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Brian Clarke


Alice was interested in an article she had found whilst waiting for her dental appointment. It was titled: 'The End of Instability, Opacity and Risk in the Global Financial Market – A Pipedream?'

Reading through the article Alice drifted off into a dreamlike state…

Alice had no real intention of visiting Financial Regulatory Land. It was just that she knew she had money tied up in pensions, ISAs and other investments and wanted to be sure any proposed rules and regulations would make her investments safe.

The article she had read raised a number of things that were concerning Alice. With this in mind she set off to find answers to the many questions that were racing through her head. Where better to find her answers than the Financial Regulator's tea party. She wasn't too sure why she would find answers to her questions here but remembered registering for something online.

"Why are you here?" said the MadHatter, who was seated around a large table with the March Hare and the Dormouse.

Brian Clarke

Brian Clarke

Puzzled by her surroundings, Alice replied, "I was led to understand that you would be able to reveal all about the initiatives that will be in place to avoid a future meltdown in the Global Financial Market".

"You've certainly come to the right place. Please take a seat and make yourself comfortable. Cup of tea?" said the March Hare.

As she was making herself comfortable the Mad Hatter said, "Where would you like to start?"

"I understand that the problem with the financial system was global in nature and I am interested to hear what the global solution is going to be", replied Alice.

"Well," said the Mad Hatter, "Let's start at the beginning. You see, it all came to pass in 2008 when …"

Alice interrupted, "Stop please! All I read about is the crisis in 2008. In reality it means nothing to us mere mortals. I would just like to hear what global solution will be in place to prevent anything untoward happening in the future".

"In that case," said the Mad Hatter, "We should look at the pillars that are being built to make sure nothing of this nature happens again".

"The first pillar is to do with the unique legal entity identifier that is being introduced globally" said the Mad Hatter clearing a space on the table. "Think of this cup and saucer as the LEI pillar on which other pillars will be built."

"How does this work?"inquired Alice.

"Let me explain," said the Mad Hatter. "It was thought, for a long time, that there needed to be a mechanism in place that uniquely identified all Financial Institutions throughout the world."

"Really?" said Alice.

The Mad Hatter, sensing some sarcasm, continued; "This came to the fore, after er… 2008 and has resulted in the LEI system, which will facilitate aggregation and analysis of trade data across all financial market participants. This system will remove the opacity and uncertainty around risk and exposure in derivative trades by financial counterparties."

"A truly standardised global system?" inquired Alice.

"Not quite," said the March Hare, "Due to timescales imposed by the Dodd-Frank Act, for the reporting of swap trades, the US Commodity and Futures Trading Commission were mandated to plough on way before the global LEI was agreed and put in place."

"Umm!" said Alice "So the unique LEI system is based on the US one?"

"Not really," said the March Hare. "The globally agreed LEIs have a Local Operating Unit identifier in the first 4 characters and this is numeric and unique. Unfortunately, the US solution is different and the first 4 characters are alphabetic, therefore all historically created LEIs on the US LOU will not follow the globally agreed implementation ofISO 17442. It's not clear if the US LEIs will be brought into line as they are deeply imbedded in financial systems and trade repositories. At the moment we have a system of pre-LOUs in place. I know, don't ask."

"Sounds unnecessarily complicated," interjected Alice.

"But think of it like football. The US plays the same game as the rest of the world but they call it soccer!" said the Mad Hatter.

 "But if one regulator implements something before a global standard is put in place wasn't there always a risk involved?" enquired Alice.

"Well quite," said the March Hare.

"It's a marathon, Alice," said the Mad Hatter impatiently. "Some runners set off at a sprint and others catch up later."

"That's OK," said Alice. "But wouldn't it have made more sense if everyone left the starting blocks at the same time? I guess that as long as they all pass the same finishing line it might be OK."

"This has been thought about and we now have a globally agreed governance structure in place under the Financial Stability Board that will oversee the global LEI system. Hopefully, all these little issues will be ironed out by the regulatory oversight committee managing the global legal entity identifier foundation who will be guiding the central operating unit who will be working with the local operating units around the globe. Until then we will have a system of pre-LOUs," said the March Hare.

"But isn't the running of the LEI system based on a federated approach?" said Alice. "Surely this could lead to duplication and quality issues when all the data comes together and what will happen when something like a merger or takeover occurs?" Alice was recalling the fact that she had read an article about this very recently.

"We won't know until the fully working system is in place and this is some way off," the March Hare replied.

The Mad Hatter announced, "All will be working perfectly once there is a central repository in place. Did you know that over 300,000 legal entities have registered across the world so far? There are also sites emerging to show consolidated LEIs. For example,the following, and allow anyone to download a consolidated list of LEIs. Let me ask the Dormouse to explain."

The Dormouse had gone to sleep.

"So, all the data is in the same format" Alice thought out loud.

"Not quite," said the March Hare. "Unfortunately there isn't an agreed standard schema. This means that the data has to be mapped to some extent although the contents remain the same. There are exceptions, one being that where the full country name is used by the LOUit is converted to the two character ISO 3166 code.Another one is to do with the conventions for the LEI status, which have not yet been agreed and therefore some transformation must take place."

"Also," said Alice. "Isn't it true that FATCA, amongst others, require legal entities to register using completely different numbering systems? Like the global intermediary identification number?As I understand it one of the issues before was not being able to readily identify all the legal entities of Lehman Brothers that were involved in trading, what turned out to be suspect investments. And hence what the company's total exposure was. Will the LEI record hold the unique identifier of the business hierarchy or at least the LEI of the business entity? I feel this is important."

"Dormouse, Dormouse!" shouted the Mad Hatter in some despair, but there was no response.

"Is it true that the LEI itself doesn't readily identify the legal entity and therefore the name supplied to the LOU is very important?" queried Alice, sensing a problem or two.

"Yes," said the March Hare. "But the names will be in the local language, including character based ones. This may make it hard to confirm the correct LEI for the counterparty."

"DORMOUSE!" implored the Mad Hatter but the Dormouse appeared to be in a world of his own.

Given the lack of a response, Alice asked,"But how does the LEI help?"


"It is one part of the global regulatory jigsaw puzzle and this brings us to the next pillar which is to do with the reporting of derivative trades to a trade repository," said the Mad Hatter placing another cup and saucer on the first causing the construction to appear less than solid.

"And the unique trade identifier?" added the March Hare.

"That makes sense," said Alice.

"It should," said the March Hare. "But there are some complications with it. The globally agreed proposal is for a UTI based on a 10 character prefix and using characters 7-10 of the LEI followed by a uniquely generated transaction identifier. You see the CFTC in the US jumped the gun again by creating the USI."

"The USI?" said Alice.

"The USI is the unique swap identifier and it is mandatory for all financial institutions registered with the CFTC and trading in swap derivatives," continued the March Hare. "Furthermore, the 10 character USI bears no resemblance to the globally proposed UTI."

"Oh," said Alice. "This sounds very confusing. How will this be resolved?"

"Simple. If the counterparty usesthe USI format, even if not reporting a particular trade to the CFTC, then they should use a USI. Otherwise they should use the UTI as clarified above," explained the March Hare. "Furthermore, the EU countries have their own trade repositories. But whereas in the US only the seller is required to post the trade, in the EU both parties have to report the same trade. In addition, there is no global agreement on the type of trade to be reported."

"Oh, a federated system again!" shouted Alice in frustration. "But could this lead to a high level of mismatches when the data is consolidated? Not to mention the quality issues."

"This is true" said the March Hare "some evidence suggests a very low matching rate to date. The hope is that this will improve".

"And will there be a central repository of all derivative trades carried out around the globe?" enquired Alice.

"This is probably not going to happen in the short term, if ever, as each jurisdiction will want to maintain its own vested interests. Sharing data wouldn't be seen as a positive thing and there may be local data protection laws to consider," said the March Hare.

"Vested interests?" exclaimed Alice"but what does that mean?"

"It means," said the March Hare. "That the regulators will use organisations in their own jurisdiction to facilitate the regulations being enacted, whether for LEIs, trade repositories or central clearing. Hence, any solution will be federated, even in the EU. It also means they can look out for the financial institutions in their jurisdictions. If you like, all for one and that one's me!"

"Again, a federated system to deal with a global problem," exclaimed Alice. "But how will we know the total global exposure of each financial institution if each trade repository only holds trades made in its own jurisdiction?"

"The federated approach has already been agreed upon and accepted by the G20 nations," said the Mad Hatter. "There's really no prospect of going back."

"Even at the expense of global financial stability and transparency?" worried Alice out loud.

"You need to look at the regulatory reform as work in progress. If something is not working then it can be corrected or at the very least obfuscated," said the Mad Hatter.

"And what about dark pools?" said Alice. "One of the main tenets of the regulations was for transparency. I understand that dark pools defeat the very purpose of a transparent market. Will dark pools be subject to the same regulations?"

"Oh, Alice, you read far too much for your own benefit," said the Mad Hatter. "Rest assured that that the G20 governments and their regulators have employed the finest minds in financein order that the world at large has no need to worry – about anything."

"Butwill those minds be looking after any vested interests?" said Alice.

"Umm," said the March Hare. "This is more than likely."

"There's more to come. You really need to look at the whole regulatory pie," said the Mad Hatter as Alice fidgeted in her chair looking as if she was about to leave. "You must stay."

 "But so far the pie looks undercooked to me," replied Alice. "This is all very confusing and we only seem to have scratched the surface," said Alice looking concerned. "I really must be going."

"We haven't talked about the third pillar – central clearing. Not to mention collateral management, MiFID, AIFMD, FATCA, GATCA, Basel III, Solvency II, UPI, HFT, SEFs and much, much more," said the Mad Hatter.

"What's central clearing?" asked Alice watching the Mad Hatter place the third cup and saucer gingerly on top of the other two.


"Let me explain about central clearing," said the Mad Hatter, wanting toappear knowledgeable. "You see,all standardised OTC derivative contracts will be processed through central clearing parties. These parties will be responsible for settling the trade on behalf of both the seller and buyer sides. This should bring stability to the financial markets in the future as these contracts will no longer be bi-lateral."

"Is there a risk with this approach?" wondered Alice out loud.

"The biggest concern is that the relatively small number of central clearing counterparties will become too big to fail. You may remember some banks were deemed as such during the crisis and were bailed out by governments around the globe," said the Match Hare.

"Nonsense," said the Mad Hatter. "This has all been thought through in detail. And, don't forget all these trades have to be reported to the appropriate trade repository as well".

Alice was eager to push forward with something she had read. "I was reading an article that said the financial crisis was caused by unscrupulous traders selling collateralised debt obligations and mortgage backed securities. These products bundled together mortgages designated as sub-prime because the people taking them on would likely default if there was any turmoil in the housing market. The housing market crash in the US brought the lot down like a house of cards. I don't pretend to understand this at all but it also said that the buyers of these securities had poorly performing or non-existent risk assessment functions and this all happened within a regulatory-lite framework," said Alice, keen to understand as much as possible before she left.

"I wanted to know if these types of transactions are covered by central clearing?" continued Alice. "And will not cause another crisis."

"Oh no!" said the March Hare. "These transactions are referred to as structured products. They are not in scope of any of the regulatory reforms taking place."

"So," said Alice. "It could all happen again even though millions of dollars have already been spent and millions more yet to be spent by financial institutions."

By now the cups and saucers were beginning to look like the leaning tower of regulation and Alice felt that one small tremor was all it needed to come crashing down. The March Hare had already sought sanctuary under the table. Even the Dormouse was stirring, sensing that all was not well.

The Mad Hatter noticed the wobbling structure and was urgently trying to interject and said, "You mustn't believe all you read Alice, this is all very complicated and that is why the regulators want to get it right."

All this time it had been quite plain to Alice that the regulators knew nothing about designing and implementing a global solution for a global issue. As for all their obfuscation, well Alice didn't care.

"Sorry," said Alice. "But I have to return to the real world".

Before the Mad Hatter had a chance to speak Alice disappeared, she seemed to be in a hurry.

"Wake up, Alice, wake up," said the nurse gently shaking her. "The dentist is ready for you now."

Startled, Alice awoke from her dream only to realise that she hadn't returned to the real world. She had been in it all the time. Furthermore, she now understood that getting meaningful information from the financial regulatory bodies would be harder than pulling teeth.

It was clear that this whole business of bringing stability, transparency and a risk-free global financial system was not going to be a tea party!

She promised herself that, at the earliest opportunity, she would liquidate all her assets and place them under her mattress. She knew it made sense.

Brian Clarke

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