17442 and all that
Years of work have culminated in a legal entity identification standard. As David Bannister reports, while not perfect, the development will help to improve credit risk management
Bored with ISO 20022? Don’t worry, here comes ISO 17442, the proposed authoritative legal entity identification (LEI) standard.
The development of an identifier that can differentiate between the many different corporate guises a financial institution may operate as – ABC Bank plc, ABC Bank (CI), ABC Investment Bank plc and so on – has been going on for some time.
It has its roots back at the turn of the century in some of the initial work done by reference data associations such as Europe’s the Reference Data Users’ Group and the Reference Data Coalition in the US. Worked then moved on to the Financial Information Services Division of the Software and Information Industry Association and more recently the Enterprise Data Management Council.
In the past two years, however, it has come alive and a proposed global standard is on the table, ready to be adopted whenever local regulators decide that it should, which could be as early as next year. And many industry participants are already looking beyond the initial goals of improving automation through standardisation and improving regulatory reporting and oversight. The LEI, they say, will form the basis of a whole new set of applications, along with new approaches to identity verification, largely based on cloud computing concepts. And if nothing else, it’ll make electronic invoicing much simpler.
The latest chapter began with the publication in December 2010 of Creating a Linchpin: the need for a Legal Entity Identifier, a discussion paper written by John Bottega, chief data officer in the markets division of the Federal Reserve Bank of New York and Linda Powell, chief of the micro statistics section of the division of research and statistics at the Board of Governors of the Federal Reserve System.
The collaborative approach recommended by that paper was clear in April this year, when nine trade associations: Securities Industry and Financial Markets Association (Sifma), American Bankers Association, Asia Securities Industry and Financial Markets Association, Association for Financial Markets in Europe, The Clearing House Association, The Financial Services Roundtable, the Investment Company Institute, International Swaps and Derivatives Association, and International Bankers Association of Japan – wrote to all G20 finance ministers indicating their joint support for the development of a uniform and global LEI.
The Office for Financial Research, established by the US Treasury to oversee this and other consequences of the Dodd-Frank Act, backed the trade associations by instructing them to make recommendations on implementing the development
By August the trade associations recommended that ISO 17442 be used as the authoritative LEI standard, with the Depository Trust and Clearing Corporation (DTCC) and Swift, plus DTCC’s wholly owned subsidiary Avox, operating the core LEI utility as the central point for data collection, data maintenance, LEI assignment and quality assurance.
Alongside this, the Association of National Numbering Agencies (Anna), through its network of national numbering agencies, will be responsible for registering, validating and maintaining LEIs for issuers, obligors and other relevant parties in their home markets.
At first glance, it has all of the characteristics of a kludge, a cobbled together solution that nonetheless works. LEIs were originally a trading systems issue that went around in circles as people argued about how granular they needed to be, and now they are a regulatory-mandated standards effort that will be largely supervised by the back office clearing and settlement people at Swift and DTCC.
And that’s just fine with everyone other than a few diehards who are still arguing about how many angels will fit on the head of a pin.
“It’s a fantastic step and it has taken the wisdom of Solomon to get Swift, the DTCC and Anna to be the combined supervisors,” says Hugh Stewart, sales director at SmartStream’s DClear Services reference data division.
Tim Lind, global head of strategy and business development, enterprise content at Thomson Reuters says: “This is the broadest group of industry associations working together on a common objective that I’ve ever seen. What I cynically thought would take a long time they got together very quickly over the summer. All of these individuals have day jobs and had to give a lot of their personal time. I was impressed by how quickly and how harmoniously they did it.”
Lind says the outcome is a good solution from an international perspective, despite being driven by the US Treasury. “It was an objective, fact-based selection process and the individuals involved were representing their firms’ global operations. It was also a Who’s Who of global investment banks: a US-only solution would have helped none of those in fulfilling their goals,” he says. “Swift, the DTCC and Swift are appropriate choices. They have one critical aspect and that is the ability to mutualise the capital required to get a project like this off the ground.”
Part of the reason that it happened so quickly was that Swift and others were already looking at the problems of creating an LEI, but it was heading in a different direction as recently as a year ago.
“Late last year, Swift had two propositions on the table,” says Marcus Treacher, head of ecommerce at HSBC global transaction banking. “One was to redevelop the bank identifier code (BIC) to make it more flexible and do more things, and the second was to enable the BIC to be a legal entity identifier. That was borne out of the back office problem that we now have dealing with de-merged organisations.” The obvious example is ABN Amro, which is now partly merged into RBS and partly into Fortis. “In this case you have an organisation whose BIC could be confused between two different organisations,” says Treacher. “In the past generally banks just bought each other, which is why HSBC’s BIC is still that of the Midland in the UK.”
Treacher says the limitations of using an extension of the BIC as a LEI were becoming apparent. “It was becoming difficult to marry up within the Swift community; certainly within the UK national members’ group. We were uncomfortable with packaging quite so much into the BIC,” he says. “So when the LEI came along, driven from the US, it gave us a big push to create an entirely separate new identifier. We felt good about that because it enabled us to deal with a new number that didn’t require the hacking around and changing of source code to make the old BIC something different from what it has been for years.”
Swift “can be very quick off the mark when it has a favourable environment with a good, strong directive” from its major jurisdictions and members, says Treacher. “If the outcome is a good standard output identifier that can be used ubiquitously and globally that will make it better for everybody.”
Paul Janssens, LEI programme director at Swift, says everybody understood the urgency and the need to work quickly on LEIs. “The Office of Financial Research made a public statement in late November that gave hard deadlines saying that by mid-2011 things need to be clarified and ready to roll in 2012,” he says.
“It was decided in February or March that a new standard had to be developed to make sure that everybody talks the same language and is looking at the same thing. It also needs a registration authority which is where Swift and Anna came into play through the International Standards Organisation [ISO] voting process.”
Swift was made the ISO registration authority and at the same time a draft standard for ISO 17442 was put together and circulated. That started in June and in November the working group will take those comments and integrate them into a final draft. This will be followed by two months where “cosmetic comments” will be incorporated, but no more substantial changes, says Janssens. After this the standard will be published by ISO and becomes official.
It is not a perfect solution, but it has removed a massive log-jam and is already helping to move things forward. “Having something new is clearly a good thing, although conceptually there is an overlap with the BIC,” says Treacher. “In some cases you will have one to one relationships, and that is redundant in terms of data normalisation. But having it, and having it not as a bastardisation of an existing code, is better than not having it.”
DClear’s Stewart also cautions on the limitations of the LEI. “I think it’s great. I’m not a naysayer I am a yea-sayer, but the hierarchies of who owns whom is very important in the credit exposure business,” he says. “My understanding is you record businesses where you have 50 per cent ownership or more, but a lot of naughtiness can occur in the sub 50 per cent level. It would have helped in the Lehman’s case to indicate to people faster if they had exposure, but it’s not a panacea.”
While the standard will mean “increased business for data management companies because it’s another symbol to cross-reference to”, Stewart points out that the different perspectives of the different users could create problems.
“The essence of risk management lies in the exposures of particular types of instruments, not in the individual instruments,” he says. “A reference data person thinks in terms of security masters, a risk management person thinks in terms of exposures and positions, not instruments and identities. The LEI can only be a good thing, but it is not a panacea for all credit management issues and is not necessarily the herald of a universal instrument master code through which all symbols will become manageable.”
John Mason, chief operating officer of data management and reporting specialist Netik, agrees. “There are current issues around the updating of BICs and updating of LEIs also will be an issue,” he says. “The biggest challenge is that it will be a living, breathing code. There is also a time series issue because you need to know what the entity was at a point in time, such as with corporate actions. This is something you don’t see with other data sets: some of the basic principles of codification simply don’t apply to financial services.”
While not minimising the pitfalls, Thomson Reuters’ Lind says the LEI will enable greater synchronisation of large data sets stored across multiple locations and talks of data enhancement, a concept that Sibos delegates are going to plenty about in the standards forum and innotribe sessions.
“LEI data is immature but is a growing content set in and of itself,” he says. “Reference data has focused on security master files, but understanding corporate hierarchies in global organisations is a new science that firms are struggling with in one way or another.”
He points to the example of the US Social Security number being used in ways beyond its original scope. “Credit scoring agencies use it as a primary means of identifying me and I think LEIs will be at the wholesale level what the Social Security number is for the individual,” he says. “Once we have a key to link information to an entity we can bring in information like news, country information, the businesses they deal with, do they still have sovereign exposures? There is a lot of this kind of information that would address creditworthiness that we haven’t done yet.”
At the basic level, it will improve the users’ ability to synchronise with data vendors and that will improve automation, but it will also lead to more specific demands for information. “Customers will be able to ask for specific information so we will definitely have to undergo product enhancements and extensions, but the most important ability will be to link content sets together that previously weren’t linked,” says Lind. “I don’t think that in the capital markets world we are as advanced as they are in the credit scoring world in terms of looking at all of the information that tells you about the performance of an organisation. A much broader concept of risk management comes from using the LEI to link all of these: it is a key opportunity.”
What was once seen as an issue in particular parts of investment banking has very quickly taken on an importance across the board. “Entity identification is not split between front and back offices; it exists everywhere,” says Janssens. “The basic requirement is coming at the risk management level. There is a business need for all firms to better identify their exposures at various levels. If you want to manage risk you need to link and map those exposures.”
The creation of new opportunities is one thing, but don’t forget the basics, says Treacher: “If you have a single legal identifier, it allows many things to happen that couldn’t happen beforehand. One is clarity around regulation and the other is clarity around counterparty risk and counterparty behaviours. Another is good old fashioned efficiency.” DNS
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