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Financial Planning > Behavioral Finance

Could 20 digits prevent another financial crisis?

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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.

And last month the SEC proposed rules that would require mutual funds and ETFs also to have LEIs, but there is no mandate yet for financial advisors. If, however, an advisor has an LEI, the advisor must include it on its Form ADV. Also, investment advisors that manage private funds must include the funds’ LEI on the PF forms they file on the funds’ behalf, according to the Investment Adviser Association.

It’s possible at some point that advisors will be required to have LEIs, and if that happens they will file, says Brian Hamburger, president and CEO of MarketCounsel, a business and regulatory compliance consulting firm that works with investment advisors.  “It’s a ridiculously simple process,” says Hamburger. “Investment advisors are typically not seeking anonymity.  Rather, it’s their clients that often seek discretion.” Hamburger says he’s hasn’t heard anything from advisors or regulators about the issue.

Entities can obtain LEIs from one of many Local Operating Units that issue them, such as the DTCC (formerly known as Depository Trust and Clearing Corp.) There are currently 20 LOUs around the world. They’re overseen by the Global LEI Foundation, or GLEIF, which maintains a centralized database of LEIs and their reference data — a system known as GLEIS, for Global LEI System. A Regulatory Oversight Committee (ROC), representing 60 financial regulators from around the world, oversees GLEIS.

Stein lauded this “public-private partnership” behind the LEI program which is being adopted in phases. The first phase — Level 1 — includes essentially an entity’s business card — name, address, date the LEI was established and last updated, and so on. The second phase will include more data about corporate hierarchies — the immediate parent and ultimate parent of the entity, according to Matthew Reed, the chief counsel of OFR and chair of the LEI Regulatory Oversight Committee, who was on one of the panels at the SIFMA conference.

“More regulation will drive adoption” of LEIs, said Ari Marcus, director of Citigroup’s Information Services Group, who was on another panel at the conference. He said Citigroup is an advocate of the LEI system because it “helps establish and label relationships” and “lowers operational risk.” 

See also:

This is what the fiduciary debate is really about

6 questions you should ask about variable annuities


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