The concept of a Legal Entity Identifier (LEI) is simple and has the potential to drive increased efficiency and control throughout the financial services industry. However, despite the widespread promotion of the global LEI system, there are still a large number of entities unaware of the requirement to have an LEI, let alone the benefits. With this in mind, this article aims to provide the reader with a better understanding of the LEI system, by focusing on the concept, background and its potential impact to the financial services industry.
What is an LEI?
An LEI is an alphanumeric reference code that is allocated to distinct legal entities, enabling the instant and precise identification of parties to a financial transaction. It can be viewed and described in the same way as a barcode; it is aligned to a standard format, unique to an entity and linked to key referential data about that entity.
Why do we have LEI’s?
The collapse of the Lehman Brothers in 2008 demonstrated the extreme complexity of corporate structures, with Lehman operating over 7,000 distinct subsidiaries. When the bank filed for bankruptcy, counterparties struggled to identify which of these entities they had business with and thus to whom they were exposed. Out of this arose an imminent need for a standard legal entity identification system; one that could help connect data and answer three basic yet fundamental questions: Who is who? Who owns whom? And who owns what?
The Financial Stability Board (FSB) responded by proposing the establishment of the Global LEI Entity Identifier System (GLEIS), which aims to allocate an LEI to every entity engaged in financial transactions. The GLEIS structure is made up of three layers:
- Regulatory Oversight Committee (ROC): responsible for coordinating and overseeing the global LEI initiative.
- Global LEI Foundation (GLEIF): the operational arm of the GLEIS, responsible for the application of global operational standards that deliver global uniqueness of the LEI, seamless access and high quality reference data.
- Local Operating Units (LOUs): issuers of LEI’s, supplying registration and acting as the primary interface for registrants.
How do I get an LEI?
An entity can apply for an LEI via an LOU which will collect and validate a minimum set of reference data on the entity. Once the data has been confirmed, the LOU will then issue the LEI and publish it to the global LEI repository. End users can readily access this data via an open data license. Whilst LOU’s are non-profit organizations, LOU’s operate under a cost-recovery model which means entities seeking an LEI are charged a fee to cover the operating costs of both the GLEIF and the LOU.
As noted above, uptake of the new system has been relatively low. It is estimated that the total number of LEIs that should be allocated globally is approximately two million, however only around 410,000 have been assigned, and roughly 96,000 of these have lapsed, i.e. the required periodic maintenance updates are overdue.
Why should I get an LEI?
Like with any new initiative, the concept is only as good as its execution. For the LEI to succeed as a universal standard, mass market adoption and long-term commitment from its users will prove vital. So below are three reasons to embrace the LEI initiative…
- Regulation: Firms that acquire an LEI will be compliant with current regulations that mandate the use of unique counterparty identifiers for regulatory reporting, such as EMIR and Dodd Frank. More compelling perhaps is the impending implementation of MiFID II that will essentially act as a barrier to trade in Europe for counterparties without an LEI.
- Risk Management: If the LEI is accepted as the universal standard for identification, it will provide better data for aggregation of exposures, risk measurement and monitoring and responding to systemic financial risk. For example, standard legal entity identification would have helped firms understand their exposure to Lehman Brothers in 2008, and take more rapid action to limit this exposure.
- Operational Efficiencies: Standard identification of entities offers the opportunity to improve operational efficiency of processes by removing widespread duplication and inconsistency in counterparty data. For example, LEI’s can help automate client onboarding and KYC processes, and also reduce breaks in post-trade matching, documentation, clearing and settlement by alleviating inconsistencies in the data recorded by both counterparties.
Will the LEI system deliver?
The LEI system has the potential to meet multiple needs and drive substantial social and private benefits throughout the financial services industry. It is also viewed as essential in improving the safety of the financial system and preventing a repeat of the global financial crisis.
If the global LEI system is to truly deliver, it is crucial that the LEI becomes the first choice of entity identifier across the financial services industry. With regulation being the greatest driver behind LEI adoption, securing market coverage and preference in jurisdictions where LEI’s are required by law is easier to achieve. Entities outside of these regulated jurisdictions will pose the greatest challenge for the GLEIS, requiring a clear vision on how it will incentivize and encourage voluntary adoption within these regions. However, given the benefits highlighted above, entities should not wait to be forced – it’s time to get your LEI.