BoE's Haldane urges tags on trades to cut risks

LONDON, March 14 Wed Mar 14, 2012 9:31am EDT

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LONDON, March 14 (Reuters) - A common global tagging system for financial trades would make markets safer and allow faster risk assessment while potentially boosting competition in banking, a top Bank of England official said on Wednesday.

His intervention backs moves by leaders of the world's top economies (G20) who meet in Mexico in June to endorse a global governance framework for a Legal Entity Identifier (LEI), one of their post-financial crisis reforms.

The aim is for each firm that trades on financial markets to have its own unique code, so it can be quickly recognised when regulators want to check whether exposures are becoming risky.

"Missing inventories and mistaken counterparties could be all but eliminated if financial firms' information systems spoke in a common tongue," BoE Executive Director for Financial Stability, Andrew Haldane, said in a speech in New York.

Markets were unnerved when it took regulators so long to find out who was exposed to derivatives transactions on the books of U.S. bank Lehman Brothers when it went bust in 2008.

Lehman was "seriously defective" with no clear firm-wide picture, Haldane said.

"It is clear that these failures in data infrastructure and aggregation were not unique to Lehman. They were endemic across the financial industry," Haldane said.

The LEI notes the bank's full name, address and other basic details and would be tagged to each transaction.

A global industry coalition has proposed introducing an LEI system this year, starting with transactions in derivatives like credit-default swaps and interest rate swaps, with other assets such as stocks phased in later.

The 20-digit code would be designed by the International Standards Organization (ISO) and operated as an at-cost utility by the U.S. Depository Trust & Clearing Corp (DTCC) and the Society for Worldwide Financial Interbank Telecommunication (Swift), an electronic messaging system between banks.

The G20's regulatory arm, the Financial Stability Board (FSB), is drafting the governance framework and backing for the industry plan from world leaders would mean wider buy-in to make it cheaper to launch.

People familiar with the thinking among regulators say the aim is to have a common global standard that is flexible enough to be applied across the world's three main regions.

The new system should be open, freely available and not bundled with other services, the sources say, adding that a "federation" of systems using a common standard would be cheaper and more flexible, and avoid over-reliance on one system.

Existing identification systems could be adapted and plugged into a federated system to avoid the high outlays.

All types and sizes of financial institutions that are counterparties to transactions would be encouraged to use the LEI, though it would not likely be mandatory at the start. Non-financial companies that use derivatives to hedge against adverse price movements would also be expected to use an LEI.

USEFUL PILOT

In any case an LEI mechanism will have to start in the United States on July 16 for identification of swaps under the U.S. reform of Wall Street known as Dodd-Frank.

"The initial system operation date is June of this year," a DTCC spokesman said.

The regulatory thinking is that the U.S. system could then be later plugged into a federated global system.

"This pilot will provide valuable experience when moving to a broader range of products and market participants," Haldane said.

The LEI is part of wider efforts to shine a light on markets in combination with a G20 pledge for all transactions in the $700 trillion derivatives sector to be logged at a repository.

"The regulators want to know who owes what to whom but the LEI is only the first step," said Alistair Milne, professor of financial economics at Loughborough University in Britain.

"The more difficult challenge is having the standardised classification of derivatives instruments," said Milne, a former Bank of England and British finance ministry official.

Regulators say product identifiers would come later.

In a rare endorsement for a G20 regulatory reform, those directly affected, banks and brokers, have welcomed the initiative because it will slash compliance costs.

Other G20 rules like stricter capital buffers are bumping up costs for the industry.

An industry grouping said in a submission to the U.S. Securities and Exchange Commission last year an LEI will allow automation of "back office" transaction processing which is currently costly due to a patchwork of identity codes.

For example, UK retailer Tesco has about 40 identifiers, including those provided by financial industry data providers Thomson Reuters, Bloomberg LLP, Edgar Online, ExtelFinancials and Hoover's.

Industry officials say it was not clear if these proprietary codes would eventually be replaced by a global LEI.

It was estimated in the submission to the SEC that each big U.S. bank spends $250 million to $1.25 billion a year on processing non-standardised, faulty or duplicated data. An unidentified investment bank has estimated it would save $300 million from an LEI regime, the submission said.

"The industry will benefit from improved risk management, including a more holistic view of counterparty exposure, as well as operational benefits," said David Strongin, managing director at SIFMA, which is part of industry coalition proposal.

The LEI will also give big banks a quick snapshot of all exposures for drawing up "living wills" on how they would be wound up quickly without triggering major market upheavals.

"Reconciling competing claims on Lehman Brothers' asset pool has already taken insolvency practitioners three and a half years and thousands of man hours," Haldane said.