We learned a lot of lessons from the financial crisis of 2008 - but how well have we applied that learning? Unfortunately we still lack the level of visibility into financial institutions that was promised as part of the many bailouts of banks, markets and lending agencies. As we face another potential crash in the financial sector as a result of the COVID-19 pandemic, LEIs hold significant promise to help avoid many of the issues we experienced in the last financial crisis.
Prior to 2008 banks had a lot of leeway in what they disclosed to regulatory bodies and to the public. They frequently operated as closed systems, using proprietary data standards, platforms and reporting systems that made inspection extremely challenging. This lack of visibility, coupled with lax regulations and a global “bullish” outlook on growth, enabled runaway banking behavior in the early 21st century that ultimately led to the financial crash of 2008. With the crash, hundreds of banks disappeared almost overnight - many acquired by larger or semi-state banks that had negotiated significant government bailouts. The expression “Too big to fail” summarized the thinking of governments at the time, but in some cases these banks leveraged their heft to become even larger. J. P. Morgan Chase Bank, for example, acquired the investment bank Bear Stearns and the retail banking assets of Washington Mutual during the tumult of the crisis, along with many smaller banks in the following years. Today Chase is the largest bank in the U.S. with a market cap of over $300Bn and operations in over 100 countries.
But while the institutions stabilized through acquisition, resource rationalization and digitization, those most significantly impacted by the crash, the individual investors,were left to figure things out on their own. This meant dealing with one lender after another as their debt was sold, absorbed and consolidated by bigger and bigger banks, and with limited visibility into the hierarchy of the bank in question.
The system by itself doesn’t directly solve the problem of accountability and visibility - it’s simply a 20-digit representation of a banking or financial entity. But it does provide a way to avoid the risk of a collapse on the scale of the one endured in 2008. The Global LEI Foundation (GLEIF), which administers the project, also carries the heft of the Finance Ministers and Central Bank Governors of the G20 countries. Since its creation in 2013, over 200 different regulatory bodies across the world have adopted LEI for engaging in inter-organizational financial transactions. The system is widely recognized as an effective tool for risk mitigation for individual entities and within the broader international financial system.
Risk Mitigation and the legal entity identifier
The success of the system extends beyond its usefulness in driving regulatory compliance and risk mitigation however. Equally important is the direct financial benefit to financial organizations as a result of increased efficiency. Research conducted by McKinsey on behalf of the Global Legal Entity Identifier Foundation (GLEIF) concluded that broader adoption of LEIs could save the global banking sector as much as U.S. $4billion annually in client onboarding costs alone. Further McKinsey research indicated potential annual savings of over U.S.$150 million within the investment banking industry and up to U.S.$500 million for banks in the issuance of letters of credit.
In short, the benefits to financial organizations significantly outweigh the overhead of adopting LEIs.
What can be done at the institutional level to enhance the risk mitigation capabilities of LEIs? One of the biggest opportunities lies within the repository of LEI data maintained by the GLEIF. While this data is stored and presented in a relatively flat structure - built around the LEI number - the GLEIF also offers an API so third-party organizations can build their own applications that leverage the data. A simple example of this is pTools LEILex which provides an easy interface for searching across all LEIs, including company address, issuing agency, date and country of issuance, and activity status. The opportunity exists for software developers, consultants, or banks themselves to tap into the API and build rich hierarchical modeling tools to provide even greater insight into “who owns who, and who should I do business with.” It’s easy to see the benefits of this when engaging in a risk analysis. Beyond the data maintained by GLEIF, the recent activity between the GLEIF and ANNA holds promise for even greater insight by promoting free and full data exchange between the two organizations. Since going live on April 4th 2020, over 4.5 million ISIN records have been linked to 64,000 unique LEIs.
As the volume of data stored in the GLEIF database grows, so does the intrinsic value of the whole system. This provides an incentive for institutions, the G20 legislature, and any legitimate financial institution worldwide to “stick with the program.” While there is always potential for fraud and omission, LEIs provide a level of transparency into financial organizations that was simply not available back in 2008. As such we are in a much better position to identify trends before the turn into crises.