Identifying and Managing Risk in an Increasingly Digital and Interconnected World
In this blog, Alan Deaton, Chairman of the Legal Entity Identifier (LEI) Regulatory Oversight Committee (ROC), summarizes the important role that the LEI plays in helping businesses manage risk. At a time when market recovery from a global pandemic is a universal priority, he outlines how lowering risk through trusted identities and transparency can support growth, efficiencies, and stability across the global economy. He also emphasizes the need for industry collaboration to unlock the benefits of wider-scale LEI adoption.
Author: Alan Deaton
Many who work in the financial industry are familiar with the LEI and the value it adds to the payments and securities industries and digital supply chain. In fact, many industry representatives recognize that this 20-character alphanumeric code, which acts as a unique identifier for legal entities, could play an even greater role beyond the finance world. Its potential importance in identifying and managing risk should not be overlooked, particularly as our increasingly digital society seeks to rebound from the economic repercussions of a global pandemic. When business-as-usual resumes, growth and stability, underpinned by risk mitigation, will be a key priority.
LEI legacy: promoting stability and growth in the financial market
The origin of the LEI was the financial crisis of 2008. At the time, the downturn was one of the most severe in decades, which resulted in nearly nine million people in the U.S. alone losing their jobs. As a consequence of the economic downturn, almost 500 banks failed. Estimates of the cumulative net cost of the crisis to the U.S. range from 10 to 14 trillion dollars, or up to roughly 80 percent of annual GDP. The U.S. was not alone in suffering such losses. Similar storylines ran worldwide, requiring extreme market interventions from Europe to Asia.
The cause of that economic crisis was very different from the current global situation. Experts agree that the 2008 downturn was rooted partly in the degree to which the global financial system had become highly concentrated, interconnected, and perhaps most importantly, in this context, opaque. Innovative products and mechanisms linked homebuyers in the U.S. with financial firms and investors around the world. When one of those firms showed signs of trouble, its counterparties struggled to assess their exposure to potential loss. Similarly, financial regulators grappled with the unclear consequences of such a failure, in part because no industry-wide and global standards existed for identifying and linking financial data representing entities or instruments.
Following the crisis, leaders from the world’s largest economies, operating through the G20 and the Financial Stability Board (FSB), agreed to develop a coordinated solution to help overcome these impediments. And so, the Global LEI System was born. Stakeholders from around the world, including regulators, industry, and private firms, worked hand in hand to develop a global standard for identifying legal entities. This public-private partnership has been very successful, with LEIs issued to over 1.5 million entities in more than 220 countries.
The Global LEI System increases transparency for investors, reduces reporting burdens for financial companies, and promotes market discipline and efficiency. It also addresses one of the root causes of the 2008 financial crisis, in an effort to help prevent a similar economic consequence unfolding in the future. The success of this effort illustrates the immense power of partnerships in advancing the public good.
As Chair of the LEI ROC, I am proud of these achievements. But there is still work to do. Efforts continue on several fronts to increase the transparency and efficiency of markets around the world. For example, in October 2019, the FSB established governance arrangements for a globally harmonized Unique Product Identifier (UPI) , which will facilitate the effective use of over-the-counter derivatives trade reporting data and help authorities assess systemic risk and detect market abuse. Lack of transparency in derivatives markets was one of the key problems identified by the financial crisis.
Looking ahead: the potential of the LEI beyond the financial world
While delivering on public policy and financial stability goals, the LEI has also been useful in supporting commercial business needs. Benefits to firms include not only the potential to decrease the cost of regulatory compliance but also to reduce entity resolution costs, increase efficiencies, and improve operational risk management. The need for a global legal entity identifier for business is no more evident than in the business climate in which firms of all kinds—large and small, financial and nonfinancial—now operate. Best practice mechanisms which promote growth, efficiencies, and stability are vital to firms seeking a strong recovery from the global pandemic, which has affected markets world-wide. In parallel, the supply chain has become increasingly global and digital. It requires even more stringent and transparent systems for identifying business partners. The LEI is the leading candidate to provide such high quality identification of legal entities. As an open, freely available source of legal entity reference data, its usefulness will only grow with more widespread adoption and its use in identifying firms, their family structures, and their counterparties. Embedding the LEI in digital business processes will further enhance the interests of both the business community and public policymakers alike.
In 2019, the FSB published a peer review of LEI implementation that highlighted the successes and shortcomings of LEI adoption to date. It noted that the benefits of the LEI are substantial, in particular, its support of regulatory and private sector analysis of counterparty risks, interconnectedness, and complex group structures. The FSB recommended in the peer review that the LEI ROC and GLEIF work further with industry and the public sector to raise awareness of the benefits of the LEI and to encourage greater adoption by demonstrating use cases for market participants and by supporting pilot programs and research projects.
The LEI ROC remains committed to open and constructive dialogue with the private sector to advance our common interests in the Global LEI System and the benefits it provides. GLEIF’s regular ‘Meet the Market’ events provide both the ROC and GLEIF with the perfect opportunity to engage with a diverse group of experts from the business community and discuss how the LEI can improve the environment in which businesses operate.
The ultimate success of the Global LEI system in solving public policy and business process challenges will continue to require support from the global regulatory community, private sector firms, and industry associations. On behalf of the LEI ROC, I warmly welcome engagement with all stakeholders so that we can collectively advance the Global LEI System and reap the myriad benefits it places easily within our reach.
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Alan Deaton is the Chairman of the Regulatory Oversight Committee. He serves as Associate Director in the Division of Insurance and Research at the Federal Deposit Insurance Corporation (U.S.). He oversees a team that manages critical data collected from insured depository institutions, maintains a variety of data management systems used to analyze the data, and publishes the data for public use. Alan has worked at the FDIC since 1997 and has held roles in project management, data management, financial analysis, and economic analysis.