LEI update: hidden costs prevent enthusiastic take-up
Until the world has a definitive Legal Entity Identifier, we are going to have to recognise that piecemeal adoption brings with it significant hidden costs in validating, enriching and mapping for regulatory purposes.
According to the fount of all knowledge, Open LEIs, as we open the reporting floodgates for Europe we still have some way to go before we have a reliable identifier to spot systemic risks. WM Daten has issued over 34,000 LEIs, while the LSE has issued a mere 11,000. The French INSEE is just shy of the UK count, while the Dutch Chamber of Commerce drop in at slightly under 3,000.
Clearly, if the total number of registered market participants is meant to include all the corporates that trade FX forwards, we are far short. Some would suggest we are short by millions. All the usual caveats about last minute rushes and rumours about queues around the block for registrations aside, something is seriously wrong with this picture.
One could blame the regulators. Have they really made it impossible to survive without an LEI? No. Have they clarified to all concerned that ignorance and inaction are not to be tolerated? No. Are there still other things that could be stuck into reporting fields instead? Yes.
However, the regulators don’t bear all the blame on this one. Recent academic research shows that there is up to $10 billion in cost savings to be gained from the LEI. We have been testing the assumptions behind this and are officially raising an eyebrow.
Take the conclusion of the EBA in its recent decision to ignore industry concern and push ahead with LEI adoption deadlines of 31 March for some and 31 December 2014 for all institutions under their supervisory remit: “Even after considering the costs arising from the indirect factors above, the overall additional cost (direct and indirect) from the implementation of LEIs would still lead to negligible cost in relation to the overall operational cost.”
Like many statements about the ‘obvious’ value of the LEI, this is fuzzy thinking. It is still not clear that the addition of another ‘mapping column’ will achieve benefits that outweigh the costs of its implementation and ongoing maintenance. The costs of validation, enrichment and quality assurance should not be underestimated. Ensuring data quality is a labour-intensive task that requires skilled people. And all of those costs will be added to the explicit registration and maintenance costs.
The average price across pre-LOUs for registering an entity for an LEI is approximately €133, plus the additional costs associated with its maintenance. But, this is merely the tip of the iceberg.
Recently, the EBA consulted on the use of the LEI for regulatory risk reporting, which has the potential to significantly increase the total cost of LEI implementation. The number of entities required to register for risk reporting is a considerable increase over the number required for EMIR. Some estimates place this increase to be tenfold, so a firm required to register 500 LEIs for EMIR would need to register 5,000 for risk reporting.
Simply registering and maintaining 5,000 entities for five years will cost €2.16 million doing so (based on the average registration and maintenance fees. But this external fee pales in significance to the internal costs, with our analysis showing that external registration cost is a mere 20% of the internal cost.
The costs of the internal systems changes required are substantial. Scores of source systems, data warehouses, risk analytics systems, management information and reference data management systems will need to be updated. As mentioned above, these risk systems will need to be kept in synch with other systems that are using the LEI as well (e.g., trading, AML). For a large firm, this could cost millions.
Without an accurate cost/benefit analysis to benchmark against, it’s likely that firms will continue to treat the LEI as ‘yet another’ regulatory requirement rather than push for enterprise adoption. The challenge in defining a business case is the need for caretakers of that code to engage with multiple stakeholders to determine its value. Each business process that consumes the LEI will derive some efficiency or effectiveness gains from it (e.g., fewer trade breaks, fewer people, lower pay grades, better service levels, etc.). There is real work required to model and quantify where the benefits outweigh the costs (i.e., licences, hardware, physical space and, most importantly, labour).
Obviously, there is a benefit to the adoption of the LEI that could well make a positive business case for it, but this advantage needs to be visibly identified and off-set against the costs of its implementation. And, clearly, we need real, meaningful and thought-through plans to make this happen.