OR why everyone should care about the LEI
Tracing family ancestry has been gaining in popularity. PBS and cable TV programs feature celebrities (and non-celebrities) finding out surprising facts about their roots. Genealogy web sites and DNA testing kits have made a business out of helping people trace detailed ethnicity, and even find out if there were any celebrated historical figures (or skeletons) in the family closet.
Learning about your own background — the good, the bad, and the ugly — can be interesting. But for investors and for companies doing business with other corporate partners, understanding the “ancestry” of the companies in which they invest or do business, can be critical.
Businesses need to understand the kind of risk they’re taking on in partnering with or developing a relationship with another company. How much due diligence do you undertake when considering doing business with another company? Do you check references? Confirm that they are in good standing with creditors and customers? Do they compete with your organization or have some other conflict of interest? Performing due diligence can ensure proper evaluation of a specific company, but what if that company has (or had in the past) a subsidiary that has some skeletons in its closet? It’s often difficult to make the connection.
It’s equally critical for investors. Companies often have complex relationships with lots of other companies, and those companies have relationships with other companies, and so on, and so on. A problem with a subsidiary of a company in which you invest could spell big trouble for your own investment down the road.
OpenCorporates.com maintains a publicly-accessible database of companies worldwide, established to help track information on corporations. A search on the company Pfizer, Inc, for example, identified 888 active related companies . A search on Facebook, Inc. found 201 active related companies . These statistics point out how important it is to consider how numerous corporate connections might be efficiently and accurately tracked so that investors and businesses can fully understand their risks.
A standard to track corporate ancestry
The Legal Entity Identifier (LEI) is a globally used, unique, 20-digit, alphanumeric code for companies based on standards developed by the International Organization for Standardization (ISO) and issued by several coordinating organizations. It connects to reference information that enables clear and unique identification of legal entities participating in financial transactions. Reference data available with the LEI, which includes the official name of a legal entity and its registered address, is referred to as “Level 1” data, which explains ‘who is who’. In May 2017, the Global Legal Entity Identifier Foundation (GLIEF2) began enhancing the LEI data pool, by including “Level 2” data, which allows the identification of the direct and ultimate parents of a legal entity. Level 2 data for the complete LEI population is expected to be available in the first half of 2018.These “layers” of data effectively helps investors and businesses “connect the dots” between companies of interest and their subsidiaries so that they have a much better window into potential risks. LEIs are broadly used around the world, but less so in the United States.
Regulators understand the value of the LEI
Global regulators understand the importance of identity tracking, and the LEI is rapidly gaining traction around the world, as noted by the Financial Stability Board report on OTC Derivatives Market Reform , “LEI coverage has grown in recent years, and as of end-May 2017, over 513,177 entities from 200 countries had obtained LEIs”.
Here in the U.S., the Securities and Exchange Commission (SEC) recently proposed as part of their FAST Act Modernization, that publicly traded companies, if they already maintain an LEI, be required to report their LEI in their financial filings. Public companies today report using a Company Index Key (CIK) which is a 9-digit code assigned by the SEC. The CIK is only used for SEC filings so it’s not especially valuable outside of the realm of corporate financial statements. Moving to the LEI seems like a good idea as a means to help businesses and investors track corporate and investment risk, although not all public companies in the US are convinced about the value of the LEI.
SEC filers are not enthusiastic about the LEI
We conducted an online survey among SEC filers in late Fall 2017 to gauge their reaction to the SEC proposal. Of the 71 respondents to this survey, only eight (11%) said using the LEI would be helpful to investors and to themselves in conducting comparative analysis. The balance were either neutral or disagreed with the statement that the LEI would be of use. A few open-ended responses we received noted:
“There is absolutely NO reason for a LEI when there is already a CIK number associated with every public flier. . . ”
“It sounds like a complete waste of time and money while adding no value whatsoever.”
This response is not surprising given that most US companies don’t use the LEI. In fact, among survey respondents, only 18 (25%) said that their organization maintained an LEI.
Data providers support the LEI as valuable to investor clients
We also checked in with seven commercial data providers to gauge their reaction to the SEC proposal. This group was unanimously supportive of the LEI. Observations from the group included:
- The LEI can help track counterparty and entity exposure, and aid in credit and risk evaluation.
- Data users often combine XBRL financial statement data with other sources like corporate information reported through the patent office or the Federal Drug Administration.
- In the absence of the LEI, workarounds are required for entity resolution, which are prone to error.
- Availability of the LEI would increase the quality of data and provide more robust capital markets data that is more efficient and more easily consumed.
The disconnect between SEC filers and data users is not unusual. But in an increasing global marketplace – both for business and investment – it’s important for US corporations to gain access to the tools that the rest of the world is leveraging to their advantage. The SEC owes it to the US capital markets to help educate SEC filers on the hows and whys of tools like the LEI that can keep us competitive .
Tracing corporate ancestry by adopting the LEI will require some upfront work, as any standard does. But the insights that can be gained by investors and businesses are important, and in an ever-global marketplace, critical.
Read the SEC proposal on FAST Act Modernization.
Read the XBRL US comment letter to the SEC on FAST Act Modernization.