Esma’s LEI Xmas Extension: Last-Minute Gift or Lump of Coal?

More than 1 million Legal Entity Identifiers (LEIs) were registered in the lead-up to the January 3, 2018 deadline for compliance with Europe’s revised Markets in Financial Information Directive (Mifid II). Yet that number still falls far short of the estimated number of LEIs necessary as mandated under Mifid II’s rules, which require nearly every company, charity, trust, or fund to obtain an identifier. 

As a result, five days before Christmas and two weeks before Mifid II’s deadline, pan-European regulator the European Securities and Markets Authority (Esma) announced a six-month grace period for full LEI implementation, stating that “in the last weeks, Esma and National Competent Authorities (NCAs) learned that not all investment firms will succeed in obtaining LEI codes from all their clients ahead of the entry-into-force of Mifir.” 

Before getting into the business of how Esma’s decision may affect trading during the first half year with Mifid II in force, it is worth unpacking exactly what the extension encompasses.

Extension with Limits

“This is not a general grace period of six months, where everybody can come and go whenever they like,” says

Stephan Wolf, CEO of the Global Legal Entity Identifier Foundation (GLEIF). “Esma put around the extension very strict guidance on what investment firms have to do in order to remain compliant in the first half of the year. For instance, if a counterparty—let’s say one that is not located in Europe—doesn’t have an LEI yet, and the bank doesn’t want to lose the business with this party, the ‘No LEI, no trade’ rule still applies.”

This refers to Esma’s Mifid II brief, issued in October 2017, mandating that all entities trading with European counterparties across all asset classes obtain an LEI code. Wolf says that in his example above, during the grace period, if a bank can prove the LEI-less counterparty has started the process of obtaining an LEI, then the bank is permitted to report the trade without the identifier.

“Esma’s statement doesn’t mean that banks can continue to report without LEIs; it means a very strict guidance on how [a trade temporarily missing an LEI] could be achieved,” he says. 

Data expert Naomi Clarke says she doesn’t expect the change to make much of a difference to her day-to-day work, although it may have a bigger impact on the market in general.

Tony Freeman, executive director of industry relations for the Depository Trust & Clearing Corp. (DTCC), the largest

issuer of LEIs worldwide, says LEI uptake “is clearly behind schedule,” and so Esma’s grace period is “sensible,” but acknowledges that it did cause “some operational issues for some of our clients who were ready and had coded the ‘No LEI, no trade’ rule into their systems.”

Wolf says these are minor corrections. “Some people say that they have programmed their system in a way that everybody has to have an LEI and they’re now in the process of looking at what Esma’s December 20 statement means to them. Others were more relaxed about it from the beginning,” he says, noting that for banks, the Mifid II task list is quite long. “I think the LEI piece in itself, this grace period, is just a minor thing.”

Clarke says the LEI mandate was an opportunity to clean up inconsistent data—such as the same counterparty being called different things on older systems—and to develop more robust processes. She describes the grace period as a “breathing space,” and says that the focus now is on proper maintenance, keeping on top of any changes, and continuing to ensure that any information being exchanged with brokers is correct. 

Esma’s publication outlines a second option for missing LEIs during the grace period: investment firms may apply for LEI codes on behalf of non-EU venues that have not obtained their own identifier. Freeman says while this is a workable concept, there are issues around industry coordination. For example, if a buy-side firm in Asia that doesn’t have an LEI trades with more than a dozen European brokers, which of those broker-dealers is responsible for registering the LEI? If a code is registered, who disseminates that information to the other counterparties? And if an investment bank registers a code on behalf of a client, are they then responsible for maintenance of that LEI? Freeman says that’s a tough sell. 

“[Firms] don’t want to be third-party agents for their clients. They think clients should manage their own LEI processes,” he says. “The third-party role thing is not new; it’s been around for some time, but it’s not been very widely used because it does have its own operational issues that need to be resolved. Using a third party to create the LEI is a fairly simple process, but distribution is best done by the client.”

Data Quality 

Regardless of their reaction to the LEI grace period, parties involved with all aspects of LEI implementation are keeping a close watch on what mandating the identifiers, and Esma’s extension, will mean for data quality. 

“The trouble is, what happens to data quality during the breathing space,” Clarke says. “The regulators will not have

the whole picture until everything is in place. In order for the regulators to start to use this data, all the standard identifiers must be in place so that the regulators can analyze it. They need everything to be there, including the LEIs. But if you look at the readiness of the market—and that includes software suppliers, Approved Reporting Mechanisms (ARMs) and Approved Publication Arrangements (APAs)—and the fact that there’s such a backlog of LEIs needing to be issued, I don’t think they’re going to get to that point in data quality where they can do as much as necessary with the underlying data.”

Specifically, Clarke cites concerns around the increasing number of Local Operating Units (LOUs), which issue the identifiers, and the subsequent increase in volume of LEIs. “I hope that GLEIF will keep up pressure on making sure that there’s quality there,” she says. 

Wolf confirms that “providing the services that ensure open access to the LEI data pool and high data quality,” are a key priority for GLEIF. “We’re very committed to keeping high data quality marks, and [are] heavily under review by regulators on that also, so this goes hand in hand,” he says. In addition, each accredited LOU is inspected annually. 

Clogged LOUs? 

Clarke says there is a backlog of LEIs waiting to be issued, but Freeman says the DTCC is on top of requests, and Wolf says reports of an LEI backlog do not hold water. 

“There were constant rumors about a backlog of applications for LEIs, but our analysis has not shown any evidence of one,” Wolf says, noting that the process of issuing LEIs includes some steps that must be handled manually, such as validation of information, which requires a physical read-through of documents provided by the registrant. 

“Depending on whether the registrant provided all documents on time and in good shape, and whether the LOU was able to outreach to third-party authorities for validation, that could take a few days,” he says, adding that backlog rumors may stem from frustration that the process is not faster. “People had the expectation that they subscribe to something, and within the next mouse click they get an LEI.”

Wolf says that to his knowledge, the LOUs performed well, tackling a peak of more than 8,000 LEIs per day. “I think that’s very good proof that basically everybody who wanted to have an LEI should have one by now,” Wolf says. 

The increase in the demand for LEIs placed on LOUs is undeniable, of course, with a surge in November that Freeman says did create backlogs, because it was not possible to predict precisely when that surge would happen. He says the DTCC took on contingent resources in preparation for this, adding that while these are in place now, they could not be implemented overnight.

“The operational processes are now back to the normal two- or three-day service-level agreement standards,” he says, adding that the number of requests remains high, but is neither as high as they anticipated, nor as high as some predictions, which estimated that up to 3 million new LEIs would be registered in anticipation of the Mifid II deadline. 

“The Mifid effect is easy to determine here,” Wolf says. “There are a few other regulations around the world, but I think Mifid/Mifir and the EU Prospectus regulation are the major drivers for the recent growth.”

Clarke concurs, saying it is “good practice in reference data to have a market identifier for all instruments, and it’s the same for parties, which is where the LEI comes in. For every party on the data hierarchy, it is important to make sure they have an LEI where one exists.” 

At press time, the total number of LEIs in circulation is 1.03 million—more than double that of six months ago. 

To meet that demand, Wolf says, the list of accredited LOUs will keep getting longer. “We see continued interest by organizations that want to become an LOU, so don’t be surprised if you see 45-plus new LOUs in a short timeframe,” he says, adding that GLIEF is in the process of reviewing applications, and will issue accreditation certificates as those reviews are completed. 

Looking Ahead

In addition to making sure LEIs are integrated smoothly into the process, and allowing market participants to keep a close eye on data quality, the six-month grace period will also allow firms to ensure their counterparties all have the identifiers necessary to continue trading once Esma’s extension expires. 

According to Freeman, there is variety in how DTCC’s clients have approached LEIs, but the ones that have embraced it have benefited from that decision. 

“Having one identifier for each entity, able to be spread across all of those different platforms, is a huge advantage—that’s what they’ve found,” he says. “That might sound entirely obvious, but it wasn’t something that people seemed to think would be a benefit of the overall issuance of LEIs. The firms that have embraced it have significant onboarding, Know Your Customer and Anti-Money Laundering benefits because they know exactly who they’re talking about at all times and it’s independently verified.” 

But some remain unconvinced that LEIs are worth buying into. 

“There are firms, most likely in Asia, that are trying to avoid using the LEIs because they have a reluctance to have all their trading position data disclosed to a regulator to whom they have no reporting obligation,” Freeman says. “On the fourth of January, I spoke to a client in Asia who had only found out about the Mifid II requirements the day before. There clearly are some firms… that were taken by surprise by Mifid II on January 3, but that have dealt with the changes by making quick manual adjustments to their systems that are based on people and manual processes.”

For example, he says, the client that was surprised by the LEI requirement is maintaining its automated process of trade confirmation with institutional clients in Europe, but manually modifying the trades via a graphical user interface. 

“No broker wants to lose a client because they can’t process the transactions, and they will throw resources at it, but the real work is much longer term, particularly where those entities have fragmented IT architectures with client data in lots of different forms in lots of different systems,” he says. “It may take all this year to resolve—and actually, from an IT architecture perspective, it may take quite a lot longer.”

Freeman says the European brokerage and custodian industries will spend the grace period educating clients about what they need to do if they’re not yet ready, and adds that those efforts are under way. 

“Another surge in demand at the end of the six-month period is unlikely,” he says, predicting smooth implementation throughout the grace period, with demand returning to pre-Mifid II levels toward halfway through 2018.