The Legal Entity Identifier (LEI) and Counterparty Risk – Ready for the Next Crisis?
By Larry Roadcap, FI Consulting
I recently attended a Global Financial Markets Association (GFMA) event in New York to learn more about the development of the global Legal Entity Identifier (LEI) system – a 20-digit, alpha-numeric code that is the emerging standard for identifying counterparties and market participants in financial transactions.
At first, LEI didn’t seem like an exciting topic until I heard first hand from advocates, such as SEC Commissioner Kara Stein and OFR Director Richard Berner, about the tremendous benefits the LEI system will bring to an industry that continues to struggle to understand the distribution of risk exposures in the financial system. Though institutions have invested heavily in risk data aggregation and stress testing capabilities, far too many institutions still spend weeks each month compiling the most basic information about their counterparty exposures. It has been seven years since the Lehman Brothers crisis but many institutions are still unable to identify their exposure to a specific counterparty with any degree of accuracy in a timely manner.
I’m convinced that the global LEI system is a game changer for monitoring counterparty risk and with broad adoption it will bring about tremendous operational efficiencies, more accurate calculation of exposures and stronger risk management practices. I left the GFMA event surprisingly excited about something as mundane as a data standard.
Here are some of the key things I learned about the LEI:
- Institutions spent days, weeks and even months trying to pull together a view of their exposure to Lehman Brothers in 2008 – leaving many exposed and unable to act while markets moved against them.
- Public and private entities supported by the Financial Stability Board and endorsed by members of the G-20 want to address this critical weakness by developing the LEI system to be an international standard to identify legally distinct entities as transaction counterparties.
- LEI advocates such as SEC Commissioner Stein and OFR Director Berner are compelling supporters with the vision and energy to focus the attention of the global community of regulators, private firms and industry associations to get the LEI rolled-out.
- More than a quarter of the 370,000+ LEIs in 191+ countries are in the US where regulators mandated use of LEIs for swaps reporting. Advocates think that further regulatory mandates will be required to accelerate adoption in other asset classes.
- Data quality will be an issue without supervision and appropriate incentives to keep LEIs up to date. Corporate identifiers are complicated due to the sprawling nature of global institutions with complex parent and subsidiary ownership structures that frequently change. Maintaining the record of relationships will require an ongoing investment of resources from registered entities.
- Institutions who began using LEIs for swap reporting have seen immediate benefits. Industry panelists expressed a common and understandable degree of regulatory fatigue but several large players acknowledged that LEI adoption has allowed them to dramatically improve the quality of their information and reduced the time required to analyze counterparty exposures.
Learn more about the Global Legal Entity Identifier System at https://www.gleif.org/en.
Larry Roadcap leads FI Consulting’s Commercial Financial Institutions practice which serves the needs of our for-profit clients outside the government sector. He is a financial systems and risk management executive with 20 years of experience working with banks, corporate finance teams, and capital market participants across the US, Asia, Australia, and the UK. Larry is responsible for ensuring clients get the most from FI Consulting’s services across our core expertise in data management, risk analytics, financial modeling, and technology. Larry is a Virginia native and holds degrees from Georgetown University, Columbia Business School, and the University of California – Berkeley.