Incoming MiFID II derivative rules will force widespread adoption of Legal Entity Identifier Numbers. Here is what you need to know.
Corporates trading across many asset classes in Europe using derivatives should take note that from 3rd January 2018, any firm subject to MiFID II transaction reporting obligations will not be able to execute a trade for a client who is eligible for a Legal Entity Identifier (LEI) and does not have one.
This means that to continue entering into derivative contracts with banks, corporates if they have not done so already will need to obtain a LEI.
What is a LEI?
A LEI is a unique 20-digit identifier that connects to key reference information – such as the company name and domicile location – to enable the clear and unique identification of legal entities participating in financial transactions.
Launched in (the) response to the 2008 crisis, LEIs enhance transparency in the global marketplace.
“A LEI is very like a barcode or product identification number that you see on nearly all consumer goods,” says Mark Davies, Global Head – Data Services for Thomson Reuters Risk Managed Services. “Once issued, the number lives with the company or legal entity for its life.”
Obtaining a LEI
To join the over half a million companies and legal entities issued with LEIs, corporates as well as all parties to in-scope transactions need to contact a LEI Local Operating Unit (LOU) – who can be found on the Global Legal Identity Foundation website – to obtain a code, which will be issued in line with an ISO standard.
Corporates will have to find a provider that suits their business, as some only provide LEIs to countries in certain markets, whereas others can issue globally, explains Davies. There are some variations between LOUs in both the level of service or support provided, such as timeliness, volume handling capabilities, payment methods and currencies supported. There is also a small cost to obtain a code, (the London Stock Exchange, for example, charges an initial allocation cost of £115 plus VAT and annual maintenance cost of £70 plus VAT per LEI).
Once obtained, corporates will then need to work to embed this number into their existing data set. The number can then be used in a variety of different ways.
Beyond regulatory reporting
As mentioned, the most pressing reason to obtain a LEI for many corporations will be to ensure they can continue to transact seamlessly using derivatives once the MiFID II regulations come into force next year. But Davies is keen to stress that obtaining a LEI should be more than a MiFID box-checking exercise.
“Encouraging all businesses to obtain a LEI, be it through regulatory enforcement or best-practice education, can have many knock-on benefits for corporates,” says Davies. “For instance, if parties in a corporate’s supply chain have LEIs then these can be used to achieve greater visibility and transparency over who you are doing business with and how companies are connected.”
Davies adds that this can be especially useful if a company changes location. “A treasurer will be able to find out this information more readily than if they didn’t have a LEI. This will not only ensure that their corporate information is up to date, it will also enable them to adjust the risk profile of this counterparty accordingly.”
In the payments space, SWIFT is also working to link payments with LEIs to provide increased transparency. For corporate treasurers having the LEI of the payer included in the payment message would help them to identify who the payment came from, solving some reconciliation issues and driving greater straight through processing of payments. It could also potentially act as another safeguard against internal payment fraud if the BIC code is changed and this does not correspond with the LEI.
Davies notes that these are only a few of the benefits that can be achieved from having the ability to unambiguously identify the parties involved in financial transactions. Thomson Reuters, following its announced acquisitions of Clarient and Avox, is now exploring how to embed more information behind the LEI to help reduce costs and improve processes around areas such as KYC.
The challenge though for all advocates of the LEI is achieving a critical mass of adoption. “MiFID II could see the number of LEIs issued double to one million by early 2018,” says Davies. “This will certainly raise awareness of it in the short term and provide mid-term benefits by improving market transparency.”
To drive long-term adoption, Davies notes that the global regulators that form the GLEI Regulatory Oversight Committee have committed to writing the LEI into domestic financial regulation. “The issue is that writing and launching regulation takes time, so it will take some time for critical mass to be reached internationally, but 3rd January is an important milestone.”