The United States has taken a big step toward a standardized system to clearly identify counterparties. So-called Legal Entity Identifiers, or LEIs, aren’t here quite yet, but their forerunners are, and equity traders should take note, as the new IDs could help firms better analyze risk and ultimately make more money.
Last week, regulators announced the Depository Trust and Clearing Corp. and SWIFT will form a joint venture to provide unique IDs for swap dealers. That organization is now laying the groundwork for a full-fledged LEI system, which could change the way everything—from equities to options to foreign exchange—will trade in the future.
Tim Lind, head of legal entity and corporate actions at Thomson Reuters, said the only current rules requiring LEIs are for swap disclosures, but the IDs will soon be used for all financial transactions. And the impetus for that change is coming as much from the industry itself as from regulators.
“I’ve never had a conversation with customers—with anyone in the market—who said this was a dumb idea,” Lind said.
To understand the value of LEIs, Lind pointed to Citi. The firm has more than 4,000 different entities under the Citi umbrella, but regardless of which of those entities is on the other side of a trade, the counterparty is still Citi. When firms do their risk analysis, however, it isn’t clear that many of their different trades are actually all with the same firm.
Lind compared an LEI to a Social Security number on an institutional level. With a single identifier for each institution, firms can then join together all of the information on that institution, providing a better perspective on its credit worthiness and level of risk.
“Understanding who you’re doing business with is a real critical piece for every bank, every trader,” Lind said. “The more you know your counterparty, the better your risk management process is.”
Potentially, firms might even be able to set aside less money for capital adequacy purposes if they have a better understanding of their risk. That would mean more money to trade with, and perhaps more money to be made, Lind said.
In a white paper released today, Lind looked at the potential of LEIs to not just reduce costs, but to create new revenue opportunities. The paper argues that both risk and opportunity are measured by the same yardstick, and it would be a mistake to overlook the potential predictive value of LEI data.
Markets tend to surprise us, and there are fortunes to be made by those who are less surprised, the paper found.
Lind told Traders Magazine that even if firms can aggregate information without LEIs, by the time they can collect all of the data and analyze it, they might miss the window of opportunity in which they can take remedial action.
“If we had the ability to uniquely identify the entity, we could start to connect the dots,” Lind said. “Now I can connect derivatives positions to it, I can connect equities positions, unsettled trades, and begin to get a better picture of that entity, but it all starts with being able to identify it.”
Further down the road, firms might even be able to predict stock movements of companies that have LEIs by analyzing all of the information they have attached to a company’s identifier, Lind added.
There is little traders themselves have to do to prepare for the coming of LEIs, since the new identifiers will be handled by their support staff. However, Lind urged traders not to fight allocations of budget resources that will enable the new system to be put into place.
“The faster that happens, the faster the trader can do his job and trade,” Lind said. “The traders will be the benefactors of it. It will enable their support staff to be more effective and efficient and accurate.”
