Connect with us

FINANCE

LEI: Not a garland from Hawaii but a foundational risk management component  

LEI: Not a garland from Hawaii but a foundational risk management component   38

By Peter Newton, Managing Director and Eric Mueller, Strategic Netting Lead, D2 Legal Technology

What is a Legal Entity Identifier (LEI)?

Introduced under a mandate by the Financial Stability Board in November 2011 following the credit contraction of 2008, the LEI is a 20-character, alpha-numeric code based on the ISO 17442 standard developed by the International Organisation for Standardisation (ISO). It provides key reference information that seeks to create unique identification of legal entities engaged in financial transactions anywhere in the world. Each LEI provides information about an entity’s ownership structure and enables financial market participants to understand ‘who is who’ and ‘who owns whom’. In essence, a publicly available LEI data pool is a golden source reference library which is designed to provide transparency for all participants and certainty of who you are facing in transactions.

New regulations have been introduced around the world over the past decade that mandate the use of LEIs when firms are transacting in the Capital and Commodities markets and are required to provide reports to global regulators and Trade Repositories. In the EU, these regulations include MiFID II and EMIR which require EU firms to document trades with the trading counterparty’s LEI.  Similar rules exist around the globe, such as the Dodd Frank regulation in the United States. From a regulatory perspective, LEIs provide a reliable entity identification data point, which is of benefit to the transacting parties and to the market as a whole.

While LEIs are mandated for trade reporting, the benefits of using LEIs as a key client identifier extend much further. Processes such as KYC, AML, risk management, regulatory capital calculations, cross-border and conflicts compliance, to name but a few, can benefit from the use of LEIs to consistently and accurately identify clients and their associated risks. The application of the use of LEIs integrated into each of these processes has been slow. This is not surprising, as legacy systems, processes and databases are difficult and time consuming to change. These challenges have been highlighted in the Bank for International Settlement (BIS) April 2020 report: “Progress in adopting the Principles for effective risk data aggregation and risk reporting”. Of the 34 global systemically important banks (G-SIBs), only five banks report full compliance with the BCBS 239 data architecture and IT infrastructure principals. The report cites one of the principal challenges as “adapting to one single source for data due to the fragmentation of the data landscape.”

Driving greater adoption of LEIs by accruing tangible benefits from their integration into firmwide data structures across lines of business and functions would improve client experiences, ensure more accurate risk management and better alignment with initiatives such as BCBS 239 and act as a foundation for cross functional data standards. Better handling, classification and management of the due diligence function of who you face is critical to the ability of firms to unlock business value and manage their businesses in an orderly and efficient manner.

LEIs are a crucial foundation to a digitalised future, where resources such as capital, liquidity and collateral are optimised by financial institutions. In particular, prudentially regulated financial institutions continue today to struggle with counterparty data management for netting (and collateral enforceability) determination purposes. Unlike other areas of client data, the due diligence continues to be undertaken by very senior in-house lawyers – ill-suited to such a high-volume operational task. Forward-thinking firms have started the journey to address this, with their legal functions providing the classification guidance, and moving the actual due diligence roles to operational client-onboarding teams, with some two-thirds of respondents to a recent D2LT industry survey revealing this as a key direction of travel. Furthermore, they are keen to address this task as an industry – with the due diligence completed once per LEI – rather than by each prudentially regulated firm.

This results in reduced costs for the counterparty due diligence that needs to be conducted, by circa. 50%, allowing legal headcount to be redeployed on more technical matters of law with much greater value to the firm. This is a key step in re-imagining the legal operating model of the future as well as reduced regulatory capital requirements and credit and legal risk.

LEIs and their subsequent classification (if treated correctly) solve a number of business-critical functions both at the point of origin/ ingestion and for use in downstream data sets and provide certainty about the entity type being faced and therefore the nature of business that can be transacted under close out netting legal opinions which act as an additional risk management tool alongside Collateral in insolvency or bankruptcy situations. The regulator is seeking greater transparency in markets and ways for firms to better risk manage their positions; LEIs provide this level of comfort for both firms and regulators – a goal to be embraced to ensure financial stability.

Continue Reading
Editorial & Advertiser disclosure

Recommended