An Overview of Legal Entity Identifiers (LEIs)
What is the LEI code?
The Legal Entity Identifier (LEI) is designed to create a global reference data standard that uniquely identifies every legal entity, in any jurisdiction, that is party to a financial transaction. This captures legal entities at every level in an organisation's structure, from the ultimate parent downwards. Such an identifier for each legal entity should allow regulators to conduct more accurate analysis of global, systemically important financial institutions and their transactions with all counterparties across markets, products and regions, allowing regulators to better identify concentrations and emerging risks. It will also allow local regulators to realise these same benefits. For risk managers in financial institutions, the LEI will increase the effectiveness of tools aggregating their exposures to counterparties.
Why are they needed?
Establishing the identity of the counterparties to a financial transaction has historically been reliant on linking together a number of data elements pertaining to the participating organisations. For example, a normal equity trade will have a trade identifier that is used by the dealers on both sides that is linked to the legal name of the fund or asset owner and cross referenced to the custody account number for settlement. This approach has resulted in systemic risk as a consequence of financial organisations having to map and manage these data elements largely independently of each other.
At the end of the 90s, in response to the goal set by the Securities and Exchange Commission (SEC) for T+1 settlement for all asset types, the Global Straight Through Processing Association (GSTPA) endeavoured to establish a unique counterparty identifier. However, with the SEC subsequently relaxing its target for T+1 settlement in recognition of the scale of the challenge, a key impetus behind establishing a unique counterparty identifier was lost.
The global financial crisis of 2008 re-focused regulatory attention on the need to understand the exposures that are layered into the financial system. Starting with "over the counter" derivatives (OTCs), the asset type considered most opaque terms of ultimate legal identification, Dodd Frank and EMIR regulation was introduced in the US and Europe respectively. Both regulations demanded transparent trade reporting from market participants and as a consequence, LEIs moved up the agenda once again.
Endorsed by the G20, the creation of a Global LEI System (GLEIS) has been critical in establishing a centralised standard for issuing LEIs and improving the measurement and monitoring of systemic risk. GLEIS has three tiers:
- Top level - Regulatory Oversight Committee (ROC) comprised of financial regulators from jurisdictions around the world
- Middle level - Central Operating Unit (COU) governed by a Global LEI Foundation (GLEIF), which will coordinate and oversee the actions of Local Operating Units
- Bottom level - Local Operating Units (LOUs) based in national jurisdictions, sponsored by local regulators, to assign and maintain LEIs that will feed into the COU.
How is the LEI being introduced?
The Financial Stability Board (FSB) has established a program to identify a global solution for LEI. Through a coordinated initiative between the Global Financial Markets Association (GFMA) and other trade associations, the industry has worked on the creation of the LEI solution. In July 2011, after extensive consultation with the industry, the GFMA defined its recommended solution which is based on the use of the ISO 17442 standard. The GFMA also recommended adoption of a joint DTCC and SWIFT solution to build and operate a LEI solution for all asset classes as a central global utility, operated on a cost recovery basis. This centralised utility would leverage the combined resources of DTCC and SWIFT in the issuance of identifiers and maintenance of the associated reference data. The DTCC/SWIFT industry solution is compliant with the five key requirements for LEIs:
- the official name of the legal entity as recorded in the official registers
- the registered address of that legal entity
- the country of formation
- codes for the representation of names of countries and their subdivisions
- the date of the first LEI assignment, the date of last update of the LEI information and the date of expiry, if applicable.
International Entity Identifier (IEI)
The London Stock Exchange (LSE) has gained authorisation to be a LOU so that it can issue LEIs. The LSE has established a pre-LEI version known as the International Entity Identifier (IEI) that will be used to meet the EMIR regulations whilst the development of the solution continues and will be transferable to the LEIs managed by the GLEIS once the solution is in place. The LSE charge fees on a cost recovery basis with an initial allocation costing £100 plus VAT and annual maintenance of £55 plus VAT per IEI. For firms who require a bulk allocation of 10 or more IEIs there are more favourable pricing models. Other issuers will have other charging structures.
Will LEIs only be used for OTC Trading?
The European Securities and Markets Authority (ESMA) have mandated the use of LEIs for derivative transactions and, as the body mandating other regulations such as AIFMD, the adoption of the LEI as the standard entity code for uses other than trade reporting is likely. The success of maintaining the LEIs for derivative trading will indicate whether the solution can support the required scale.
What is the impact on asset managers? The introduction of a key new data element such as the LEI will impact systems and the data management function. However, there is clear benefit to asset managers in being able to use the LEI to accurately group exposures by company ownership. In its first version, there is no ability to roll-up to "parent" implicit in the information as it was deemed critical that the LEI not have any intelligence in itself. However, hierarchy data is planned for subsequent phases of the global LEI initiative. The point of the LEI itself is to establish a common nomenclature, not on its own to assign risk. Nonetheless, even without full hierarchies, having a common means to unambiguously identify entities through the LEI will improve a firm's ability to do risk analysis. Importantly, it should allow data vendors to provide more accurate change in ownership information in a standard format that can be fed into the risk process.
The timeframe for adoption of LEIs will depend upon the success of the GLEIS roll out for OTC transactions and the subsequent phase delivery for exchange traded derivatives. Once the issues have been ironed out in relation to derivatives, ESMA can be expected to mandate the use of LEIs for trading in all asset classes.
The LEI itself currently contains only basic information but will develop in scope and sophistication over time. For example, links to parent companies are likely to be added. The LEI is also likely to be used by firms for positional and counterparty risk management to replace (or sit alongside as a cross reference) their existing internal codes. Consequently, firms adding LEI functionality to their IT systems should ensure that those systems can be easily upgraded as the LEI develops.