Twenty years ago when confirmations for OTC products were produced using Word for Windows 2.0 and sent by FAX for manual review, identifying the legal entity was a hit and miss affair. Was it right for example to put “Barclays Bank Ltd.” or “Barclays Bank Limited” or “Barclays Capital”, “Barclays Capital Inc.?” all different, and not all correct, depending on who the trader really executed the trade with, or on behalf of. The reason this matters, is obviously money – having a trades booked in the wrong entity will eventually lead to P or L which doesn’t belong, plus hedging activity, confirmation and settlement issues through the life of the trade.
Move forward 20 years and thank goodness we have moved on from FAX to using messaging and FpML, but the problem of identifying who the legal entities are, still remains unresolved. At present FpML relies upon SWIFT BIC codes to be precise about the parties – but not all firms use SWIFT, and the fallback in FpML is a free format text field, leading to the same issues as above.
With the development of centralised services such as the DTCC Trade Information Warehouse, their own approach to allocating unique identifiers to all their customers at least avoided some confusion on each system, but unfortunately didn’t lend itself to use in multiple systems with other vendors. Whilst a firm like Barclays appears to trade in the main from two legal entities (Barclays Bank plc & Barclays Capital Inc), behind the scenes more complexity can be found – as evidenced by the administrators of Lehman Brothers, who had to cope with over 2,300 legal entities within the group structure.
For credit mitigation techniques to work fully, capturing the exposure between any pair of legal entities must rely on accurate mapping of trades to legal entities, and onwards to exposure & credit limit calculations, and ultimately margin calls. Mapping trades to the wrong legal entity just leads to confusion for a firm making a margin call – it is well known that disputes under ISDA CSAs are an on-going problem, one wrong trade in a small portfolio can lead to time consuming investigations and portfolio reconciliations.
A recent announcement by the Global Financial Management Association (GFMA) moves the world one step further towards a new ISO standard (ISO 17442) which provides a global solution to allocating a unique identifier to any and all legal entities. The GFMA have recommended that ISO 17442 is adopted as the global standard, which stands a good chance of success, given there isn’t actually any competition! The standard will be applicable internationally, with SWIFT as the registration authority to administrate the procedure for registering each legal entity.
ISDA has said that FpML could adopt the new standard immediately, as it was originally designed to allow for multiple ways of labelling each party to a contract with identifying information, so no redesign is needed for firms to add the new Legal Entity Identifier (LEI) once the new scheme is up and running. Firms with ISDA CSAs to operate should eventually see better accuracy from trade booking through to exposure management, and just in time, CCPs should have a common way to map trades to the thousands of new buy-side funds which are expected to be pushed into clearing by Dodd-Frank or EMIR next year.
How quickly SWIFT can begin operating the scheme, and begin to take on the thousands of entities active in the capital markets will determine how soon the OTC market can see the benefits of this new scheme. Given budgets and the current economic climate, considerable resources will be needed to retrofit, translate and reconcile the new scheme into existing systems and infrastructure – start planning now.
