New regulations require cleaner data
By Mark Davies, contributing author for Compliance Complete
LONDON, Apr. 18 (Thomson Reuters Accelus) – Continuing efforts by financial regulators and by firms themselves to monitor and offset risk have affected almost all areas of firms’ operations, including the management and maintenance of data. The overhaul of global systems following the financial crisis has led to an audit of data, and specifically of the information which firms hold about themselves and their counterparties or clients, known as business entity reference data.
This “data exploration” is being driven by the cumulative effect of several individual pieces of regulation, including the European Market Infrastructure Regulation (EMIR) and Solvency II in Europe and the Dodd-Frank Act and the Foreign Account Tax Compliance Act (FATCA) in the U.S., all of which are likely to have an impact globally. The primary goal of these proposals, with the exception of FATCA, is to improve risk management in the financial system.
Business entity reference data
Business entity reference data describes the legal structure of a firm or entity. It includes corporate hierarchies, registered address information, industry sector codes and company identifiers. It is used for know your customer (KYC) activities in the banking and insurance industries, and for the settlement and reporting of trades across the financial markets. Aside from its use in the client on-boarding process, interest in entity reference data has mainly come from those operating in the back or middle office, although one repercussion of the new regulatory environment has been a significantly broader interest in this data, from the compliance and risk departments all the way to board level members and investors.
The industry has come to realise that, all too often, business entity reference data can be unclear, inaccurate and maintained using legacy processes, often manual, which cannot keep pace with or satisfy the demands of today’s financial markets. Records, over time, have become stagnant, and this has been compounded by the fact that entities may have undergone multiple changes in their legal structures which have not been reflected in the information held by firms. It is hard enough for firms to maintain one version of the “truth” but the complex system architecture that many firms run as a consequence of mergers and product or geographic silos can make it almost impossible to separate good information from bad.
The less than pristine quality of entity data that exists in the financial markets is causing both reputational and operational harm. During the collapse of Lehman Brothers in 2008, it became apparent that the entity reference data held by firms was neither current nor useful enough to paint an accurate picture of market risk and exposure. As a result, before the default regulators did not have the information required to identify the build-up of systemic risk, and afterwards counterparties to the bank were unable to identify quickly or accurately which of their trades were with Lehman group entities or other exposed parties.
Legal Entity Identifier
New mechanisms are being developed to help monitor risk, including the Legal Entity Identifier (LEI), a unique identification system for parties to financial transactions. The creation of a global LEI system has been endorsed by the G20 and positive progress has been made towards its implementation. In the U.S., a provisional LEI solution known as the CFTC Interim Compliant Identifier (CICI) has been active since August 2012 for reporting interest rate and credit default swaps, a requirement under the Dodd-Frank Act. Similar reporting rules for these contracts will come into effect in Europe within the next six months under EMIR.
Firms are under more and more pressure to make sure that the data they hold reflects the correct legal structure of their business and their counterparties, and the LEI should help with that effort. Organisations currently use a variety of methods to gather, organise and manage entity identifier information for the huge number of de facto standards that exist today. This inevitably leads to duplications, inconsistencies, erroneous mappings and, therefore, greater risk.
Before the LEI implementation and the raft of new rules and regulations come into effect, firms should ensure that their data has been verified as both correct and meaningful, a process known as data validation, and then that it is properly maintained on a continuing basis. This is to ensure that firms, and ultimately the whole of the financial system, are making decisions on the basis of clean, correct and useful data.
An important lesson
In recent years, it has become incumbent upon regulators and participants in the financial services industry to make sure that the financial markets are underpinned by a robust infrastructure. An essential lesson from the crisis is that data is absolutely critical to these efforts, and that firms must take individual responsibility for their data. Many institutions, particularly larger banks, have already begun the process of analysing their current data architecture, determining where entity data is present, matching their internal records, and identifying data quality issues within their data. Many have not, however, and for these firms, processes relating to business entity reference data will require attention sooner rather than later.
(Mark Davies is the general manager and head of Avox, a specialist provider of business entity data solutions and a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC). The company maintains, corrects and enriches business entity reference data, including corporate hierarchies, address information, industry sector codes and company identifiers for its global clients across the financial services industry. The views expressed are his own.)
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