Legal Entity Identifiers: Scrutiny of EU Firms Tightens

When the concept of a new global legal entity identifier first took shape among regulators in the US and across the globe, it was hailed as a brilliant revolutionary move.

Financial firms and trading counterparties could now be appropriately identified and tracked by regulators seeking to mitigate systemic risk. No longer would they have to rely on the hodgepodge of third-party and proprietary ID codes.

Fast forward, four years later. After regulators in the US and Europe mandated legal entity identifiers or temporary pre-LEIs be used to identify counterparties in exchange-traded and over-the-counter swap transactions, the European Banking Authority (EBA) has introduced a much bigger step. In its recently published Recommendation on the Use of the Legal Entity Identifier (LEI), the EBA says LEIs need to be used in regulatory reporting by every “credit and financial institution” in the European Union. That goes far beyond disclosing information on exchange-traded and over-the-counter derivative transactions.

Everyone knew such a requirement was inevitable. But based on responses to the EBA’s request for comments, the timing, breadth and occasional lack of clarity has some financial organizations worried.

Just why does the EBA want to rush into using pre-LEIs, even before the standards and operational details of the global LEI system are fully established? The EBA’s proposal offers a glimpse into its rationale. The EBA wants national regulators across the EU to be able to collect sample systemic risk data within their own markets as of July 2014. To do so, they will need to use a “supranational identifier” for each of the credit and financial institution they include in their reports. Since there are no such supranational identifiers, the EBA sees pre-LEIs as the best solution, for now and the long-term.

Of course, that stance presumes that every financial firm that needs one has one. According to one media report, the registration for pre-LEIs has generally been well below projections. What’s more, there is concern that the issuers for the new ID codes may not be able to keep up with the demand as regulatory deadlines arrive, because thousands of firms still don’t have an ID code. Not good news for European LEI issuers right now, because, as of this week, financial firms have to include pre-LEIs in reporting both over-the-counter and exchange-traded swaps to regulators under the European Market Infrastructure Directive (EMIR).

And is the EBA’s proposal for pre-LEIs just a recommendation? On further reading, it sounds a lot more like a requirement. National regulators have until March 29 to tell the EBA whether or not they will comply with the EBA’s recommendation. Can anyone picture a national regulatory agency declining to jump on this bandwagon, especially when it significantly expands their tracking capabilities and their ability to slice and dice all kinds of reported information?

Practically speaking, what that means to financial firms which might not have needed a new ID code before is that they will now have to get one. That’s just for starters. They will then have to integrate the identifier into the business systems that feed all types of regulatory reporting, if their national regulator demands it.

Rather than summarizing responses to the EBA’s proposal, FinOps Report is republishing excerpts from four of the best written respondents to the EBA’s recommendation or requirement, depending on one’s interpretation. Individually, they are insightful. Taken in unison, they speak volumes about the operational realities that regulators neglect to discuss in their  high-level talk.

JWG Group. The London-based think tank provided solid figures to back its convincing argument that obtaining and integrating LEIs into internal applications will be far more costly than the EBA thinks. “The costs of validation, enrichment and quality assurance should not be underestimated. For example, KYC [know your customer] systems will need to be modified to require LEI capture, new workflow will need to be introduced to account for expired LEIs and extensive data quality programs will need to be implemented.” Bottom line, according to JWG: it will cost a financial firm €2.16 million over five years to register and maintain LEIs for 5,000 entities. It will need an additional €8.6 million for internal costs.

British Bankers Association (BBA). The trade group for British banks offered the best explanation for why a Big-Bang timetable for using pre-LEIs or LEIs is not feasible. “Based on factors such as materiality, business activity and status (e.g. dormant or non-trading) it would seem disproportionate to have to register all entities to meet FINREP deadlines or indeed to register them at all. The FINREP template 40 requires an entity-by-entity breakdown of the group structure, including the LEI code. We would be concerned if this meant there was a requirement for all subsidiaries of a firm to register for an LEI code to meet that requirement alone.”

The reason: BBA’s members may have hundreds of subsidiaries. The BBA’s alternative: prioritize firms which really have to get the new ID code first and let the rest follow. [Editor’s note: Developed by the EBA, FINREP is short for financial reporting. The pan-European regulation, which applies to credit institutions, significantly increases the level of reporting of financial information].

European Fund and Asset Management Association (EFAMA). The trade group for the European investment management community offered a compelling rationale for why more firms, rather than fewer should fall under the category of entities needing pre-LEIs. “We are aware that there is some debate around umbrella funds and funds that do not constitute legal entities, as such, either contractual funds or pooling arrangements utilized by funds. We believe that it is important not to force un-necessary change of what is a legal entity as that would cause an infinite problem in reporting duties of any transaction still open as of August 16, 2012.” [Editor’s note: EMIR calls for reporting of swap trades open as of that date to be reported to trade repositories].

Instead, EFAMA advocates that the legal operating units, or pre-LEI registration organizations in each market, take into account the contracting parties and structures currently recognized in the international market including contractual funds, compartments of umbrella structures and investment pools associated with investment funds. “We see no detriment in such an approach to the overall objectives of stability and transparency and we see significant advantages in achieving full and accurate reporting,” says EFAMA.

Deutsche Borse Group: Count on the operator of the German stock exchange, German and international securities depositories Clearstream Banking and Clearstream International, and German clearinghouse Eurex Clearing to provide the most predictable, yet practical reason for why requiring the use of pre-LEIs for supervisory purposes isn’t a good idea. “We do not see the need to introduce a pre-LEI system as long as international agreement on Final LEI is not reached. Credit institutions in the EU are currently faced with the implementation of CRD IV and CRR while still a lot of details including final technical standards and technical guidelines for reporting are missing.” If the EBA insists on going ahead with the pre-LEI requirement, at least it should limit it to “group entities” which have to do regulatory reporting. [Editor’s note: CRD IV refers to the capital requirements directive which implements the Basel III Capital Accord]

FinOps Report wants to hear what you have to say about the EBA recommendation. Please send your comments to Chris.Kentouris@finops.co, or use the Contact page here on the website. If we report on the comments, we will keep your name and your firm’s name confidential, if you wish.