Regulators, markets must embrace new tech for enhanced transparency

The legal entity identifier (LEI), much like the United States’ employer ID, is a business entity identifier but with a distinction. It is a universal code meant to be used as the entry key to the global financial system by businesses wherever they are domiciled.

This code must be used to send financial data to regulators. Without this code, businesses, clients and financial institutions alike, cannot transact in the global capital markets.   

The LEI is the direct result of the observation after the Lehman Brothers bankruptcy in 2008 that its 6,000 subsidiaries, affiliates and other organizational components spread across the world could not be identified through automated means.

Lehman and all who did business with them as well as all who regulated them had different identities for the same legally separate but, from a risk perspective, co-joined parts of Lehman. 

This global issue was taken up in 2009 by the Group of 20 (G20), a global body of the heads of the world’s leading economies. It empowered a new standards entity, the Financial Stability Board (FSB), to oversee global financial stability.

In 2012, it endorsed the global LEI system as set out in the FSB Report of the Global Legal Entity Identifier for Financial Markets and called for global adoption of the LEI to support the identification and management of financial risks.

The FSB is chaired by Bank of England Governor Mark Carney. It counts the top 35 financial regulators of the G20 member jurisdictions, as well as international financial institutions and global standards bodies, as its members. 

Some U.S. legislators have declared America's sovereignty from the FSB’s broader initiatives related to global financial regulatory standards. However, not adhering to the LEI as a business entity data standard, given its benefits, should be off the table.

The operational overseers of the LEI, the Global Legal Entity Identifier Foundation (GLEIF), is comprised of a board of 16 industry representatives. It has even grander ambitions for use of the LEI beyond finance.

In September, the GLEIF and the Data Coalition, a U.S.-based trade association advocating for the publication of government information as standardized, machine-readable data, published the GLEIF and Data Foundation Research Report - Envisioning Comprehensive Entity Identification for the U.S. Federal Government.

Their joint aim was to determine how LEI adoption by U.S. federal agencies could streamline entity identification and produce benefits within and beyond financial markets. 

The report found 50 distinct business identification systems among federal agencies. At this same time, the FSB launched a peer review on implementation of the LEI and invited feedback from stakeholders on expanding its use.

The situation the FSB first observed in the complex infrastructure of finance, where thousands of multiple identity codes of the same entities exists, as demonstrated by the GLEIF/Data Coalition report, is also prevalent among all types of regulatory bodies and businesses. 

Past solutions have led to sustaining systems architectures wherein each identity code is connected to another through a concept of interoperability. It is a legacy concept reinforced by regulators’ acceptance of industry best practices which, by its very nature, is backward looking.

Interoperability is enabled by the costly and risk-prone matching (mapping) concept associated with maintaining proprietary identity data. This technique appears to be the preferred answer.

It postpones replacing internal legacy systems at the cost of capital in favor of permanently sustaining higher costs and greater risk for all in maintaining mapping tables. The cost amongst the world’s 134 domestic and global systemically important financial institutions is estimated at $250 billion annually.

What is wrong with sustaining the mapping process that is the anchor of interoperability?

Mapping requires matching different computer readable identity codes. There are literally thousands of these codes, all representing the identical business entity. If the matching tables storing these codes were static, as language dictionaries are, it would not be much of a problem.

However, entries in the tables maintained by firms throughout the global supply chain are always changing, changing at different times and, at times, incorrectly changing.    

This mapping and interoperability model is still being embedded into regulators’ and the industry’s digital long-term futures even though new technologies such as distributed ledgers, smart contracts, artificial intelligence and machine learning need singular data standards to be effective.

Originally thought of as the industry’s collective action problem, regulators participation and collaboration is now the key to meaningful progress in LEI adaption. The FSB, as the highest-level bully pulpit for regulatory initiatives, is seen as the solution to this collective action problem.

Compelling regulation is the only way to assure every affected party commits to the long game to implement a global business entity standard.

With distributed technologies and global data standards as an enabler, the interoperability model needs to be reviewed for replacement over time with the long-sought-after digitally aligned straight-through-processing model.

The LEI is the first significant step toward that objective. Regulators and businesses alike need to adapt this singular, uniquely global business identifier. Transparency in our digital future depends on it.