In a recent research note, Financial InterGroup (FIG) reports that Legal Entity Identifier (LEI) issuance is peaking at the same time that the rate of lapsed LEIs is growing. In a Q&A. Allan Grody, President and founder of FIG, shares the recent findings and his views on whether LEIs are evolving to become the standardized entity identifier as initially hoped for.
Q. Looking at the top-line figures, why are LEIs lapsing and why is registration for parent relationships increasing? What do you make of the reversing trend of newly issued LEIs exceeding lapsed LEIs?
A. The registered LEI population of 1,412,195 is at an all-time high, stabilizing at an average of 18,314 new registrations a month over the last two quarters, and in April, 2019. These seven months represent a more normalized, steady-state period, after a year in which nearly half of the total population of LEIs were registered, and after allowing a full year for these newly registered LEIs to be renewed.
This surge in the LEI population was prompted by new EU regulations, best summarized as the ‘no LEI no trade” mandate, a part of MiFID II that went into effect in July 2018. This mandate extended the earlier EU mandate – The European Market Infrastructure Regulation (EMIR) – to register LEIs for identifying counterparties in OTC derivatives transactions to all securities, bonds and futures transactions conducted in the EU.
Lapsed LEIs, those that are not renewed at the one-year anniversary, are stabilizing at about 30,075 per month over this same seven-month period. The recent monthly average gap of 11,761 lapsed LEIs over newly issued LEIs has steadily increased the total population of lapsed LEIs to 25.7% of all registered LEIs.
While the number of lapsed LEIs continues to increase, in March and April, LEI issuance exceeded lapsed LEIs respectively by 3,301 and 3,887 per month. This shift appears to be the result of the EU’s stricter mandates on LEI registration, which has resulted in EU registrations now overtaking other countries’ registrations, most notably those of the US, which until recently had dominated LEI registration. US registrations have fallen behind those of the EU owing to the slower pace of mandating LEI registrations beyond the original OTC derivatives mandate, which the US was the first to implement. This lag has been recognized and new US legislation is currently being drafted.
Lapsed LEIs are a significant inhibitor to the success of the LEI initiative. The EU, owing to the significant number of lapsed LEIs already used in transactions, and fearful that existing transactions with lapsed LEIs would need to be withdrawn, has permitted lapsed LEIs to be used in transaction reporting. In contrast, the LEI Regulatory Oversight Committee has stated its position that lapsed LEIs should not be permitted to be used in transaction reporting. They note that legal entities in a lapsed status may be an entity that has ceased its activity or merged with another entity. This latter case may result in market participants using two different LEIs for what has become the same legal entity (the LEI of the merged entity, and the LEI of the successor entity). Also, there is a risk that changes to the LEIs reference data (name, address, etc.) are not recorded, and that a second LEI may be assigned to the same entity. LEIs with a lapsed status also affect the funding of the LEI system, as they are not paying renewal fees. Industry trade associations have recommended that renewals be mandated.
Relationship data – the recording of LEIs for parents and ultimate parents of legal entities, and the reasons for opting out in doing so – has been recorded in the global LEI database since 2017. Relationship data is critical if the LEI is to be used for hierarchical constructions of legal entities for risk management. Importantly, 79% of those legal entities that are included in the “LEIs with complete parent relationships” category (1,218,932) include entities that are reporting that they do not report an immediate parent and/or ultimate parent. This is because the entity is not required to supply one if the legal entity is controlled by natural persons (not required to have a LEI), is controlled by legal entities not subject to preparing consolidated financial statements, or has no known person controlling the entity such as in diversified shareholdings. Also, of the 177,811 legal entities reporting either an intermediate or ultimate parent entity, 62% that report a LEI for an intermediate parent report it directly without Local Operating Unit (LOU) validation; 55% for ultimate parents. This lack of validation is also an inhibitor to the success of the LEI initiative as the LEI is intended to be the highest quality ‘go-to’ data base of legal entity information.
Q. Looking at the recommendations from the Global Financial Markets Association (GFMA) and the International Swaps and Derivatives Association (ISDA), what are your views on whether these will achieve the end goal – establishing LEI as a single legal entity identifier replacing proprietary identifiers?Why is this objective still relevant?
A. These two global associations filed a joint response to the Financial Stability Board’s (FSB’s) review of the LEI, the results of which were scheduled to be reported on in May 2019 (and were not available at time of writing). They are generally supportive of the LEI initiative but are looking to further efforts by regulators.They encourage the FSB to take a stronger hand in the regulatory mandating of the LEI registration and renewal process world-wide. They recognize that many non-proprietary entity codes exist, and that the LEI promises to replace them over time. This is critical to achieving the important objective of a single legal entity identifier, the end game for realizing significant industry cost reduction promised by the LEI initiative.
GFMA/ISDA expects that expanding mapping of the LEI to other codes will support an interim method of interoperability on the way to the longer-term goal of replacing proprietary codes with full adoption of the LEI. They suggest strengthening intermediary involvement in direct registration; encourage improvements in renewal processes and changes to reference data; and reinforce the importance of linkages of LEI relationship data for risk and credit monitoring.
They see the quality of the LEI as a function of its ability to convey current and accurate information. They observed that initially accurate information regarding a legal entity ceases to remain accurate as the legal entity evolves and changes. It needs to be properly maintained. GFMA/ISDA suggests work needs to be undertaken to think about the roles of the various parties in the process of maintaining the data, rather than just relying on the registrant. The responsibility of maintaining reference data could be shared among registrants, financial firms, other market participants, LOUs and the Global Legal Entity Identifier Foundation (GLEIF).
A long list of recommendations have been put forward by GFMA/ISDA: standardizing representation of data at LOUs; allowing banks to obtain LEIs on behalf of the legal entities who are their customers; having multiple regulators eliminate duplicate documentation collection to satisfy KYC requirements; allowing reliance on LOU validations rather than requiring banks to collect the documentation; allowing banks to pull and consume the data in the LEI centralized database for a myriad of internal business entity processing purposes; and placing the LEI on legal documents to facilitate direct data input. Further efficiency gains will be achieved as the ROC undertakes efforts to enhance the LEI record by adding better information about fund relationships and ensuring that relationships are consistently represented and using corporate actions and legal entity data history information in the GLEIF to enhance LEI accuracy and utility.
As the collection and validation of immediate and ultimate parent information continues to grow, this will aid the analysis of risk and credit exposures. However, the current iteration of the relationship database is very difficult to use, and the industry would like to see the GLEIF make near-term improvements to the usability of the database. Complete relationship data will help unlock the real value that industry participants hope to achieve in risk management and credit risk.
GFMA/ISDA supports future LEI uses by exploring new technologies such as digital signatures, digital certificates, and utilities based on Blockchain technology. These technologies are expected to be integrated into many different processes, including the onboarding process of financial institutions. Employing LEIs could provide certainty of entity identification to improve data quality.
Q. What are your views on how pending legislation may impact LEIs or the general drive towards standardization?
A. The pending Financial Transparency Act legislation in the US should improve the US financial regulators’ ability to mandate the use of the LEIs more broadly than previous legislation had provided. The recent assignment by the FSB of the Derivatives Service Bureau (DBS) as the UPI administrator should facilitate the ability to identify and match OTC derivatives transactions. DBS already assigns International Securities Identification Numbers (ISINs) to derivatives in the EU. It remains to be seen how such decisions will be recognized in other venues, especially in the US.
The global nature of the financial system and the impact of the global financial crisis has moved the previous era view of sovereign country or regional compact standards to the global view stage. Most importantly, these current global standards initiatives, while based on best practices and industry consensus, many decisions taken over a decade ago, will not prepare us for the industry’s evolving future state already apparent.
I hope that the FSB’s current review of the LEI will take the industry’s input, as well as our own, into consideration, and ‘adjust’ the implementation plans for not only the LEI but all other global standards, the ISIN, UPI, UTI and the CDE (Common Data Elements) to meet the demands of a digitized 21stcentury global financial system.
Q. What would you like to happen next in this space? Any predictions?
A. The administration of global data standards needs a global data management entity to oversee its global development and implementation. These standards are now being implemented in silos, the ISIN overseen by an industry body, the Association of federated National Numbering Agencies (ANNA) in an overnight process; the DBS also an industry body is overseeing a centralized real-time ISIN and now Unique Product Identifier (UPI) assignment process for OTC derivatives; the LEI is overseen by a globally endorsed government/industry entity, the GLEIF reporting ultimately to the FSB operating in essentially an overnight or intermittent daily batch process; the UTI assigned by various industry participants as they generate transactions; and the CDE still not yet finalized, either as to content or in its implementation.
All of these standards must work together flawlessly to match transactions for assuring the proper financial market participant receives or delivers, or pays or collects, its payment and/or securities. This silo-based global standards initiative is repeating the dysfunctional pattern of past data standards initiatives – too many cooks in the kitchen that reinforces multiple points of error introduction, timing differences in updating data, mapping issues, etc. This even though each transaction generated anywhere at the entry point to the global financial system must have an identical LEI, ISIN, UTI and set of CDE’s to assure timely settlement.
Solutions to silos that was once thought to be solved through centralization now have a new solution thanks to Distributed Ledger Technology (DLT), a component of Blockchain technology. A DLT application which maintains a global financial industry standards data base would be the simplest, most secure, most fail-safe and the most technically simple way of supporting multiple points of data input, centralized real-time updating, and immediate availability of a golden source of participant and product identifiers and common transaction data elements.
Regulators, financial institutions and sovereign government entities would be nodes on the network, permissioned to provide information if updating or registering new data, able to access data to be used to build out financial transactions, and, for financial regulators, to be used to understand and aggregate data for fulfilling their oversight responsibilities.
The current approaches are backward looking and have already been overtaken by new technologies. We need a course correction on global data standards to position our financial system to its new reality, a seamless straight-through-processing real-time digital future.