The Office of Financial Research was created first and foremost to address the government's need for better data and financial analytics. The widely accepted view that underpinned the creation of the OFR is that government policy makers and regulators lacked timely data and analyses required to understand the extent of the recent crisis and how best to respond. 

The Dodd-Frank Act explicitly includes the statutory requirement for the creation and publication of: a financial company reference database (commonly referred to as the Legal Entity Identifier); and a financial instrument (i.e. contract) reference database. To date, most of the focus has been on the OFR's and the Financial Stability Board's efforts to build the first reference database via the adoption of a global LEI registry system. That system would assign a unique identifier for each potential corporate counterparty to a financial contract, including those legal entities that are part of larger corporate families.

However, a second and equally necessary responsibility of the new agency remains the one less spoken about – the development of a financial instrument reference database.

Without doubt, the technical challenges to building this tool are much greater than those faced in designing and building the LEI registry system. However, the instrument database is every bit as critical if the OFR is to be able to fulfill its role as a monitor of threats to financial stability.

The role of the financial instrument reference database is to enable the OFR to collect granular transaction and position data. This data will help make possible new approaches to monitoring systemic risk built around how the cash flows of major financial companies are affected by changes in risk factors.

For example, the data could enable system-wide stress testing that could be used to help identify not only which firms are at risk of failing, but how those firms are linked to other firms, as well, in terms of cash flow obligations. This kind of network analysis will make it possible to better understand the risk that one company's failure could trigger the failure of other companies that do business with it. 

While this reference database is critical to fulfilling the OFR's mission, it can also provide market participants with the information needed to more fully understand the risks and returns of different financial products. 

The solution to this challenge will require a system that: produces representations of financial contracts in the reference database that are machine-readable; identifies cash flow patterns in a way that simplifies the data structures; clearly represents the linkage between changes in risks and financial contracts' cash flow obligation; includes a governance structure to help assure the accuracy, broad acceptance and provenance of the reference data; and provides enough flexibility so that the reference data system does not prevent beneficial financial innovation. 

There are likely several different alternatives to solving this considerable challenge that can be developed. To assess the value of these alternatives, OFR might consider proceeding with an approach that includes multiple competing prototypes to identify alternative ways of creating the required database. 

This approach would permit the evaluation of alternatives for addressing the many known and unknown challenges, provide a basis with which to assess the implementation costs of the alternatives, provide a forum for peer review, and help improve the likelihood that the final form of the chosen implementation can be cost effective and the most beneficial to financial companies and regulators in monitoring and managing financial risk.

The OFR might also consider providing further leadership in promoting the leading practices in data management and governance, to help drive long-term industry adoption of the reference databases. These practices may offer industry participants guidance on methods to leverage the value and applicability of the reference data across their operations. 

OFR and global stakeholders are making commendable progress on developing the legal entity identifiers.  They should also move forward with bold new steps to lead regulators and industry participants to define the financial instrument reference data, pilot innovative implementation approaches, and move the process forward to realize its value for regulators and industry. 

We have seen the value elsewhere in harnessing competing approaches to spur innovation, and the OFR could do the same in leading the development and global adoption of this immensely valuable reference data standard.

Allan Mendelowitz is the co-founder and co-leader of the Committee to Establish the National Institute of Finance, which advocated for creation of the OFR during the deliberations over Dodd-Frank, and a strategic advisor to Deloitte Consulting LLP. Tim Walsh is a principal in Deloitte Consulting LLP's banking and securities team.