| LONDON, March 14
LONDON, March 14 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.
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
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.