Integrating the LEI to enhance data and risk management
Stephen Koch is senior director, pricing & reference data, at Interactive Data Corporation
With the newly formed LEI Foundation moving forward with establishing processes for issuing and managing the Legal Entity Identifier through its Regulatory Oversight Committee and the registration of seven pre-Local Operating Units, it is worth taking a step back to understand exactly why the industry is pushing forward with the LEI and what it could achieve, writes Stephen Koch.
Although the primary driver behind the LEI is the need for regulators to improve oversight of systemic risk, there are secondary drivers, which have garnered support among many financial participants. Financial firms are starting to explore the potential of this identifier beyond its initial intended purpose. While the debate may continue about the best way to implement the LEI, most participants have not only resigned themselves to its creation, but are actively supporting it.
We are still at the early stages of a journey toward what could become a global standard; however thoughts are already turning to the application of the LEI in a wider context. Using the LEI as a common data point to cross-reference other codes and link to core reference data would bring a number of operational benefits.
When packaged with additional content and reference data, the LEI becomes a tool to aggregate different identifiers to support an investment firm’s business requirements. Data linking via the LEI could support financial institutions’ efforts to improve the flow of data, by adding clarity and timeliness as well as enhancing risk management processes.
As such it would also feed into the data validation and maintenance required for regulatory initiatives including AIFMD, Dodd-Frank, EMIR and FATCA, alongside any internal efforts to improve data and risk management procedures.
LEI implementation considerations
As firms think about bringing the LEI into their workflows, there are five steps that should be considered for a successful integration to exploit this potential.
First, every firm, if they have not done so already, should take the time to understand what the LEI is, and what it does or does not provide. It is important to understand that the LEI is intended to be an unambiguous identifier for the entities that are participants to a financial transaction. It is intended to replace the ambiguous, freeform name and address fields that most firms and regulators currently contend with. However, the LEI does not identify securities issued by a legal entity, nor does it explain the relationships between entities (e.g. parent/subsidiary, affiliates or other hierarchical relationships).
Second, it is critical that each firm reviews the current state of counterparty data within their organisation. Ask yourself how entity data is currently being stored at your firm. Is it easily accessible in a separate entity database, or is it more difficult to extract because it is mixed with other reference data? If separate, is it being held in a central depository or duplicated in separate silos? Understanding where and how your counterparty data is stored enables you to better understand where your systems will have to go.
The third aspect to examine is how and where counterparty and issuer data are used today. Cataloguing current uses such as trade comparison, risk analysis and portfolio management, is essential to prepare for step four, which is defining the use cases for the LEI going forward.
The most obvious use cases for the LEI are driven by regulatory requirements. It is critical when building use cases to first identify the effective dates for compliance with applicable regulations.
Developing other use cases may be as simple as looking at how to improve existing processes by substituting the LEI for freeform entity text descriptions. For others it may be more complex as these use cases may only be partially addressed by the LEI in its current state and may require additional data. For example, it may be necessary to supplement the LEI with additional external data to understand the linkages between issuers and their securities and the hierarchy of an organisation’s legal entities.
The most difficult use cases require discussions about difficult processes never undertaken or previously abandoned because a tool like the LEI did not exist. For example, organisations will be able to analyse bonds based on lead manager, guarantor, obligor or custodian, all entities currently identified in freeform fields, once these entities are assigned an LEI. This will allow them to better assess their exposure to an entity regardless of the entity’s role. Additional use cases may be identified after the establishment of the LEI. It therefore makes sense at this stage to reach out to all the internal business units to identify as many use cases as possible.
The last step in preparing for the LEI is to create a plan. With the above information collected and the use cases created, prioritising each use case is paramount. Regulation will take care of some of the use cases, for example, if a regulatory body is mandating use of the LEI by a particular date, then all work needs to accommodate that deadline.
Prioritising other use cases will be decided based on the current criteria your firm uses whether that is ease of implementation, improvement of service or efficiency vs. cost of implementation; keeping in mind that it may make sense to overlap development.
The LEI is not a panacea. It is not meant to be. Rather, it is meant to be a tool, and one that when fully exploited can transcend its initial intended purpose. To fully capitalise on this identifier, though, takes preparation and planning. By following the five steps outlined above, financial firms will be in a much better position to fully tap the potential of the LEI.
