LEI on the Edge: What Needs to Happen for Wider Adoption?

It was supposed to be the “barcode for business”—but the Legal Entity Identifier (LEI) is taking so long to get to a critical mass of adoption that the financial industry is losing faith in the initiative, observers say.

“We are going slow here, and people are perhaps not believing that this could ever be successful as envisioned,” says Allan Grody, president at consultancy Financial InterGroup Advisors. “While we have 1.5 million legal entities [registered for LEI] now, the projections are that anywhere from 40 million to 200 million are needed to complete this project.”

Currently, 1,560,608 entities (as of January 31) have been assigned an LEI—a far cry from the 40-million low estimate that Grody cites, let alone the 200 million some say is needed to build the view of the industry that the code is supposed to facilitate.

The LEI—a 20-digit, alphanumeric code based on ISO standard 17442—was developed after the financial crisis at the behest of the Group of 20, after authorities realized there was no standardized mechanism to relay every piece of the bankrupted Lehman Brothers back to its parent company.

A group of 60 public authorities from around the world set up the Regulatory Oversight Committee in 2013, which, according to recommendations from the Financial Stability Board (FSB), set up the code and its oversight body, the Global LEI Foundation (GLEIF). The resulting global framework of issuers (called Local Operating Units, or LOUs) overseen by GLEIF is known as the Global LEI System (GLEIS).

The idea was—and still is—that the LEI would be a means of uniquely identifying a legal entity, but particularly financial ones. While any ice cream parlor could get an LEI—as the joke went in the industry for a while—the real point was transparency into the twisted family trees of financial institutions. Never again should administrators take 10 years to pick through the post-Chapter 11 remnants of a global investment bank with 6,000 subsidiaries; never again should counterparties to trades be ignorant that the legal entity they were exposed to was owned by a bank in administration.

And so, unusually for news from the world of reference data, the topic of the LEI generated excitement among industry bodies, regulators, and the media, even making headlines outside the trade press when no less a star than the FT’s Gillian Tett called it the “bubblegum fix for banks”.

However, some industry observers, like Grody, say the simmering hopes for the LEI have now congealed into a colder reality.

Price to Pay

The fact is that regulatory mandates are the only way to drive full adoption, and regulators across the world have adopted patchy approaches to the code. Regulatory compulsion is necessary because the LEI costs money to register for and maintain. In order to make sure the reference data to which the LEI refers to is current, entities have to update their LEI registration annually; LOUs charge not only a registration fee, but also roughly £100 to £200 ($130 to $260) per legal entity, depending on the LOU, as fee models differ between these entities. (Most sources say they set them on a cost-recovery basis.)

As Grody estimated in a research note, the financial industry has spent almost half-a-billion dollars registering these 1.5 million LEIs in 200 countries and territories, but “no member is reporting significant cost savings. Industry members are instead reporting that complete adoption of the LEI (GLEIF estimates this at 20 to 200 million LEIs) is necessary, along with full adoption of [other identifiers] unique product identifiers, unique transaction identifiers, and standard critical data elements for identifying each financial transaction, for these cost savings to be realized.”

If someone told you that you could buy something for £100, but you didn’t have to and it wasn’t compulsory for your business, and none of your competitors had bought it, would you buy one? Probably not. So another incentive is needed: the force of regulation. Grody says the crux of the low adoption issue is that critical mass won’t be achieved until firms are essentially forced by regulatory mandates to adopt LEIs.

“There is no global regulator with the power to command that everyone does it,” he says; instead, what has happened is that multiple financial regulators have taken their own different approaches.

In Europe, authorities adopted the attitude of “no LEI, no trade” in the second iteration of the Markets in Financial Instruments Directive (Mifid II). That means EU parties to a financial transaction may not act on behalf of counterparties who do not have an identifier. LEI mandates show up in other EU regulations, from the Market Abuse Regulation to the upcoming Securities Financing Transactions Regulation (SFTR). So it’s no coincidence that the EU leads the world in LEI adoption.

In fact, Mifid II’s dictum saw LEI registration surge so much that regulators allowed a temporary grace period to relieve the burden on LOUs from the flood of new registrants. The year up to July 2018, when Mifid II went into effect, saw nearly half of the total population of LEIs registered. At the end of 2016, 481,522 LEIs had been registered in total; that number had more than doubled to 975,741 by the end of 2017, according to Grody’s figures.

In the US, on the other hand, while the Treasury Department’s Office of Financial Research and the Commodity Futures Trading Commission have called for mandatory adoption everywhere; the Securities and Exchange Commission mandates it only in some cases, and the other federal agencies merely “request” it—meaning it’s optional.

Catherine Talks, product manager at UnaVista, a subsidiary of London Stock Exchange Group and an LOU, says SFTR may help drive adoption. LEIs are embedded in Esma’s SFTR transaction reporting technical standards, she says, in order to identify parties to a transaction. Uniquely, however, counterparties with a reporting obligation under SFTR must provide the LEI of the issuer of the security they are trading on, calling this a bone of contention because, especially if you are trading a security outside of Europe, there isn’t an obligation for an issuer to get an LEI.

“If you’re trading on a US stock or an Asian stock or a Chinese stock, there’s currently no obligation for them to get an LEI. So participants may not pay it’s not something they currently need for their own purposes,” Talks says.

Market participants were worried that this rule would impact liquidity, and put pressure on the European Securities and Markets Authority (Esma), which reviewed the requirement. The result was a guidance paper that came out in January this year, which grants a grace period of a year to reporting parties, during which the national competent authorities will accept transaction reports without the LEI of third-country issuers of securities involved in a securities financing transaction.

However, “Esma would expect that the counterparties, as well as the other entities that participate in SFTs …that lend, borrow or use as collateral securities issued by third-country entities that do not have an LEI, to liaise with those issuers to ensure that they are aware of the requirements under SFTR and are able to further facilitate the use of their securities by the counterparties subject to SFTR reporting requirements,” the regulator said in a statement in January.

Talks says that once the grace period is over, there will be a hard stop on trading with counterparties without LEIs. “A number of firms have started noting that a year’s extension is fantastic,” she says, ”but then what do they do after that year?”

Lapsed LEIs

In addition to the issue of slow adoption, firms that have obtained an LEI have not been updating them after their year’s registration was over, and so they fall into “lapsed” status. A lapsed LEI might not reflect recent changes in reference data—for example, those caused by corporate actions.

Grody’s research note says lapsed LEIs now make up just under a third (29.8%) of all registered LEIs. “Without solving this accelerating lapsed rate problem, the data quality of the GLEIS database will increasingly become suspect, negating the expected value of the LEI as the best-in-class source for legal entity identification,” he says.

Even EU authorities have not wanted to insist on active LEIs, and allow lapsed LEIs to be used in regulatory reporting. The validation rules for SFTR allow “lapsed” or “retired” LEIs in some instances. However, in other parts—mainly the fields where the reporting entity identifies itself—the LEI cannot be lapsed, Talks says. 

“If you’re a reporting party, your LEI has to be active. This is one of the slightly more contentious things because many of the fields will not allow for a lapsed LEI. If you have a look at the validation rules, in a lot of instances, that LEI has to be in specific status’s to be accepted by the repository,” Talks says. “If you don’t report within your timeframe, you’re in breach of the regulation and the NCA’s won’t take kindly to not reporting when you should, because there’s been plenty of time to prepare for it.”

Lapsed LEIs could get firms into more trouble with regulators than not having one at all, Talks says.

The GLEIF says in its Q4 2019 report that renewal rates were on average 66.7%, slightly lower than previous quarters, where they hovered around 70%. “At the end of the quarter, 69.2% of all LEIs were in good standing (last quarter: 72.1%),” the report says.

Renewal rates in the US and UK are among the lowest. In the US they were at 55.4%. The UK, the country with the densest concentration of LEI registrations, saw a rate of only 54.2%. The highest reporting nation for Q4 was Japan, at 90%.

The GLEIF tells WatersTechnology: “Regulations such as Mifid II and Mifir necessitate that financial services firms renew their LEIs annually, but the same does not apply to non-supervised organizations, which are often counterparties. This can cause the issue of lapsed LEIs. The LEI RoC and the FSB have addressed this issue as part of the recommendations contained in a recent FSB peer review report.”

Slow… but Steady

Talks says LEI adoption is growing, and will grow more as not only more regulations demand it, but also as it is demanded in more contexts.

“The LEI for issuers is new—it’s a change that issuers have to go out and get this data. As time progresses, we will see wider and wider adoption, much like we have [with the] LEI for counterparty fields.”

OFR director Dino Falaschetti said in a speech last year that the LEI has made amazing progress, growing in a mere eight years from just a twinkle in the FSB’s eye to a reality with 1.5 million registrants.

Falaschetti concedes that “take-up by the largest financial firms is not sufficient to crown LEI a broader success”; but, he says, “evaluated against LEI’s original goal—that is, identifying counterparties where financial stability concerns may arise—we could argue that at 1.5 million, the LEI has already achieved an important milestone. Globally, most large financial firms have LEIs. And identifying those counterparties today is much easier than it was even a decade ago.”

GLEIF CEO Stephan Wolf tells WatersTechnology that the LEI provides something unique: a global, standardized way of trusting counterparty information and free tools with which to check the accuracy of the data.

“Please compare this with any other data product that you have in the world. It gives you, the user, flexibility to take care of it: you can decide what to do with the data, the level of trust you associate with it. If you were to buy a data vendor feed, for instance, you would have absolutely no idea about the timeliness of that data.”

Lapsed LEIs still link to useful data, and the lapsed status gives the user more information about whether to trust the information, Wolf says.

Business registries don’t carry all the validated information the LEI database does; some countries don’t even have proper public listings of business information. And all this information is available to download, for free, under a creative commons license. It is usable not just in trade and transaction reporting, but also in customs declarations and internal processes such as invoicing.

“It’s a multi-purpose tool,” Wolf says. “And what we are trying to do now is extend the reach into other industries to make the LEI a tangible and valuable asset in those industries as well. We started with the banks, but we now want to cover large corporates, cross-border traders, supply-chain firms and healthcare firms in the long run.”

We started with the banks, but we now want to cover large corporates, cross-border traders, supply-chain firms and healthcare firms in the long run

Stephan Wolf, GLEIF

In terms of the financial industry, Wolf says the figures for full adoption that analysts tend to quote do not reflect the numbers of entities that should have an LEI, which is probably far lower. The figure of 40 million was a rough estimate made in the earliest days of the LEI initiative that was communicated to the public prematurely, he says. The figure of 200 million appears to come from an assumption of the number of eligible legal entities in the world based on data from the World Bank, and has been repeated throughout industry commentary by various trade bodies as a kind of yardstick for critical mass.

However, Wolf says the GLEIF is aiming for more like 20 million entities with LEIs. “[That] is based on research that we conducted over the last few years. That translates pretty much into roughly 50% of all companies engaged in international, cross-border trade. The vast majority of companies only work domestically. … That [20 million] is a pretty ambitious goal, and that will happen in the next five to eight years.”

As for costs, Wolf counters that the LEI can save the financial industry money. The GLEIF partnered with McKinsey & Company on a research report published late last year, which found that banks adopting LEI could save at least 10% of total operational costs for client onboarding and trading processes.

“For the broader investment banking industry alone, this would yield savings of over $150 million annually,” the report said. “Banks in trade financing could save an additional $500 million per annum overall by using the LEI in the issuance of letters of credit.”

Wolf adds that “the banks have internal costs—data management and shuffling data from left to right, mapping and matching of data. That is an operational cost that [can] be dramatically decreased if the LEI would be deployed everywhere.”

If banks help clients get LEIs, that could become part of their overall service and increase client satisfaction, he adds.

Additionally, Wolf says that GLEIF studies have found another potentially huge cost saving for banks. “When consumers want credit, sometimes they don’t have time to wait for the bank to do the due diligence, so banks can lose an average of 15% of business during onboarding because customers don’t want to wait,” he says.

The LEI can also help save money in compliance fees, lower regulatory risk and fewer sanctions from regulators, he says.

Banks form the backbone of the GLEIF’s strategy for widening adoption in 2020, Wolf says, because of their penetration into the entire economy and because they generally have high standards for data quality. The GLEIF will be communicating this strategy to the industry soon, with bank-driven pilot projects coming during the year.

“The regulators will get us to 2.5 million LEIs,” Wolf says. “What we want is voluntary adoption by the private sector, by banks. And that will bring us, hopefully, in the next few years to over 20 million.”