Legal Entity Identification (LEI) for Financial Contracts, a Universal Standard for Identifying All Parties to Financial Contracts is a new standard to be established by U.S. Treasury - Office of Financial Research. It is a key element in the broader effort to understand and monitor systemic risk. Its creation will likely have exceptionally broad impact throughout the financial markets at a very fundamental level.
A solution put forward by the Depository Trust & Clearing Corporation (DTCC) and SWIFT was recommended by the umbrella Global Financial Markets Association (GFMA) trade association. In this solution, SWIFT will act as the registration authority, acting on behalf of International Organization for Standardization (ISO) to assign the ISO 17442 LEI standard. DTCC will act as the facilities manager, receiving, reviewing, and publishing entity information.
As stated in the development notice published in the Federal Register "The scope of the reference data provided for each LEI issued should be sufficient to verify that users have correctly identified an entity and should include at a minimum the following information for each Identifier: "
It is unclear if the data elements associated with each identifier will all have information that can link parents, subsidiaries and various affiliate relationships. More below.
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Any trade on any exchange will likely involve many LEIs encoded into the detailed transaction record: buyer, buyer's broker, seller, seller's broker, exchange where traded, clearing facility, company that issued the security being traded, etc. In addition, its likely any related "infrastructure" firms involved in supporting that trade (deemed by Treasury to be potentially systemically important) will also have its LEI encoded. The concept is to pin down legal entities for every transaction, and also for every securities position (long or short) maintained.
One goal of the LEI is to have it "persist over the life of an entity regardless of corporate actions or other business or structural changes". In the above noted requirements list that would mean the name, address, country of incorporation, and the entity status might all change several times with the LEI remaining constant. However, when the legal entity ceased and a new legal entity assumed the operations, the LEI would change. Events such as the following are likely to cause a legal entity to change:
Keeping track of relations linked through LEIs will be exceptionally challenging.
One major impetus for the development of the LEI is the perceived need to assemble consolidated audit trails quickly of security transactions: who bought and who sold what, when, and who were all the intermediaries and "bottom line" owners? This can be accomplished today, however it takes a great deal of manual time and effort as the data is very widely distributed. It must be more or less manually collected and hand assembled. As of today there are formidable alignment challenges. The LEI is proposed to greatly simplify and automate that process.
Another impetus for the LEI is to more quickly and accurately determine potential domino scenarios. One single LEI fails unexpectedly, what is the domino like linkage pattern likely to be? What other LEIs are potentially effected and how might that all ripple out?
Alternatively, LEIs might be each coded for a very broad array of systemic risk exposure attributes. Then scenarios to run might be, for example, "California residential real estate plummets 30% inside a 90 day window" which LEI entities are hurt? And, most important from a systemic risk prospective, what is the LEI linked ripple effect out from there?
Bank / Broker codes (Likely to become obsolete with LEI)
Market Identification Codes (likely to become obsolete)
Securities ID (many securities tied to one LEI)
Other