Standards: Collaboration or Cartel (LEIs and ISO17442)

I had a lovely conversation with a group of investment bankers last night about technology transformation in capital markets. During the opening, a consistent theme cropped up: standards, interoperability, collaboration and cooperation … or lack of it. It is interesting that, in the buy and sell side world, few standards have worked except for FIX Protocol in the front office. SWIFT has tried to create standards in post-trade settlement for years and struggled, but at least SWIFT has managed to crack some of that nut. MiFID and Dodd-Frank have also started a regulatory resolution to standards inconsistencies, and therefore by law can force the markets to create efficiency. Or can they?

The only reason FIX protocol works is because the largest buy-side liquidity provider Fidelity said that their sell-side had to use it or they wouldn’t trade with them. When your biggest customer says do this, then you tend to do it. Since then, there’s been very little cooperative or collaborative activity. Some say this is because it makes you look like you’re building a cartel, but that’s not necessarily true and, to be honest, I can point to some collaborative operations.

High frequency trading platforms like BATS CHI-X came around through a small group of the market makers making it happen. Digital Asset Holdings and R3 are examples of other ventures that may achieve the same result. And that’s the key thing: the result. If you can save $20 billion or more a year in post-trade operations, then it makes sense to cooperate. In fact, the very nature of blockchain protocol, creating shared and distributed ledgers, demands cooperation. You cannot have a shared ledger if you’re the only one sharing it. This means that one of the many early start-ups in post-trade blockchain will succeed, but only the one that gets the most collaborative support which, right now, is Blythe Masters’ Digital Asset Holdings.

The result is that have an industry in flux, with technology transforming front office regularly and back office saying pretty stable. It was pointed out that back office only really gets one big change a decade: SWIFT in the 1970s; Real-Time Gross Settlement from the central banks in the 1980s; Central Counterparty structures and Custodial services in the 1990s; High Frequency Trading with post-trade reporting in the 2000s; and now shared ledgers in the 2010s.

Link this with the forced mandate of every transaction traded in Europe having to have an LEI (Legal Entity Identifier) reported with the trade, and you can see standardisation starting to break through. LEI’s are mandated under ISO17442 as a global standard, and these requirements under MiFID II and other regulatory structures will change the game. In fact, LEIs are going global and this could be more important in rationalising the challenges of inconsistency than anything else, even blockchain (see end of blog entry).

All in all, the fine line between cooperation, collaboration and cartel is a tough one, but when it comes to billions of dollars wasted in post-trade inefficiency, surely the industry can justify it for a change?

About the Global LEI Initiative

OVERVIEW

The Global Market Entity Identifier utility (GMEI), formerly known as the CICI Utility, is DTCC's legal entity identifier (LEI) solution offered in collaboration with SWIFT. GMEI is designed to create and apply a single, universal standard identifier to any organization or firm involved in a financial transaction internationally and was developed in response to the financial crisis of 2008-2009 after governments and regulators called for new regulation of the financial markets. DTCC and SWIFT designed the GMEI solution with assistance from a consortium of 14 global financial services organizations led by the Global Financial Markets Association (GFMA) to meet global industry requirements across all asset classes. The solution went live in August 2012, and has since been endorsed by the Regulatory Oversight Committee (ROC), the group of global regulators established by the Group of 20 and the Financial Stability Board to oversee development of the Global LEI System (GLEIS). This endorsement means that GMEIs are recognized as pre-LEIs by all of the 55 global regulators who are members of the ROC and will be required by them on regulatory reporting as they upgrade reporting requirements. The GMEI utility operates as a Pre-Local Operating Unit within the GLEIS.

WHO CAN USE THE SERVICE

Legal entities from all jurisdictions involved in financial transactions can use GMEI utility to register for globally-accepted pre-LEIs. These pre-LEIs will become LEIs once the GLEIS is fully operational. The GMEI utility is a global service with data quality validation procedures in over 230 jurisdictions which have been developed and proven over the past ten years. Thus, a large global organization with many legal entity subsidiaries and affiliates can register and maintain the reference data for all those entities in one place.

BENEFITS

The information afforded by the GMEI utility is a critical tool for helping regulators and market participants understand exposures, enhance market transparency and manage systemic risk. The GMEI provides regulators and financial firms accurate, consistent, and persistent legal entity identifiers and corresponding entity reference data to enable more accurate risk aggregation capabilities when analyzing positions and transactions on a global basis. The GMEI utility enables legal entities to meet current and future regulatory requirements around the globe, in one place with simple, low cost registration and maintenance procedures.

HOW THE SERVICE WORKS

Legal entities involved in financial transactions that have to be reported anywhere in the world with pre-LEIs, simply register for a GMEI at the GMEI utility Portal, a process that takes minutes to complete at a nominal fee based on a cost recovery model. The GMEI utility then validates the accuracy of the associated reference data supplied by the registrant and assigns unique identifiers in a standard format, according to the ISO 17442 LEI standard. The system stores all the information in a public database free for all to use and redistribute, with no fees, licenses or redistribution restrictions. In August 2012, financial institutions began using the CICI database after the CFTC became the first regulator to mandate the use of an ISO 17774 identifier to identify reporting parties and counterparties for over-the-counter (OTC) derivatives trades reported to trade repositories. With the endorsement by the ROC in October 2013, the GMEI utility's 90,000+ registered entities from more than 140 countries became pre-LEIs eligible for regulatory reporting to any global regulator. DTCC and SWIFT will continue to upgrade GMEI to meet the needs of the industry and to accommodate more asset classes that require reporting party and counterparty identification with pre-LEIs.

ABOUT DTCC

DTCC has operating facilities and data centers around the world and, through its subsidiaries, automates, centralizes, and standardizes the post-trade processing of financial transactions for thousands of institutions worldwide. With 40 years of experience, DTCC is the premier post-trade market infrastructure for the global financial services industry, simplifying the complexities of clearance, settlement, asset servicing, global data management and information services for equities, corporate and municipal bonds, government and mortgage-backed securities, derivatives, money market instruments, syndicated loans, mutual funds, alternative investment products, and insurance transactions. Supported by DTCC's knowledge of global entity validation and SWIFT's capabilities as an existing ISO Registration Authority, the GMEI utility supports:

1. Self-registration by entities requesting the assignment of a new GMEI code.
2. Assisted registration of entities by third party financial institutions, trade repositories, vendors and other intermediaries, with the explicit permission of the registered entities themselves.
3. Availability of these submitted requests in the GMEI Staging Database upon completion of the request.
4. Validation of submitted data against publicly available sources. The results of this validation are made available on the GMEI Issued Database in the Record State attribute.
5. Upon completion of the validation process, self-registration and assisted registration requests are then assigned GMEIs and made available in the GMEI Issued Database.
6. Annual maintenance of records.
7. Database searching and filtering capabilities.
8. Credit card and wire processing through selected providers for registration/maintenance fee payment.
9. A download capability of the full GMEI database and a database of daily changes via industry standard interfaces once per day.

From CICI to GMEI: A TIMELINE

2008 - 2009 The financial crisis underscores the need for transparency and regulation in the financial markets. Governments and global regulators consider new regulation for the markets. November 2010 - The Office of Financial Research, a newly established division of the U.S. Treasury mandated by Dodd-Frank, issues a Statement on Legal Entity Identification for Financial Contracts citing the criticality of a global Legal Entity Identifier (LEI) in order for it, on behalf of the Financial Stability Council, to monitor systemic risk and asking the industry to recommend a solution. The OFR cites the need for global consensus around a single unique identifier for each counterparty in order for the initiative to be successful. May to July 2011 - A coalition of global financial-services trade associations publishes Requirements for a Global LEI Solution, conducts a Solicitation of Interest process for solution providers and ultimately recommends that the industry solution be provided by DTCC, SWIFT, ISO and ANNA. November 2011 - The G20 instructs the Financial Stability Board (FSB) to prepare recommendations for an LEI governance and implementation framework. March 2012 - The U.S. Commodity Futures Trading Commission (CFTC) calls for proposals from organizations participants to provide entity identifiers for reporting parties and counterparties on swap transactions to be reported to trade repositories registered with CFTC. May 2012 - ISO Publishes final ISO 17442 LEI Standard. June 2012 - The FSB publishes it recommendations for a global LEI system. July 2012 - DTCC and SWIFT are chosen by the CFTC to provide ISO 17442 identifiers under the interim name of CFTC Interim Compliant Identifier (CICI). August 2012 - There are two major milestones:

• DTCC and SWIFT launch the CICI Utility web portal to begin assigning CICIs to legal entities involved in swap transactions.
• DTCC opens a new facility in Wales to support CICI registrations

September 2012 - DTCC and SWIFT register more than 1,100 entities in first weeks since launch of the CICI Utility web portal. October 12, 2012 - CFTC is first regulator to mandate use of an identifier for OTC interest rate and credit derivatives in regulatory reporting, phasing in the CICI requirement and mandating its use on all transactions by April, 2013. November 2012 - The G20 and the FSB establish the Regulatory Oversight Committee (ROC) to oversee the Global LEI system. January 2013 - There are three major milestones:

• The CFTC's mandate for reporting parties to report transactions with CICIs is extended to OTC foreign exchange, commodity and equity derivatives. All active counterparties must have CICIs by April 2013.
• DTCC announces that it has registered more than 47,000 entities from 125 countries.
• The ROC holds its inaugural meeting.

July 2013 - ROC publishes framework for organizations to operate under in order to become endorsed, globally accepted Pre-LOUs, a key step to ensure global consensus and the use of a single LEI for each legal entity, globally. October 2013 - There are two major milestones:

• The ROC recognizes the CICI Utility as a globally accepted Pre-Local Operating Unit.
• CICIs are now pre-LEIs eligible for regulatory reporting to any global regulator and are endorsed by all of the 55 global regulators who have agreed to the ROC Charter.

November 2013 - ESMA announces that globally accepted pre-LEIs are required on reporting beginning in February, 2014. The announcement cited the CICI Utility (now known as the GMEI utility) as one of the endorsed pre-LOUs. December 2013 - CICI Utility becomes DTCC's Global Markets Entity Identifier utility with more than 90,000 globally accepted registered entities from over 140 countries, including more than 14,000 from Europe. Entities begin registering for Pre-LEIs in preparation for EMIR reporting of derivatives transaction to ESMA registered trade repositories beginning in February, 2014.