Time's Up: Esma Sticks to the Schedule for Mifid II LEI Compliance

[Editor’s note: This article has been edited to reflect that the July 2 grace period deadline has passed.]

Mifid II requires that nearly every company, charity, trust, and fund domiciled in a European Union country—or based elsewhere but doing business within the EU—must have an LEI. In October 2017, Pan-European regulator the European Securities and Markets Authority (Esma)  issued a brief that declared ‘No LEI, No Trade,’ warning entities around the globe that they must have an LEI to be able to trade with European counterparties. During 2017, in the lead-up to the Mifid II compliance deadline of January 3 this year, more than half a million new LEIs were issued, according to the Global Legal Entity Identifier Foundation (GLEIF),  nearly doubling the LEI population worldwide. But despite that late sprint, uptake still fell short of what is required.

On December 20, 2017, Esma introduced the grace period, during which banks can apply for an LEI on behalf of customers, and trading venues can use their own LEI codes for non-EU issuers that currently don’t have an identifier.

“Since then, Esma and NCAs [national competent authorities] have been closely monitoring the use of LEIs and have observed a steady and substantial increase in its use: currently 95.5 percent of the instruments reported in our reference data system have the correct LEI,” said Esma chair Steven Maijoor during a June keynote address at the Federation of European Securities Exchanges in Vienna. “This positive development led to the confirmation of the end of the six-month period which means that NCAs’ activities with respect to the LEI are now shifting from pure monitoring to ongoing supervisory actions. Esma is working with NCAs to identify the necessary measures to actively supervise the compliance with this important requirement.”

On June 20, Esma announced that the grace period would end as planned on July 2. According to that statement, the regulators “are coordinating the development of an appropriate and proportionate common supervisory action plan focused on compliance with the LEI reporting requirements,” while keeping in mind that the severity and “particular circumstances” of infractions will be considered. 

Ready or Not

But the specifics of potential infractions have market participants worried, says Nick Moss, regulatory reporting project manager at Trax, a subsidiary of bond trading platform MarketAxess.

“If [entities] don’t have LEIs, and there’s no other mechanism to report, ultimately trading venues may have to start delisting some of those instruments, which reduces the liquidity available in some of those instruments,” he says.

Eugene Ing, executive director of the Global Market Entity Identifier Utility (GMEI), has a more strident view.

“Is the market ever ready?” Ing asks, noting that GMEI parent the Depository Trust & Clearing Corporation (DTCC) is the largest issuer of LEIs worldwide, and so, “We’ve seen a fair number of run-ups,” where firms scramble to comply with new regulations.

According to Ing, smooth implementation usually comes down to education, and he thinks Esma “worked hard” to ensure the market was aware of what the mandate would mean.

“If you are in the traditional OTC derivatives space, you knew [about the LEI requirement],” Ing says. “There are always going to be those firms that are outliers and taken by surprise, but I think that’s just the general nature of regulatory uptake.”

Ing says when establishing the grace period, the regulators factored in feedback from the industry and made what is ultimately a sound decision, despite any issues once the LEI mandate officially kicks in.

“I think allowing that grace period and allowing that workaround was a good implementation, because of the concern of ‘No LEI, No Trade.’ Certainly firms didn’t want to have that be a factor, especially firms needing to execute,” Ing says.

Additionally, the grace period allowed firms to trade and become compliant at the same time.

“I think there’s definitely some organic uptake,” Ing says. “I think it’s market-driven. Largely the market’s been strong, firms that are fairly active or fairly sophisticated are not sitting on a market too long, so I think we’ll see an uptick [in LEI uptake] as firms reassess their overall client list.”

On June 27, Esma executive director Verena Ross, speaking at the Banque de France conference in Paris, underscored Majoor’s point about increased LEI use.  

“Out of a total of 3 million EU instruments that were published in February 2018, only 1.4 percent were published without the correct LEI pertaining to the issuer of the financial instrument. At the end of April, the number decreased even further: only 0.6 percent of the EU instruments were still missing the correct LEI. So in the space of two months, the number of EU instruments for which the LEI of the issuer was missing dropped significantly,” Ross said. “At the same time, the initial technical limitations due to the bulk processing have disappeared.”

Matthew McLoughlin, head of trading for Liontrust Asset Management, says continued LEI complications are “not an issue for us” because his team made it a priority.

“We were quite proactive with LEIs quite early, although I heard a lot of people had issues getting the right LEIs and for different multiple entities as well. It was okay for us,” McLoughlin says, who adds that they tackled the problem by ensuring they face their European counterparties in settlement. “We trade globally, but we’ve tried to simplify it that way and always make sure we settle with European counterparties.”

Liontrust’s strategy hints at the larger problem with LEI uptake: a resistance from counterparties located outside of the EU, an issue which Ross said is high on Esma’s agenda for the coming months.

“We know that many of the remaining issues around LEI compliance can be found in non-EU jurisdictions. We have been actively engaging with market stakeholders and non-EU regulators to raise awareness about the EU requirements. We continue our educational campaigns to explain how the LEI system works and provide information about how to get an LEI. Moreover, Esma remains fully committed to the important international work on LEI. Given the wide use in various EU regulations, we believe that it is crucial for the international community to safeguard the quality of the LEI system by preserving the key feature of the LEI, which is to provide unique and consistent identification of legal entities,” Ross said.

The APAC Factor

Specifically, the Asia-Pacific region is frequently cited as a target area to encourage LEI uptake. Althought Ing says there has been some increase in the region, just 4 percent of DTCC’s LEIs issued are for APAC-based counterparties. Wenlin Juang, head of pricing and reference services for Thomson Reuters, predicts no significant increase in uptake for APAC in the lead-up to the end of the grace period.

An analyst from a financial news provider says, “LEI applications still lag from Asian companies and from July 3, it really will be ‘No LEI, No Trade.”

Although a few regulators in Asia-Pacific have encouraged the use of LEIs as an identifier, not many have stepped up to the plate and made it a requirement. Hong Kong is the latest to mandate LEI use for OTC derivative trades. On June 27, the Hong Kong Monetary Authority (HKMA) announced that its LEI mandate will become effective on April 1, 2019, giving market participants an extended timeframe to work toward compliance.

Originally, HKMA and Hong Kong’s Securities and Futures Commission (SFC) proposed a timeline of six months after the publication of a joint conclusion paper on the topic in March 2018, which stated that mandatory use of LEIs in trade reporting will apply only to the identification of entities that are on a reporting entity’s side of a transaction. These entities include the reporting entity, the transacting party that a reporting entity reports or acts for, a central counterparty or a provider of clearing services that is a reporting entity, or one that clears a transaction for a reporting entity or the reporting entity acting on behalf of the transacting party.

However, HKMA and SFC add that reporting entities should continue to identify their counterparties in transaction reports according to the waterfall of identifiers specified in the regulators’ Supplementary Reporting Instructions for OTC Derivative Transactions report.

This means if an entity has a LEI, it must be used to identify itself in trade reporting. But, if it doesn’t have an LEI, it can continue using other entity identifiers set out in the report.

“That said, reporting entities are expected to put in place a process to request LEIs from their clients after the implementation of the first phase on April 1, 2019. For those clients which do not already have LEIs, this process also includes educating their clients about LEI and encouraging or assisting them to obtain one,”  states the HKMA and SFC letter.

Aside from mandating LEIs, the March consultation paper from HKMA and SFC to enhance Hong Kong’s OTC derivatives regime also included proposals to expand the clearing obligation and adopting a trading determination process for introducing a platform trading obligation.

The Hong Kong regulators received 20 total written submissions to the consultation paper, highlighting concerns about the implementation timeline and the scope of firms affected.

In its response, State Street expressed support for the adoption of the LEI requirement in Hong Kong, but recommends that HKMA and SFC be flexible in implementing the mandate, because other jurisdictions in the region—Singapore and Australia, for example—have not mandated or required LEIs for reporting.

“We encourage the HKMA and SFC to engage with regulators in these other regions to ensure smooth implementation of LEI adoption especially for these entities who may need additional time to adopt LEIs. We urge leniency and a degree of flexibility in the event that not all jurisdictions have implemented mandatory LEIs by January 2020,” State Street’s response reads. January 2020 is the regulators’ proposed LEI deadline for transacting parties to reportable trades that fall outside other specified categories.

Meanwhile, GLEIF commented in its response to the consultation paper that HKMA and SFC should consider requiring that only LEIs that are current and renewed will satisfy the reporting obligation. It expects that, over time, the LEI will be used for multiple public and private purposes and for that reason, only valid and renewed LEIs will ensure that the LEI becomes a broad public good as expected by the Financial Stability Board.

A market data manager at an international bank says, “Looking at the GLEIF statistics, there’s not a huge change in the proportion of LEIs in the Asian region.”

Within the APAC region, Australia and Singapore—and, prior to its latest announcement, Hong Kong—requested LEIs for derivatives reporting, but left it optional. India and Malaysia have partial mandates in effect.

Juang believes that the true value of the LEI will only be fully realized once critical mass is achieved. “As long as it is not fully mandated, firms will continue to be challenged to manage and maintain multiple entity identifiers, with the inherent overheads. That said, given that LEI is allocated only at best to ‘country level,’ the system doesn’t provide the granularity of identification required by all operational activity types. There is also a question around the volumes of LEIs that are not current, and this would certainly need to be addressed in order to encourage fuller adoption, both by regulators and market participants alike,” she says.

Stephan Wolf, GLEIF CEO, says the long-term vision is to make the LEI a “broad, public good” that can be adopted and used by everybody, but he is aware of the initial challenges in some regions.

“We need to overcome the chicken-and-egg situation. Some want to use the LEI but they need enough coverage, and the others don’t want to pay for it,” Wolf says. “We’re running a series of projects, internally, on how we can make the LEI attractive for the private sector market participants. This is the way moving forward, to address the private sector with the cost savings and process speed increases that they would have using the LEI.”