RegTech Intelligence 
Last week, the Regulatory Oversight Committee (ROC) published their report on the progress the Legal Entity Identifier (LEI) has made since its proposal in 2011 as a solution to transparency, organisation and risk aggregation in the financial industry.
The report is split into five sections: (1) Completion of the Global Legal Entity Identifier System (GLEIS) governance framework; (2) Current regulatory uses of the LEI; (3) Potential regulatory uses of the LEI; (4) Attempts by the ROC to meet users’ needs and (5) Recommendations for expansion of the LEI system.
Completion of the GLEIS governance framework
The Global Legal Entity Identifier Foundation (GLEIF) has now been delegated as the overseer of the technical and operational standards of the GLEIS. While the ROC remain responsible for policy standards and the overarching principles of the GLEIS, decisions regarding topics, such as data formats, operational manuals and normalisation of reference data, are to be dealt with by the GLEIF, as well as the accreditation process for the Local Operating Units (LOUs) who are authorised to issue LEIs. This process, now refined and structured, is outlined below.
Accreditation process for LOUs
And so, what looks like a three-tiered structure is now in place for the GLEIS. At the bottom, we have the LOU, which has to sign a master agreement (as mentioned above) with the GLEIF upon authorisation as an LEI issuer. The LOUs responsibilities then include the monitoring and validation of the LEIs which they issue, the funding of the system – from a per-LEI issuance fee paid to the GLEIF – and the maintenance of their database as a freely available and accurate resource. The GLEIF, next up on the hierarchy, are permitted under these master agreements to conduct audits and investigations on the LOUs as part of their supervisory responsibilities. The GLEIF has also signed a Memorandum of Understanding with the ROC that they meet all of the responsibilities set out for them, including submitting all the relevant documentation (such as disclosure of the fees paid to the GLEIF by LOUs). This shows the beginnings of a global framework for the LEI.
Current status of LEI uses in ROC jurisdictions
This section is enlightening regarding the increasing prevalence of the LEI as a legal requirement across the globe. Rules referring to the LEI now apply in at least 40 jurisdictions – most prominently across the EU in Over the Counter (OTC) derivatives reporting, but, increasingly, jurisdictions are requiring the reporting of LEIs for primary obligors and payees of primary payment streams in derivatives contracts.
In the world of reporting, the requirement for the LEI is still expanding. Financial institutions in the EU will need an LEI to fulfil their reporting obligations under MiFID II, and insurance firms under Solvency II will require an LEI from June 2015 (from June 2016 for all other insurance firms). Central Securities Depositories (CSDs) will require LEIs from the end of 2016, including all their participants and settlement banks. From the end of 2017, settlement internalisers will require LEIs and, given the recent MiFID II delay, it will now be from the beginning of 2018 when investment firms require an LEI for themselves and all of their counterparties. The uptake is, thus, spreading like wildfire, both across jurisdictions and across regulations.
Finally, we arrive at securities issuers, who have also failed to escape the LEI coverage increase. From the start of 2016, credit rating agencies, the entities that they issue ratings to and – in specific cases – their parent entities will all require LEIs. The originator of any structured finance instrument will also be caught under these requirements.
Examples of other potential regulatory uses
But, with LEIs expected to be spreading far and wide, what other directions can be taken? Here, the ROC have considered all options, such as using the LEI for banks when identifying legal persons who wish to open an account, using the relationship data for identifying offshore non-financial entities of a corporate group used for raising finance and, of course, using LEIs in the anti-money laundering battleground. While the LEI is distinct from AML, whose standards focus on identifying natural persons behind legal entities (whereas the LEI focuses on legal entities belonging to the same corporate group), there is a clear resemblance here offering opportunities for harmonisation, data aggregation and cost reduction.
The ROC are keen to stress that, as the GLEIS expands and uptake spreads to further areas of the industry, so too will the opportunities. Using the LEI for wire transfers, for example, is a consideration that might not currently be feasible due to the relatively small amount of LEIs in proportion to the total number of financial entities but, as economies of scale in cost and data aggregation kick in, the future may see opportunities, such as this, to enter the picture.
Policy actions already taken by the ROC
This section refers to the handful of policy documents that the ROC has published, particularly recently, in response to the requests of others for further details. These include the consultation paper on providing foreign branches of head office entities with LEIs and the consultation paper on level 2 relationship data collection, set to begin in 2016.
The ROC also released statements outlining the change to the GLEIF accreditation process for LOUs, whereby LOUs already authorised by the ROC to issue LEIs are allowed to continue doing so while they are automatically transferred to GLEIF supervision, but applicant LOUs must now apply directly to the GLEIF as the new central operating unit. The most recent statement provided a brief clarification that individuals acting in a business capacity were allowed to be issued with LEIs, yet natural persons in a non-professional capacity or employees of a legal entity were not allowed to obtain LEIs. A recent article we wrote briefly covers these updates and the implications of LEI uptake for client classification under new regulations.
Further recommendations
It is clear that the LEI still has a long way to travel. Issuance remains concentrated in a handful of jurisdictions, with 245,000 LEIs issued in the EU but just 96,000 LEIs in the US. This is a fair chunk of the 390,000 LEIs issued in the last three years, however, the ROC do highlight the move towards greater global coverage, with a large number of jurisdictions having at least one LEI.
They are also keen to stress that the intended goals of the GLEIS are being comfortably met. LEI coverage is significantly higher for the entities who have been the primary focus of regulatory uses so far (such as large financial institutions trading in risk-averse securities). Indeed, over half of active securities and shares listed on the European Central system of Banks Centralised Securities Database are issued by an entity with an LEI, and most of the market capitalisation covered by securities that are not issued by LEIs stems from securities issued by EU government entities. This, indeed, shows that initial statistics, such as an apparently low LEI coverage, might not be treated at face value; if most of the larger, more influential financial institutions have been issued with LEIs, then there is indeed a much larger spread of LEI coverage due to the influence of these institutions on the industry as a whole. When MiFID II comes into force, these major FIs will require LEIs for all of their counterparties, in all of their trades. Step back and take in the gravity of just how many financial entities that will impact.
The ROC round up with a number of suggestions for increasing the coverage of LEIs, such as encouraging jurisdictions to use the LEI as a universal identifier for domestic entities (thus enabling them to leverage the data already existing on the GLEIS database), to require the reporting of an LEI when an entity has one to exemplify its use and, for these jurisdictions, to also keep watch of others in the process – the more integrated and widespread the uptake of LEIs, the less cost and the more the momentum it will carry itself.
Which leads us nicely back to what appears to be a global unique identifier for legal entities involved in financial transactions that is exponentially increasing in coverage as more regulations and more jurisdictions either require or suggest the use of the LEI. The report also outlines the structures that have been put in place to oversee the expansion of the system, and the policies and suggestions that have been – and are being – taken into account to make it as robust and flexible as possible. There is a lot of potential in this growing risk aggregating database, so it’s useful to keep up to date with developments.