Final Report on Global Identification Standards for Counterparties and Other Financial Market Participants

Abstract

Financial service industry regulators are focused on observing systemic risk across enormously complex interconnected global financial institutions. While these systemically important financial institutions continue to improve their enterprise risk management techniques and systems, regulators are now intent on adding new tools and improved methods to analyze the systemic exposures that arise across these firms and across the global financial system. Many approaches are being considered to aggregate risk within and across financial institutions and provide for transparency of financial transactions and risk exposures. Without the ability to view the underlying positions and cash flows, valued in standard ways and aggregated by counterparty through common identifiers, neither risk triggers nor risk exposures can be observed nor can systemic threats be detected.

It has been accepted by regulators that the very first pillar of global financial reform is a standard for identifying the same financial market participant to each regulator in the same way. Getting agreement on a globally unique and standardized legal entity identifier (the LEI) is the first step.

This paper is the final report by Financial InterGroup (FIG) on past and current efforts of its principles, along with industry members and sovereign regulators, newly empowered by the G20’s Financial Stability Board (FSB) - the Regulatory Oversight Committee (ROC) and the Global Legal Entity Identification Foundation (GLEIF), to develop a global identification system for such purpose. The FSB’s initial focus, counterparties in over-the-counter derivatives transactions, is but the first use of the LEI. The LEI aspires to be the universal identifier for each financial market participant across all financial transactions. In this paper we propose a government and industry partnership in which governance is shared and operating elements of the global identification system are compartmentalized for control, security and confidentiality purposes. The paper previews a global LEI code standard along with its operational and specific technical implementation. The entity-specific standard proposed is a unique, unambiguous and universal set of characters constructed around a structured, non-intelligent two part apportionment and assignment process to be conducted between regulators, their agents and financial market participants. It is shown that this two part code construction is essential to accommodate requirements of sovereignty, control and confidentiality put forward in more recent regulatory requirements. It is also shown that the establishment of business hierarchies, of consolidated group level control structures, of synchronization with internal organizational business structures, and maintaining control of changes to the registered legal entities from corporate actions within a globally federated network is best accomplished through this unique code construction method. We conclude that the proposed global identification system satisfies all known short term and longer term regulatory requirements for the LEI. Its proposed design offers practical solutions to hierarchical, maintenance and synchronization issues while avoiding perpetuating mapping issues that have plagued the industry for decades and that other suggested solutions would engender.

It also lays the foundation for further rulemaking on issues yet to be addressed for contract and instrument identification, for corporate event identification and for data aggregation of valued positions and cash flows for systemic risk analysis, the latter being the ultimate objective of the rule-making.

Keywords: counterparty risk, systemic risk, legal entity identifier, financial crisis, Dodd-Frank

JEL Classification: C8, E1, F02, F22, F23, C15, C18, G2, G38, L1, L8, O3, G18, G21