Ever met a regulator that didn't like surveillance? Fed keen on LEI, too (AP Photo/J. Scott Applewhite, file)

The National Association of Insurance Commissioners (NAIC) membership has decided to add the Legal Entity Identifier (LEI) tool to state insurance industry regulatory reporting in order to track entities beyond country borders in an effort to strengthen cross-border regulation after the 2008 financial crisis.

The LEI is scheduled for launch in March 2013, when new regulatory reporting requirements become effective.

Current registries are unique within countries and across different markets, which was a challenge with derivative counterparties and exposures during the financial crisis, as the NAIC stated. As such, regulators and participants from the derivatives and securities industry are heavily involved in the new system. 

According to an NAIC Capital Markets Bureau report, all entities (excluding natural persons but including government organizations) engaged in financial transactions, participating in financial markets, or subject to regulation by a financial regulator, their parents, and their affiliates are eligible to obtain an LEI. 

As the Federal Reserve-led background paper last year on the subject noted, passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act sparked a discussion about creating a systematic code that uniquely identifies an entity or the LEI. 

The goal of the LEI project is to assign a unique 20-digit identifier to any entity that engages in financial transactions. The project determines who is eligible to have an LEI and the rules under which they are assigned. While the LEI project determines eligibility, it is up to specific financial regulators to decide when the LEI is required and how it should be used. 

The LEI project is coordinated by the Financial Stability Board (FSB) and endorsed by the G-20. 

The FSB strongly supports rapid implementation of the global LEI system. Early delivery of the system would advance multiple G-20 financial market initiatives and provide manifold benefits to the global regulatory community as well as to the private sector, the FSB wrote.

The FSB recommended adoption of an implementation plan with the goal of establishing an independent, open, fair and transparent global LEI system by the end of 2012 with the system independently functional by March 2013.

U.S. insurance regulators have been involved in its development since early in 2011 as the project work streams got under way and are among the first regulators to adopt usage, according to the NAIC.

The June FSB paper on the subject asked,” Given that a unique LEI system for financial markets offers manifold benefits, an obvious question is why such a system is not already in place?”

“There are insufficiently strong incentives in private markets to overcome two sources of market failure. The first is a problem of collective action and co-ordination, reflecting the challenges of gaining agreement that a particular identification scheme offers the best approach. The second reflects the problem of launching a network. The benefits from the system increase as more and more parties acquire an LEI. At the launch, private incentives for potential early movers to acquire an LEI are low. To date it has proved impossible to get over this initial hurdle relying purely on voluntary adoption and market incentives.

…To ensure global acceptance and the long-term future of the LEI system, the public sector must put in place a governance framework with a number of key objectives: to support the delivery of a public good; to ensure that public interests in the system are protected; to promote common standards; and to facilitate widespread global adoption,” the FSB wrote.

Powell et al also noted that “confidentiality of the reference data, particularly ownership information, is likely to be a hurdle that must be discussed and addressed. The international nature of the LEI requires flexibility in confidentiality because of legal and cultural differences across borders.”

“The LEI system will improve the ability of insurance and other financial regulators to track, analyze and understand interconnectedness, risk exposures and systemic issues in a global marketplace,” said Kevin McCarty, NAIC president and Florida insurance commissioner. “This project represents a significant improvement in global transparency.”

There will also be reference data maintained by the registrars.

The proposal to add the LEI was exposed for comment in June and discussed among state regulators and industry participants at the Atlanta Summer National Meeting; after which the proposal was unanimously adopted by the NAIC’s Financial Condition Committee. The LEI proposal went through this process and has been adopted by all members of the NAIC through the technical changes process.