LEI: The struggle for identifiers
Many firms will find themselves involved in a late rush to apply for legal entity identifiers (LEIs) as the deadline for the new legislation comes into force. Based on current numbers, a huge number of firms will still need to get LEIs issued in the remaining few months ahead of reporting go-live, putting huge pressures on the industry. Only a small proportion of the firms who need LEIs have been issued with them, in part due to a lack of awareness and also due to a lack of immediacy. The use of these unique codes to identify businesses is mandated under new financial market regulations. Some of these regulations have already come into effect but additional regulations that broaden the scope of LEI usage are set to come into force in 2016. Backed by the Regulatory Oversight Committee (ROC), which in turn represents around 80 regulatory bodies from over 50 countries, these new rules affect a wider range of financial instruments and practices, capturing a far greater number of companies that interact with capital markets products. That draws non-financial corporates into the sphere of these rules, and will eventually make the use of LEIs ubiquitous across issuers, traders, investors, brokers and market infrastructure providers.
The size of the problem
The extent to which firms have already engaged in the LEI issuance process is largely down to existing regulatory mandates. For example, under European Markets Infrastructure Regulation (EMIR) firms trading over-the-counter and listed derivatives have been required to use their LEIs when reporting transactions since 12 February 2014. Some 400,000 LEIs have been issued, but this represents a fraction of the firms and entities that will ultimately require them. While the total number that will need to be issued is hard to gauge the following statistics provide some idea of the scale.
According to National Numbering Agencies, who are responsible for issuing International Securities Identification Numbers (ISIN) and also make up half of the Local Operating Units (LOUs) assigning LEIs, approximately 80% of global issuers across all asset classes have not applied for LEIs. The European Insurance and Occupational Pensions Authority (EIOPA) estimates that roughly 45,000 occupational pensions in the UK will require an LEI but to date, only around 500 have obtained one. Asset managers need an LEI for each fund and trust they manage, which can run into tens of thousands per manager. Anecdotal reports from UnaVista buy-side clients suggest that around 20-25% of funds and trusts have been issued with LEIs under EMIR, through their use of derivatives – this leaves a substantial number of trusts and funds that will require an LEI.
Building a critical mass
The value of LEIs to firms will increase as their use becomes more ubiquitous. Even relatively simple financial processes such as payments can be improved by the use of a consistent identifier. Using an LEI to identify debtors, creditors and counterparties, rather than using an individual or proprietary ID for those entities, gives firms a much clearer view of their risk and exposure across those companies, assisting with the management of those within a corporate group.
The LEI standard, ISO 17442, dictates which entities are eligible and required to obtain an LEI. However the real driver is typically the regulations that mandate the use of LEI.
The European Securities and Markets Authority (ESMA) indicated in its recent consultation on market regulatory news announcements, that companies may be expected to include their LEI with any regulatory news releases they do. Listed companies will also require LEI in order for market participants to engage in trading of the company’s securities and fulfil their reporting obligations, such as EMIR and MiFID II.
Due to the self-registration principle of the global LEI system, these firms cannot rely on the market participants to acquire them an LEI, and as such they will need to be directly engaged in the assignment and renewal process.
The operational challenge
There is a real danger that firms risk underestimating their LEI requirements and the work involved in obtaining LEIs. Regulatory deadlines will trigger activity for a swathe of the industry, putting a lot of pressure on the Local Operating Units (LOUs) which administrate LEI issuance. Depending on the LOU capabilities, a LOU can issue LEIs globally, so identifying a reliable unit can be preferable to working with the LOU in closest proximity. Although the assignment timeframe for obtaining an LEI is short, there are validation requirements that must be met. If an LOU becomes a bottleneck, for many hundreds of thousands of LEIs, issuance could prove challenging and likewise compliance becomes difficult.
There is a precedent for that sort of delay – when the EMIR reporting deadline was set many firms were caught out, creating a backlog of LEI issuance. This has the potential to lead to transaction reporting failures, for which many banks have been fined in recent years.
The upcoming deadline for Solvency II and EIOPA identification is January 2016 however, the MiFID II/MiFIR deadline for January 2017 will have a much broader and significant impact. Firstly it expands the asset classes to which LEIs will be applied to, multiplying the entities that fall into scope. Secondly it draws in non-financial entities, such as many issuers and guarantors who are typically less aware of the requirements than trading entities. Given the volumes of LEI issuance that will be required, firms need to undertake the process sooner rather than later or risk non-compliance for themselves or their issued securities. Beyond direct self-registration, where an employee from the entity is requesting the LEI or a parent company collecting for subsidiaries, a firm obtaining LEIs on behalf of its clients will need to obtain explicit permission from each to do so. Additionally, obtaining an LEI is not a stand alone requirement but does require annual recertification of the data provided. Authentication has to be in place to request the LEI, and once that is verified then the entity data fields can be validated against public authoritative sources, such as business registries. An entity managing trusts, pension schemes or funds where the prospectuses are not publicly available is reliant on providing legal documentation to satisfy the validation requirements.
Working closely with a LOU, such as the London Stock Exchange, from an early stage can facilitate the process, minimising the risk of error, non-compliance and associated cost; last minute attempts to register will likely face delays that could leave firms exposed and at risk of transaction reporting failures that could result in fines.