What if early in the financial crisis banks, brokerages, money managers, financial regulators and central banks around the world knew what institutions were involved in which transactions and the extent of their exposure and that of their counterparties? Could that have prevented the last financial crisis — or the next one?
SEC Commissioner Kara Stein thinks so. She told an audience of financial professionals at the New York headquarters of the Securities Industry and Financial Markets Association this week that a global system of legal entity identifiers (LEIs) “has the power to help us prevent another financial crisis.”
The LEI is a unique 20-digit alphanumeric code that identifies a legally distinct entity involved in a financial transaction. A global system composed of these identifiers would allow regulators and risk managers at financial firms to identify which parties are involved in which transactions so they could evaluate and analyze potential risks to the financial system and individual firms, respectively, according to a U.S. Treasury FAQ on the topic.
So far, 368,000 LEIs in 191 countries have been registered globally. Twenty-seven percent are in the U.S. Stein would like to see many more LEIs and urged her audience of financial industry reps to help spur the growth.
“The regulators have provided the initial momentum and have mandated LEI in a number of rules,” said Stein. “It’s now time to pass the baton to the industry to accelerate the incorporation and acceptance of LEI in financial transactions around the world… and integrate LEIs into standard industry practice — including risk systems and reporting systems.”
Stein said the LEI system would not only reduce risk in the financial system but also has the potential to reduce compliance costs and target risk management activities. “Greater use of LEI could increase profits while mitigating market risk,” Stein said.
Stein, who describes herself as a “geek” who wants the SEC to create an Office of Data Strategy — said “developing a comprehensive approach to standardizing data is critical.” She explained that during the financial crisis there was lots of data available but “neither regulators nor market participants could fully evaluate risk exposures or interconnectedness. Opacity fueled uncertainty, and that uncertainty sparked fears that ultimately froze the credit markets and shook the financial system. “
Among other initiatives following the financial crisis, Congress created the Office of Financial Research (OFR), which is housed in the U.S. Treasury and is leading the universal adoption of LEI. Congress also passed the Dodd-Frank Act to minimize systemic risk. Under that law, the SEC now requires that financial firms that are parties to security-based swaps have LEIs — which is also mandate in Europe and Canada.