July 31, 2014 5:03 pm

A bubblegum fix for banks will make finance safer

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It’s a pity it has taken a financial crisis to force financiers to embrace barcodes
illustration of bar code and people©Shonagh Rae

Four decades ago, a business revolution started with a packet of Wrigley’s Juicy Fruit chewing gum. On June 26 1974 the packet carrying a barcode was swiped under an electronic reader in an Ohio supermarket, marking the first time anything had “read” an item with a standardised, 11-digit barcode label.

Since then barcodes have become so ubiquitous – and, crucially, so standardised – that shops and suppliers can manage goods with extraordinary efficiency, via digital networks that can read the “labels”, anywhere on the globe.

Could a similar revolution now be starting in high finance? It would be nice to hope so. A few weeks ago an obscure group of central bankers, regulators and financial officials, including those from the US Treasury, met in Switzerland to create a new cross-border foundation to oversee a system of so-called global “legal entity identifiers”, or LEIs.

The news went almost unnoticed. No surprise: the financial world is drowning in so many acronyms that the arrival of LEIs is apt to sound like more banking gobbledegook. But in reality those LEIs are potentially very important. For what they do is create standardised “labels” for financial entities that can be read by computers anywhere in the world. Or as the Financial Stability Board notes: “The Global LEI System has the objective of providing unique identification of parties to financial transactions across the globe, to underpin multiple financial stability objectives.” The reason this matters is that if regulators and bankers know who is cutting deals, this should make it easier for bankers and regulators to monitor the flows of finance – in much the same way that the bar codes on gum packets enable supermarkets to track stocks.

This is long overdue. In recent decades western bankers have loved to present themselves as brilliant innovators, who can surf the latest technological trends. But a dirty secret of finance is that financiers have been surprisingly slow to adopt innovations in technology.

Thus, even as retailers have embraced standardised bar codes in recent decades, financiers have continued to operate with a confusing, primitive hotch-potch of ad hoc labels. Individual banks tend to use their own separate labelling systems for tracking financial flows, for example, which are not compatible with each other. While there are some commercial market-wide labelling systems – such as the “RICs” (Reuters Instrument Code) system operated by Thomson Reuters for securities – these only cover specific segments of finance.

Until recently there was not even a standardised system for labelling the different legal entities that were involved in cutting financial deals. Thus, when Lehman Brothers collapsed, the authorities were startled to discover that the broker had thousands of different legal entities, all of which were making trades – but most of which had never been tracked.

In theory, an LEI system should help fix this. The point of the new foundation, as conceived by the FSB, is that these electronic labels will not just be standardised; they will be a public good, free from intellectual property rights. There are already signs this concept is starting to take root, as a result of regulatory fiat and voluntary adoption.

Regulators estimate, for example, that in the past couple of years about 300,000 legal banking and asset management entities have already been “labelled” with LEIs. Officials hope this tally could double, or treble, in the next few years, as the idea spreads into other fields, such as reinsurance. For while many private sector financial groups were initially wary of LEIs, most have now jumped aboard, partly because they hope it will cut transaction costs.

Indeed, there is now so much momentum behind the idea that regulators hope to take a second step: launch another labelling system that will not just identify financial entities but transactions too. That would finally make it possible to “map” finance in a detailed way, in real time.

Do not expect this data nirvana to appear quickly. For one thing, it is difficult to co-ordinate all the regulators that need to be involved; in order to create the foundation in Switzerland, for example, deals had to be struck between six dozen government groups. Not all agree on issues such as how to pay for the LEIs or deal with privacy issues.

For another, some of the commercial entities that already run ad hoc labelling systems are far from happy about seeing their franchises undercut by a non-profit system. Thus as the LEI spreads, there could be some big behind-the-scenes battles looming about who should control the systems, and the information this generates.

Nevertheless, if regulators can iron out these differences – which is a big if – banking may finally be heading for its own version of the barcode revolution. If so, that would be a truly good thing.

The only pity is it took a financial crisis to force financiers and regulators to embrace this commonsense idea and bring an end to 50 years of complexity, opacity and foot-dragging.



Letter in response to this article:

Regulators must mandate use of the Global LEI System / From Mr Kenneth E Bentsen, Jr

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