A little-noticed fight is under way within the financial industry over new data-labeling standards. Although the dispute is esoteric in nature, at stake is the future of a system that could give globe-spanning banks vastly better insight into counterparty risks and offer regulators a way to head off the next financial crisis.
At the heart of the disagreement is the technical design of so-called legal entity identifiers, numeric codes that would distinguish market participants in much the same way that Social Security numbers do with individuals. But the dispute — which pits the Depository Trust and Clearing Corporation and the Commodity Futures Trading Commission on one side against international regulators, academics and nonfinancial companies — has raised concerns that the DTCC could seek to influence on the LEI process in ways that benefit itself or its organizers — giant U.S. financial institutions like JPMorgan Chase (JPM), Bank of America (BAC) and Goldman Sachs (GS).
DTCC officials and securities industry representatives have called such concerns outlandish. Even if they're correct, however, they have roiled an international body that appears intent on demanding that the LEI system remain independent of the DTCC and other industry bodies.
"The LEI system will de facto have a monopolistic element, so it needs to be under strict public governance," says Francis Gross, head of the European Central Bank's external statistics division, speaking in his capacity as vice chairman of the Financial Stability Board group responsible for implementing a global LEI system. "We don't want the tail to wag the dog."
Financial data experts say that while developing a global system offers great promise, it will also require an unprecedented level of cooperation among the various players to create.
"This is the CFTC causing a problem, and the DTCC willingly playing the tune," says a person familiar with the FSB effort but not directly involved in the implementation group. A major fight can still be avoided, but only if the CFTC and DTCC are willing to abandon their current approach, says the person, who wished to remain anonymous because of the ongoing talks.
Even those less invested in the technical issues of the numbering scheme say it has become a significant distraction.
"Whatever it takes to get it done, we should all swallow hard and do," says Mike Atkin, managing director of the Enterprise Data Management Council, a financial industry nonprofit devoted to improving data quality and standards. A functional LEI system would be "a big gift for the industry, and we should stop whining about the other things."
Soiling the Sandbox
The need for legal identifiers arises out of a simple problem: Unlike scannable FedEx packages, or toothpaste tubes printed with bar codes, financial institutions have never been labeled with comprehensive and universally recognized tracking data. Even the divisions of a single bank sometimes identify the same counterparty differently, confounding efforts by its own executives and regulators to track and manage its risks.
Establishing a universal system of codes that permanently identifies market participants is the essential first step in establishing a global tracking system. Proposals for such systems have circulated for many years, but it was the inability of regulators to obtain clean counterparty data during the financial crisis that ultimately gave such initiatives international momentum.
An LEI system would "do the one job that markets could not achieve by themselves ... which is to effectively standardise the most basic data," Gross says. "It's a very simple thing, making sure you are called Jeff by everyone who knows you."
The U.S. enshrined the concept in the Dodd-Frank Act, which requires the CFTC to establish swaps market identifiers. Internationally, the G-20's Financial Stability Board established expert working and advisory groups early this year.
That international process is moving along under the supervision of the FSB implementation group and a nearly 200-member Private Sector Preparatory Group advisory body. The latter organization holds discussions about proposals via email and at occasional meetings, the next of which is scheduled in Basel, Switzerland, next week. Given the size of the group, its work methods are "tedious," but thorough and engineered to build consensus says the Enterprise Data Management Council's Atkin.
The U.S., meanwhile, has sought to fast-track its numerical identification initiative. Facing pressure to roll out a new ID system, the CFTC put the creation and administration of an initial system out for bidding earlier this year. The DTCC, a 501(c)3 backed by large financial institutions, won the contract this summer in a partnership with the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which operates a secure network through which financial institutions route information about financial transactions.
They two organizations rapidly designed a tracking system for the CFTC and sought to roll it out as soon as possible. The DTCC has already assigned a total of 26,000 of the codes, called "CFTC interim compliant identifiers." Under the CFTC's rules, swaps dealers and major participants were supposed to have adopted the codes starting on October 12, though that date has been pushed back and CFTC officials have stated there is no immediate plan to enforce it.
Both the DTCC system and the FSB working group's plans are based on an international standard known as ISO 17442. It employs an 18-digit alphanumeric code, with two additional check digits used to confirm accuracy. The system provides functionally limitless variation. In fact, it could generate enough codes to assign one to every leaf on every tree that has ever grown, according to the ECB's Gross.
Early plans for the LEI numbering scheme included "non-intelligence," meaning the codes would contain no information on their own. SWIFT, which had played a role in the early discussions and design of an LEI template, was given responsibility for the relatively pedestrian task of issuing random 18-character codes.
The problem, however, is that the FSB's LEI Implementation Group hasn't signed off on the allocating the numbers at random. Many of its members want to leave open the possibility in which local entities have the capacity to issue LEIs on their own. Such an approach could encourage the LEIs' broader adoption, say people familiar with the group's thinking. The DTCC, however, has continued to insist on fully randomized 18-digit codes.
"It's a very big sandbox," says a person familiar with the FSB groups' concerns. "And the DTCC is peeing in the entire sandbox."
This appears to have become the majority opinion: In its first two progress notes, the FSB's working group has warned about "urgent" concerns related to whether the CFTC's CICI blueprint would "lock the future global LEI system into early, local technical system design choices."
The CFTC declined to discuss the development of CICIs.
DTCC and SWIFT initially proved unreceptive to FSB groups' complaints, dismissing them as "misunderstandings."
Other sizable U.S.-based financial organizations followed suit. The Securities Industry and Financial Markets Association, which represents large broker-dealers, has thrown its weight behind the joint DTCC-SWIFT initiative, saying it poses no threat to the broader global effort.
"We're incredibly supportive of the FSB efforts, and we're hoping that they can leverage, learn from, and use the [CICI] utility," says SIFMA managing director David Strongin. "It never would have occurred to me that numbering is something we'd be stuck on."
The DTCC likewise says its only objective has been to accommodate the goals of its industry backers and the CFTC. It has, however, also pledged to defer to the eventual FSB structure.
"If the financial services industry that chose to go with this version and the regulators all agree on a different type of implementation going forward, we're here to serve the regulators," says DTCC managing director William Hodash.
Monkeys with Laptops
Even the critics of the DTCC's approach acknowledge that the technical hurdles its 18-digit random numbering scheme present are likely surmountable. Some even compliment elements of its work.
"The industry really got moving on this in early 2011," says a person familiar with the FSB's process. "A lot of the informational assets have been brought to bear."
Overshadowing praise for the DTCC's template, however, is the perception that the CFTC, DTCC and SWIFT are attempting to dictate a basic element of the LEI system. That concern has given rise to broader skepticism about the organizations' roles.
Some question why the DTCC would need SWIFT to help in issuing random codes. Critics have variously said the process could be handled by "interns" or "a monkey with a laptop." Random number generators are already available at no charge on the Internet.
"There is no reason for SWIFT to be involved," says a person familiar with the FSB process. "None."
SWIFT disagrees, noting that it played an early role working with the Association of National Numbering Agencies to design parameters for the system. Paul Janssens, SWIFT's LEI program director, says that SWIFT has been a full partner in the project.
Another question is whether the DTCC aspires to a long-term role in the LEI infrastructure. It's set up a system of verifying and challenging the accuracy of the corporate identities tied to the codes, implying a centralized international control function. While some of those duties are administered out of Europe, some people familiar with the FSB process are worried that the DTCC is a New York-based organization backed by U.S. industry giants and hired by a domestic regulator.
The ECB's Gross dismisses specific nationalistic concerns, though he does stress the importance of having the system perceived as international.
"This has nothing to do with American or non-American," he says. "It's just that the [LEI system's] only chance is that ... it is a truly global system and stays that way."
Finally, some critics have suggested that the DTCC could seek to benefit the historically opaque U.S. financial services industry. They further question whether market participants will voluntarily pay registration fees of even $200 to the DTCC.
Even some critics of the CFTC's approach say that some of these fears are far fetched. For its part, the DTCC insists its efforts will in no way prevent the FSB from implementing any system it wants. If a functioning LEI system is eventually created, the use or lack of truly random numbering will be rendered a technicality.
"None of this [the DTCC's numbering system] is restricted, private or confidential," Strongin says, describing the DTCC's work as a stopgap until an international body is ready to take over. "It's an at-cost utility."
Global Aspirations, Parochial Concerns
The next action is likely to take place at meetings of the implementation group and the industry advisory group in Basel this week. The FSB Implementation Group has already ordered an urgent study of numbering processes, which is expected to consider whether the CICI code could constrain options for the LEI system.
People familiar with the FSB process say the goal will be to head off a broader fight. The hope is that high-level DTCC officials will realize that their interest is to "play nicely," says one of the people familiar with the FSB discussions.
"This is front-running the global standard by a couple of months, creating the wrong atmosphere for going forward in a globally adopted sense," the person said.