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Questionable Motives?

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I’ve spent a lot of the first two months of this year discussing the Office of Financial Research (OFR) with various industry participants, but a recent conversation brought to light something that hasn’t yet been fully explored in my previous blogs: the US government’s real motivation for standardising legal entity identification, beyond tracking systemic risk. As we all know, there’s often a less obvious motivation for governments to act in the manner they do and this often comes down to the issue of revenue, and this case could be no exception.

After all, the US government is facing a well publicised funding crisis in the wake of the financial crisis and measures such as the introduction of the Troubled Asset Relief Programme (TARP), which was used to bail out firms in trouble. TARP allowed the US Treasury to purchase illiquid, difficult to value assets from banks and other financial institutions and now those loans must be “repaid” to US taxpayers. In order to track the TARP repayments, the government needs to be able to keep a close eye on the financial institutions to which it lent funds; not an easy proposition when you do not have a fully comprehensive handle on which entities are linked to each other.

Moreover, if, as it seems wont to do, the government is aiming to crack down on tax dodgers to fill its funding gaps, what better way than to ensure that every firm active in the US market is identified by a Taxpayer Identification Number (TIN)? As the US moves from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS) over the next five years, this move makes even more sense. The introduction of cost basis accounting, the concept of revaluation and an emphasis on fair value as part of IFRS are likely to compel the US government to take the next step of validating an entity’s cost basis revenues, noted my interviewee.

The task of tracking revenue and tax more accurately and overall transparency (a new tenet of the post-crisis world) could be improved by the addition of more detailed parent/child hierarchy data linked into the taxpayer identification system. Legal entity identification standards could therefore equal a revenue generation opportunity: by nailing down entity structures, the government could ensure that every penny is taken into account and can be rolled up to the ultimate parent.

In fact, one of the responses to the OFR even suggests the TIN as a suitable entity identifier for the purposes of tracking this data. The response by law firm Schwartz & Ballen, which purports to represent a range of financial institutions with which it works, promotes the idea of the Internal Revenue Service’s (IRS) TIN in its rather US centric response. It says that the benefits of this would include that it is a system of identification that already exists and that it covers all firms in the US or those that deal with the US.

Obviously, the danger of this approach would be its US centricity, given the majority’s desire for a more global approach. However, if the US government’s real intention is to use the TIN to this end, it is likely that very little can be done to change its course. It will certainly be interesting to see whether this potential is openly discussed by government and industry participants in the coming months, as we move towards the July deadline for setting an entity ID standard.

In other news, this month should also see political fireworks fly, as the US regulators are forced to justify their funding requests related to the implementation of the Dodd Frank requirements. A hearing has been tentatively scheduled for 30 March, during which the SEC and CFTC will need to testify on the subject before representatives from Congress.

High profile Republicans have already been questioning the cost-benefit analysis of introducing all of the new requirements of Dodd Frank in light of the current economic climate. Congressman Randy Neugebauer, chairman of the House Financial Services Subcommittee on Oversight and Investigations, this week said regulators would need to prove that they are not “over-reaching” in terms of their oversight capabilities. It seems likely that the topic of the OFR could crop up, if Republicans that have already spoken out against the new agency are involved in the meeting.

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