say it’s been from a safe distance. I rarely delve into the nether world of processing trade confirms, ticket reconciliations, settlement, clearing, counterparty risk management and the technology that goes along with it.
I’ve always tended to ply my trade around the front office end of deal-making in investment banking; it’s just, well, more glamorous. That said, the widely reported extent of chaos in the back office of most investment banks is genuinely shocking and impacts heavily on the banks’ ability to conduct business with clients and each other with full transparency. This issue urgently needs to be sorted out.
Some years ago now, you may recall that JP Morgan and Deutsche Bank – by far the two biggest credit derivatives dealers at the time – had to halt trading CDS between themselves because they’d reached position-limits thanks to the complete mess behind the traders, who basically chucked bucket loads of tickets into the proverbial windowless basement “for the back-office boys to deal with” and there was no fail-safe system for processing them. Backlogs mounted up for months until the situation reached meltdown.
When Lehman was laid to rest in Boot Hill, I similarly remember being gob-smacked when a lawyer told me it could take 20 years to unravel all of the Lehman trades and have them all reconciled. How can this be, I recall thinking to myself? That’s ridiculous.
FAST FORWARD TO the present. The use of LEIs is close to being written into law in the US under the Dodd-Frank Act. I think they’re a great idea. I’m disappointed that I missed the recent SIFMA Legal Entity Identifier Symposium in New York – OK that’s a lie – but I did read the presentation delivered to the gathering by Andy Haldane, executive director for financial stability at the Bank of England. His comments sounded pretty sensible.
Since the collapse of Lehman Brothers, he said, the international financial policy community and the private financial sector have begun laying the foundations of their own second economy.
“A sequence of international initiatives, often led by the private sector,” he said, “has taken us materially closer to constructing a global financial map. The co-ordinates of that map are defined by a fledgling global financial language.”
The combination of better quality data, more robust links in the financial information chain and common standards for recording and aggregating it makes good sense and this has formed a key plank of the Financial Stability Board’s efforts to reduce the risk of another financial meltdown emanating from poorly regulated OTC markets and poorly regulated dealers.
The Office of Financial Research, a newly formed body operating under the umbrella of the US Treasury, has been tasked with bringing about data standardisation. Its EU cognate is the European Markets Infrastructure Regulation.
The possibility of reducing the number of trade fails at a practical level will save inordinate amounts of time
Policymakers and regulators are edging towards creating a common financial language. As Haldane said, it’s a means of capturing the old banking maxim of “know your counterparty” in a common data string. “Global LEIs aim to barcode counterparty linkages at any order of dimensionality,” he said.
Beyond the strained English there, this is a tremendous initiative that’s being tested in an OTC derivatives pilot scheme run by the DTCC. The FSB is scheduled to present its LEI roadmap recommendations to the G20 summit in June.
Putting an identifier code on all counterparties and ensuring that linked entities are captured for regulatory reporting purposes is a no-brainer and should be implemented into formal regulation at the earliest opportunity.
I CAN SEE some conceptual difficulties in imposing PIs on top of LEIs. While at the margin it’s pretty simple with regard to standardised products, given the degree of innovation and creativity at play in investment banking, this will require further thinking. Productisation of client solutions is an embedded feature of the industry but by definition this is non-standard. I can see PI proliferation running away with itself and potentially undermining their utility.
That said, the movement towards central counterparty clearing for derivative products and ISDA’s work on Financial product Mark-up Language are important steps that could facilitate a PI framework that covers most products. Given that the work on identifiers is geared towards improving risk management within firms and between firms, it’s perhaps no surprise that the industry is broadly positive towards developments here.
The possibility of reducing the number of trade fails at a practical level will save inordinate amounts of time and could help the industry save hundreds of millions of dollars. Beyond that, the ability to access data not only on counterparties but also on counterparties’ counterparties will be invaluable for banks and their trading clients in settling risk limits and monitoring them.
The use of LEIs should be mandatory; the initial thinking is that they’ll be optional. Regulators should offer data and technology vendors a transition timetable to adapt existing identification systems to the common standard. If it’s such a good idea, which everyone seems to agree it is, why waste time?
