Global data standards implementation evoked in the name of better risk management but missing is the voice of the risk management community by Allan Grody

global data standards implementation evoked in the name of better risk management but missing is the voice of the risk management community

by Allan Grody

A US regulator, the Commodities Futures Trading Commission, was the first to recognize the impact of non-standard counterparty identification in financial transactions. Lehman’s bankruptcy exposed this regulator’s inability to determine the risk exposures Lehman was progressively incurring. It was an awakening by regulators across the world to the importance of legal entity identity standards in knowing what risks were building up in the 6000 entities that collectively made up Lehman.

As more regulators interacted with market participants, it soon became apparent that financial data standards, more broadly, were missing. Only a global data standard’s effort could create the ability to aggregate multi-sourced, multi-identified transactions in order to provide timely regulatory transparency into risk. Errant financial transactions, each containing different identifiers and variably defined data elements, each purporting to be identical which they are not, was at the root of preventing regulators from observing risk.

The US congress responded with the Dodd-Frank Financial Reform Act. At the same time as US regulators were identifying these fundamental and long festering data problems, the G-20’s Financial Stability Board was focused on reforms in the global OTC Derivative market. They came to the same conclusions as US regulators concerning the fundamental problem of data quality and lack of global data standards for counterparties and the OTC derivative products they trade in.

With the G-20’s interest and the mandate to guide financial stability globally given to the FSB, we now have a set of global data standards for financial market participants and the products and contracts they trade in: the Legal Entity Identifier (LEI); the LEIs hierarchical organizational structures (intermediary and ultimate parent) for each registered LEI; the Unique Transaction Identifier (UTI); the Unique Product Identifier (UPI); the Common Data Elements (CDEs) for OTC derivatives, and the latest, the establishment of the Derivatives Service Bureau to extend the ISIN (International Securities Identification Number) financial instrument identification system from its origins in stocks and bonds to a vast array of derivatives.

The consequences of the lack of universal data standards are enormous - huge additional cost and risk brought about by the need to reconcile multiple identifiers across hundreds of trading markets – equities, bonds, futures, option, foreign exchange, commodities, swaps and, most recently, crypto markets. Different identifiers are found in hundreds of payments, clearing and settlement systems; in hundreds of securities depositories; and in hundreds of financial data intermediaries operating with hundreds of data formats and identifiers.

Add to this the thousands of financial institutions that operate with proprietary business process systems using proprietary data formats and identifiers sent to hundreds of regulators and hundreds of financial market infrastructure operators. Then imagine the high cost, high risk of data mapping exercises that are duplicated across the financial supply chain to reconcile one system’s output to another’s. We and others have estimated this global data duplication cost at $US 250 billion.

The LEI’s Regulatory Oversight Committee (ROC), initially established to oversee the LEI implementation, was just appointed as the Governance Body for all FSB initiated standards. The ROC consists of 71 regulators from around the world. Like the FSB they report to, they have no power to regulate, just the global megaphone of the G-20 that the FSB answers to.

The ROC is a needed central point for regulators to concentrate efforts so that the promised benefits of better risk management and lower costs from global data standards can actually be achieved. Much has already been achieved - the organization of a global government/private sector partnership, its operating principles and its operating structures are all in place now. The definition at the granular level of these data standards and the operating entities to assign them are also in place.

What is needed to accelerate regulators’ ability to achieve more complete and timely risk management and for the financial industry to achieve the promised benefits of lower costs? Perhaps it can be achieved by active participation with the ROC by a significant group that has not yet been heard from on this issue -- the Risk Management trade associations.

The ROC has been given oversight of all of the global data standards initiatives fostered by the FSB. The intent is to engage more fully with the US financial industry on a voluntary basis and, more specifically, with large financial entities, many of which are designated as systemically important.

Financial institutions will be asked to use their own Know Your Customer (KYC) validation routines to perform the validation functions for the LEI. It is hoped that by getting the larger, global systemically important financial institutions (G-SIFIs) to voluntarily adopt the LEI and other FSB inspired data standards, this will showcase significant cost savings for them. It should also show a path to data aggregation for risk analysis through registering the complete set of parent LEIs for themselves and their clients. Further, it will accelerate registering more LEIs, now totaling 1.7 million.

The FSB in their LEI Peer Review in 2019 had stated that the LEI has only been partially adopted in the G-20 member countries. The FSB estimates that global adoption will require registering 20 million LEIs. Short of global adoption, I have long advocated for completing the mission of registering LEIs and their hierarchies starting with the Global Systemically Important Financial Institutions (G-SIFIs). These institutions have had a unique status among regulators since the financial crisis. These are the ones that can spread the contagion of systemic risk. There are thirty-three (33) G-SIFI banks.

These banks are also the early test cases for implementing the global Principles for Effective Risk Data Aggregation and Risk Reporting framework laid out by the Basel Committee on Banking Supervision in 2013, commonly referred to as BCBS 239.

BCBS239 has generated new and significant demands for data standards and technology, However, it is still a work-in-progress according to the latest updated progress report of the implementation of the BCBS 239 principles reported on as of April 2020. None of the banks are fully compliant with the BCBS 239 principles for attaining the necessary data architecture and IT infrastructure. Data aggregation remains a key to effective risk analysis and the LEI and its hierarchical parent relationship structures is an essential pillar of such aggregation.

What is needed is for a concerted effort by the risk management community, led perhaps by PRMIA, to enlist the FSB’s ROC, which oversees global data standards, and the BCBS, which oversees capital standards, to mandate adherence to the FSB’s data standards for these G-SIFIs. Incentives can be provided through operational risk capital reductions rather than fines and disciplinary action, as was the recent situation with three US based G-SIFIs - JPMorgan, Morgan Stanley and Citibank. Collectively they were fined $US 1.4 billion for inadequate and faulty risk management and data management systems.

author

Allan Grody

President of Financial InterGroup Advisors, a financial industry consultancy.

In his early career he worked in various technical and management capacities in multiple segments of the financial industry. In a later career he was a partner and the founder of Coopers & Lybrand’s (now PwC’s) Financial Services Consulting Practice. At NYU’s Stern Graduate School of Business he founded and taught their risk management systems course.

He is an Editorial Board Member of the Journal of Risk Management in Financial Institutions; has been an expert witness on trading patent infringement and shareholder class action litigation; was an expert panel member to the Financial Stability Board on their Global Legal Entity Identifier (LEI), Unique Product Identifier (UPI) and Unique Transaction Identifier (UTI); an expert panel member to the International Organization of Securities Commissions/Committee on Payments and Markets Infrastructure (IOSCO/CPMI) in their Data Harmonization and Over-the-Counter Derivatives trade repository aggregation initiatives; a Blue Ribbon Panel Member of the Professional Risk Managers’ International Association (PRMIA); Advisory Chairman of the Financial Industry Ontology for Risk and Data (FIORD) Consortium; and is a contributing opinion editor for The Hill.

He has authored numerous academic papers and trade articles focused on risk adjusting the financial system and reengineering financial institutions.