Many of us have numerous credit cards, bank accounts, brokerage accounts and miscellaneous household accounts, probably with different account numbers. But most of us have only one Social Security number, so when we apply for a mortgage, the bank often begins to evaluate the risk by using that one number that unites our life, the Social Security number.
That is the simple idea behind the global Legal Entity Identifier (LEI), which insurance and other financial services regulators will soon begin to use to evaluate their charges. Companies have exposure to all sorts of counterparties in myriad ways, and difficulty identifying counterparty linkages translates to difficulty properly evaluating risk. So the G-20, through the Financial Stability Board (FSB), decided each financial services entity will have a unique 20-digit code, making it much easier to identify and roll up counterparty risk.
As the U.S. Department of the Treasury’s Office of Financial Research (serving as the U.S. lead for LEI) notes, “Currently, there are many ways to identify entities, but there is no unified global identification system for legal entities across markets and jurisdictions. The LEI will be a linchpin for financial data—the first global and unique entity identifier enabling risk managers and regulators to identify parties to financial transactions instantly and precisely.”
Last year, the NAIC voted to require insurers to use LEIs, where available, to identify counterparties across all transactions on their investment schedules beginning with the first quarter report in 2013. There are millions of different entities that will need to receive LEIs and we are just in the first phase of U.S. adoption, so many counterparties may not yet have LEIs. But the Commodity Futures Trading Commission (CFTC), which regulates derivatives, has already issued precursors called CICIs (CFTC Interim Compliant Identifier). These approximately 50,000 identifiers are LEIs for all practical purposes—regulators expect they will transition into LEIs as the system is implemented and are treating them as LEIs.
Insurers filing first quarter reports are required to use these LEI equivalents in their Schedule DB report on derivatives counterparties.
Why is this a big deal? Logistically, for now it means that insurers will add a new field to their reports. So that may mean some system changes for IT and accounting folks, among others.
Longer term, this is huge. One very senior official in our insurance regulatory system told me he saw this as a “major advancement” for risk management. Regulators expect to expand the use of LEIs as the system gains traction, and that should give them an increased level of insight into financial interconnectedness (not incidentally, one of the criteria for determining what makes a company systemically important).
As the Treasury reminds us, “When Lehman Brothers collapsed in 2008, financial regulators and private sector managers were unable to assess quickly the extent of market participants’ exposure to Lehman or to explore quickly and fully how the vast network of market participants were connected to one another. Subsequently, the financial crisis exposed the depth of the problem of identifying financial connections and underscored the long-standing need for a global system to identify and link data, which will enable financial regulators and firms to better understand the true nature of risk exposures across the financial system.”
For chief risk officers working to implement the Own Risk and Solvency Assessment (ORSA), LEI use allows for a new analytic tool that, depending on the structure, could prevent or expose previously hidden connections and concentration risks.
According to the senior official to whom I spoke, they have been getting “lots of questions from different quarters” on LEIs as insurers prepare for their first quarter filing. This may be a good time to join the conversation.
Howard Mills is a director and chief advisor of the Insurance Industry Group of Deloitte LLP and can be reached at email@example.com.
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This blog was exclusively written for Insurance Networking News. It may not be reposted or reused without permission from Insurance Networking News.
The opinions posted in this blog do not necessarily reflect those of Insurance Networking News or SourceMedia.
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