LEIs, damn LEIs and statistics
13 April 2021
With poor adoption and a grace period ending today, is the adoption of LEIs outside of the EEA ever going to gain momentum?
Image: Nikki Zalewski/stock.adobe.com
The deadline for third-country counterparties to gain a legal entity identifier (LEI) for reporting under the Securities Financing Transactions Regulation is 13 April 鈥 today. But, despite a 12-month delay to the requirement鈥檚 implementation, coverage remains patchy, putting the integrity of reported data at risk. A grace period was granted by the European Commission in January 2020, beginning in April when SFTR first went live, following a market survey that found a significant disparity between the level of LEI coverage in the EU (roughly 88 per cent), compared to non-European Economic Area (EEA) jurisdictions, where around a third of assets were not attached to an LEI.
At the time, the European Securities and Markets Authority (ESMA) stressed that it expected agent lenders and triparty agents that interact with third-country entities to ensure those counterparties are 鈥渁ware of the temporary nature of the rule change and that they are ready for the new 13 April 2021 deadline鈥.
However, recent evidence suggests there is yet to be significant improvement in LEI coverage in non-EEA jurisdictions.
The EU鈥檚 hardline stance before it authorised the grace period, 鈥榥o LEI, no trade鈥, raised fears that the introduction of SFTR would inadvertently cut off unprepared third-country entities from the securities finance liquidity pool. The latest market survey of EU and non-EEA ISINs, conducted in February 2021, included members of the International Securities Lending Association (ISLA), the International Capital Market Association (ICMA), the Association fran莽aise des march茅s financiers and the Association for Financial Markets in Europe, in collaboration with IHS Markit.
The results were cross-referenced with several LEI-focused entities and found that of the 4,7570 unique ISINs identified, 37,207 (78.22 per cent) were missing LEIs.
Of those missing LEIs, 98 per cent (36,505) were for ISINs issued in non-EEA countries, most notably, the US (17,563), Japan (3,466), China (3,382), Canada (2,210), and South Korea (2,133).
Last week, the UK鈥檚 Financial Conduct Authority extended the deadline again for the reporting under UK SFTR until at least 13 April 2022.
Despite calls from industry trade bodies including ISLA and ICMA for the commission to follow suit, at the time of publication, no decision has been made. In a joint letter addressed to UK and European national regulators and the EU鈥檚 market overseer sent 8 March, called for the grace period to be extended to 鈥渁void unnecessary disruption鈥 by allowing non-EEA issuers 鈥渟ignificantly more time鈥 to get their houses in order.
SFT spoke to industry experts Iain Mackay, global product owner, post-trade services at EquiLend, Jean White, managing director at SEI Investment Manager Services, which provides infrastructure and services for investment managers, and Jonathan Lee, senior regulatory reporting specialist at Kaizen Reporting, on why so many firms have been dragging their feet, whether the grace period will be extended and what will happen if it is not granted.
On what progress, if any, has been made to increase adoption of LEIs, Mackay says there has been a 鈥渃ollaborative exercise鈥 between market participants, vendors and industry bodies to scope the size of the problem and its reporting impacts. He says that the letter and survey coordinated by several different industry bodies serves to 鈥渄emonstrate another example of the collective work that has been achieved throughout this SFTR experience鈥 and highlights the importance with which the market treats this issue.
White echoes the sentiment of collaboration as it relates to the letter and survey but says that as significant gaps in LEI coverage remain across major non-EEA markets, 鈥渋t is clear that more will need to be done to guarantee full compliance by the grace period鈥檚 expiry date鈥.
Lee says that progress has been 鈥渟low but steady鈥 and there remains a lot to be done as the EU SFTR deadline for the adoption of issuer LEIs is looming.
Asked what is being done to encourage important but lagging counterparties in countries such as the US, China and Japan to catch up with the EEA, White singles out the Financial Stability Board (FSB), which has been 鈥渧ery vocal鈥 in its efforts to encourage and promote LEI adoption at national and international levels.
鈥淗owever, the question on everyone鈥檚 lips is what more can be done, beyond repeating such rhetoric more regularly, to encourage those outside of the EU鈥檚 jurisdiction to adopt LEIs. Unfortunately, the answer may be nothing,鈥 White says.
Trade associations have been working 鈥渢irelessly鈥 and across borders, Lee says, with the weight of organisations like the FSB behind them highlighting the issue and encouraging universal adoption of issuer LEIs.
鈥淭he Japanese Exchange group 鈥 including the Tokyo Stock Exchange 鈥 have been most vocal and proactive in closing the gap,鈥 Lee adds. But he also sees light at the end of the tunnel, hoping that as COVID-19 restrictions ease, 鈥渢here will be greater opportunities for global regulators to get together and promote their concerns and agenda鈥.
Mackay refers again to the joint letter, which invites ESMA to encourage relevant regulators to promote a broader adoption of the LEI code in their jurisdictions and 鈥渁lso to raise the matter in appropriate international regulatory forums鈥.
Moving on to what is actually going to happen in the EU once the grace period lapses, if LEIs have not been adopted, Mackay says that reports on trades conducted on an impacted ISIN will be rejected by the relevant trade repository. 鈥淗owever, the likely biggest impact will be on the reporting of collateral for loan portfolios which are collateralised on a net exposure basis.鈥
He says that because the collateral report for net exposure is submitted as 鈥渙ne large message with repeating blocks of data鈥 for each ISIN, if any one of the securities in a pool of collateral assets does not have an LEI of the issuer, the whole collateral file will be rejected.
White says that national competent authorities (NCA) are 鈥渦nder an obligation to pay significant attention to the accuracy鈥 of reporting and matching rates and the potential exists for penalties to be applied for non-compliance.
鈥淚f there are no workarounds or changes in the number of LEIs by the time the grace period lapses, this could expose all entities undertaking securities finance transactions in Europe to the risk of regulatory penalties,鈥 she adds.
Beyond regulatory fines, there is also the potential for liquidity issues within the market, White says, as a single missing LEI in a collateral pool is likely to result in a rejection of the submission. 鈥淭he industry will be watching closely for signs of this detrimental knock-on effect to liquidity.鈥
What actually happens once the grace period lapses will depend on how firms react, Lee says. 鈥淯ntil we hear otherwise from ESMA or NCAs, we have been advising firms to essentially maintain the status quo and report LEIs where they have been published, otherwise continue to report but leave the field blank.鈥
As the trade repositories have not adopted any changes to the validation rules to demand issuer LEIs are always populated, Lee says, only populating LEIs where available will not result in any breaks at present.
If the LEI field is left blank 鈥 one of the mooted options if the grace period is not extended 鈥 what impact will a validation error have on transactions and the quality of SFTR reporting data?
In this case, White says that if an extension of the grace period is not under consideration, it is important that NCAs are advised of the scale of this challenge and of the potential increase in SFTR submission rejections, in trade and collateral reports, when data is validated by trade repositories. 鈥淎n alternative solution discussed among our client base is using a dummy LEI where no LEI exists, although this will undoubtedly have unintended consequences on the quality of data,鈥 she adds.
Mackay is less equivocal: 鈥淚f聽firms聽leave the LEI field blank, the report will be rejected,鈥 which means that聽they聽will have to choose between not reporting the entire file, or trying to remove the offending item from the list, 鈥渁rguably leading to misreporting of that collateral position鈥. Either approach, Mackay says, will mean that the regulator does not receive the transparency with regard to market risk for which SFTR was arguably聽conceived.
Lee disagrees. He says if the issuer LEI has not been published, leaving the field blank 鈥渨ould appear the best course of action鈥. Reporting without LEIs in these circumstances ensures the reporting firm is 鈥渕aximising its transparency鈥 under SFTR and if the firm were to report a 鈥渄ummy鈥 LEI code in place of a missing one, that could be deemed to be misreporting. Similarly, if a firm excludes securities from reports that do not have issuer LEIs then this would constitute under-reporting, Lee adds.
On how long the grace period should be extended for 鈥 and whether it鈥檚 even likely 鈥 Mackay says that, 鈥淓SMA recognises that the issue has not gone away and, as such, the likelihood of an extension or additional grace period is rising鈥. Because there is a 鈥減ractical element鈥 of getting LEI adoption and there is also now another 鈥渟izeable鈥 regulatory initiative on the horizon in the form of CSDR, 鈥渇irms cannot be the only source of encouragement鈥.
The difficulty with regulatory exemption periods, White says, 鈥渋s that they鈥檙e usually granted late in the day and with little indication ahead of time that they鈥檒l be extended other than unreliable market mutterings鈥.
With such limited progress made on non-EEA issuer LEIs, 鈥渋t鈥檚 arguable there isn鈥檛 much value in requiring the population of an additional field, which would so rarely be possible anyway,鈥 White adds.
If the European Commission did provide an additional grace period, it would need to be prepared for market participants 鈥減aying less heed鈥 to other timeframes. 鈥淭his may not be a message worth sending from their perspective,鈥 White says.
Lee says that focusing on the length of the grace period is not the most important question as the 鈥渇undamental challenge鈥 for reporting counterparties and regulators is that the relationship between reporting counterparties and security issuers is far too tenuous to force them to request LEIs from their numbering agencies.
鈥淔or example, if the reason behind needing to report the issuer LEI of a particular security is that you have received it overnight as a piece of collateral on a loan and only hold it for one day, this is far too tenuous a relationship with the third-country issuer to compel them to request an LEI,鈥 he says.
Lee says that pressure needs to come from global regulatory bodies and local NCAs to mandate security issuers to request LEIs.
鈥淚 would argue that this is for ESMA, the FCA and other NCAs in Europe to take away, raise through the FSB, rather than impose on SFTR reporting counterparties. On this basis, it would make most sense to make this field conditional on the LEI existing for the foreseeable future, until these lobbying efforts take full effect,鈥 he concludes.
The key question of course is whether an extension of the grace period will have any positive effect on recalcitrant markets at all.
Lee is pessimistic. 鈥淭he relationship with issuers of securities is very different from the relationship with market counterparties, where you can impose some conditions.鈥
Mackay says that due to the practical effects that not adopting LEIs will have on reporting, it makes sense to extend the period to allow institutions to become compliant.
鈥淗owever, there does need to be a concerted effort not just from the market participants and industry bodies, but also pressure from regulatory bodies like ESMA and potentially also the NCAs to encourage these firms to get the LEI.鈥
White is less optimistic. 鈥淚t鈥檚 difficult to argue that granting further extensions ever has the effect of encouraging those who, up until that point, have failed to take it seriously, to give it due attention from there onwards,鈥 she concludes.
At the time, the European Securities and Markets Authority (ESMA) stressed that it expected agent lenders and triparty agents that interact with third-country entities to ensure those counterparties are 鈥渁ware of the temporary nature of the rule change and that they are ready for the new 13 April 2021 deadline鈥.
However, recent evidence suggests there is yet to be significant improvement in LEI coverage in non-EEA jurisdictions.
The EU鈥檚 hardline stance before it authorised the grace period, 鈥榥o LEI, no trade鈥, raised fears that the introduction of SFTR would inadvertently cut off unprepared third-country entities from the securities finance liquidity pool. The latest market survey of EU and non-EEA ISINs, conducted in February 2021, included members of the International Securities Lending Association (ISLA), the International Capital Market Association (ICMA), the Association fran莽aise des march茅s financiers and the Association for Financial Markets in Europe, in collaboration with IHS Markit.
The results were cross-referenced with several LEI-focused entities and found that of the 4,7570 unique ISINs identified, 37,207 (78.22 per cent) were missing LEIs.
Of those missing LEIs, 98 per cent (36,505) were for ISINs issued in non-EEA countries, most notably, the US (17,563), Japan (3,466), China (3,382), Canada (2,210), and South Korea (2,133).
Last week, the UK鈥檚 Financial Conduct Authority extended the deadline again for the reporting under UK SFTR until at least 13 April 2022.
Despite calls from industry trade bodies including ISLA and ICMA for the commission to follow suit, at the time of publication, no decision has been made. In a joint letter addressed to UK and European national regulators and the EU鈥檚 market overseer sent 8 March, called for the grace period to be extended to 鈥渁void unnecessary disruption鈥 by allowing non-EEA issuers 鈥渟ignificantly more time鈥 to get their houses in order.
SFT spoke to industry experts Iain Mackay, global product owner, post-trade services at EquiLend, Jean White, managing director at SEI Investment Manager Services, which provides infrastructure and services for investment managers, and Jonathan Lee, senior regulatory reporting specialist at Kaizen Reporting, on why so many firms have been dragging their feet, whether the grace period will be extended and what will happen if it is not granted.
On what progress, if any, has been made to increase adoption of LEIs, Mackay says there has been a 鈥渃ollaborative exercise鈥 between market participants, vendors and industry bodies to scope the size of the problem and its reporting impacts. He says that the letter and survey coordinated by several different industry bodies serves to 鈥渄emonstrate another example of the collective work that has been achieved throughout this SFTR experience鈥 and highlights the importance with which the market treats this issue.
White echoes the sentiment of collaboration as it relates to the letter and survey but says that as significant gaps in LEI coverage remain across major non-EEA markets, 鈥渋t is clear that more will need to be done to guarantee full compliance by the grace period鈥檚 expiry date鈥.
Lee says that progress has been 鈥渟low but steady鈥 and there remains a lot to be done as the EU SFTR deadline for the adoption of issuer LEIs is looming.
Asked what is being done to encourage important but lagging counterparties in countries such as the US, China and Japan to catch up with the EEA, White singles out the Financial Stability Board (FSB), which has been 鈥渧ery vocal鈥 in its efforts to encourage and promote LEI adoption at national and international levels.
鈥淗owever, the question on everyone鈥檚 lips is what more can be done, beyond repeating such rhetoric more regularly, to encourage those outside of the EU鈥檚 jurisdiction to adopt LEIs. Unfortunately, the answer may be nothing,鈥 White says.
Trade associations have been working 鈥渢irelessly鈥 and across borders, Lee says, with the weight of organisations like the FSB behind them highlighting the issue and encouraging universal adoption of issuer LEIs.
鈥淭he Japanese Exchange group 鈥 including the Tokyo Stock Exchange 鈥 have been most vocal and proactive in closing the gap,鈥 Lee adds. But he also sees light at the end of the tunnel, hoping that as COVID-19 restrictions ease, 鈥渢here will be greater opportunities for global regulators to get together and promote their concerns and agenda鈥.
Mackay refers again to the joint letter, which invites ESMA to encourage relevant regulators to promote a broader adoption of the LEI code in their jurisdictions and 鈥渁lso to raise the matter in appropriate international regulatory forums鈥.
Moving on to what is actually going to happen in the EU once the grace period lapses, if LEIs have not been adopted, Mackay says that reports on trades conducted on an impacted ISIN will be rejected by the relevant trade repository. 鈥淗owever, the likely biggest impact will be on the reporting of collateral for loan portfolios which are collateralised on a net exposure basis.鈥
He says that because the collateral report for net exposure is submitted as 鈥渙ne large message with repeating blocks of data鈥 for each ISIN, if any one of the securities in a pool of collateral assets does not have an LEI of the issuer, the whole collateral file will be rejected.
White says that national competent authorities (NCA) are 鈥渦nder an obligation to pay significant attention to the accuracy鈥 of reporting and matching rates and the potential exists for penalties to be applied for non-compliance.
鈥淚f there are no workarounds or changes in the number of LEIs by the time the grace period lapses, this could expose all entities undertaking securities finance transactions in Europe to the risk of regulatory penalties,鈥 she adds.
Beyond regulatory fines, there is also the potential for liquidity issues within the market, White says, as a single missing LEI in a collateral pool is likely to result in a rejection of the submission. 鈥淭he industry will be watching closely for signs of this detrimental knock-on effect to liquidity.鈥
What actually happens once the grace period lapses will depend on how firms react, Lee says. 鈥淯ntil we hear otherwise from ESMA or NCAs, we have been advising firms to essentially maintain the status quo and report LEIs where they have been published, otherwise continue to report but leave the field blank.鈥
As the trade repositories have not adopted any changes to the validation rules to demand issuer LEIs are always populated, Lee says, only populating LEIs where available will not result in any breaks at present.
If the LEI field is left blank 鈥 one of the mooted options if the grace period is not extended 鈥 what impact will a validation error have on transactions and the quality of SFTR reporting data?
In this case, White says that if an extension of the grace period is not under consideration, it is important that NCAs are advised of the scale of this challenge and of the potential increase in SFTR submission rejections, in trade and collateral reports, when data is validated by trade repositories. 鈥淎n alternative solution discussed among our client base is using a dummy LEI where no LEI exists, although this will undoubtedly have unintended consequences on the quality of data,鈥 she adds.
Mackay is less equivocal: 鈥淚f聽firms聽leave the LEI field blank, the report will be rejected,鈥 which means that聽they聽will have to choose between not reporting the entire file, or trying to remove the offending item from the list, 鈥渁rguably leading to misreporting of that collateral position鈥. Either approach, Mackay says, will mean that the regulator does not receive the transparency with regard to market risk for which SFTR was arguably聽conceived.
Lee disagrees. He says if the issuer LEI has not been published, leaving the field blank 鈥渨ould appear the best course of action鈥. Reporting without LEIs in these circumstances ensures the reporting firm is 鈥渕aximising its transparency鈥 under SFTR and if the firm were to report a 鈥渄ummy鈥 LEI code in place of a missing one, that could be deemed to be misreporting. Similarly, if a firm excludes securities from reports that do not have issuer LEIs then this would constitute under-reporting, Lee adds.
On how long the grace period should be extended for 鈥 and whether it鈥檚 even likely 鈥 Mackay says that, 鈥淓SMA recognises that the issue has not gone away and, as such, the likelihood of an extension or additional grace period is rising鈥. Because there is a 鈥減ractical element鈥 of getting LEI adoption and there is also now another 鈥渟izeable鈥 regulatory initiative on the horizon in the form of CSDR, 鈥渇irms cannot be the only source of encouragement鈥.
The difficulty with regulatory exemption periods, White says, 鈥渋s that they鈥檙e usually granted late in the day and with little indication ahead of time that they鈥檒l be extended other than unreliable market mutterings鈥.
With such limited progress made on non-EEA issuer LEIs, 鈥渋t鈥檚 arguable there isn鈥檛 much value in requiring the population of an additional field, which would so rarely be possible anyway,鈥 White adds.
If the European Commission did provide an additional grace period, it would need to be prepared for market participants 鈥減aying less heed鈥 to other timeframes. 鈥淭his may not be a message worth sending from their perspective,鈥 White says.
Lee says that focusing on the length of the grace period is not the most important question as the 鈥渇undamental challenge鈥 for reporting counterparties and regulators is that the relationship between reporting counterparties and security issuers is far too tenuous to force them to request LEIs from their numbering agencies.
鈥淔or example, if the reason behind needing to report the issuer LEI of a particular security is that you have received it overnight as a piece of collateral on a loan and only hold it for one day, this is far too tenuous a relationship with the third-country issuer to compel them to request an LEI,鈥 he says.
Lee says that pressure needs to come from global regulatory bodies and local NCAs to mandate security issuers to request LEIs.
鈥淚 would argue that this is for ESMA, the FCA and other NCAs in Europe to take away, raise through the FSB, rather than impose on SFTR reporting counterparties. On this basis, it would make most sense to make this field conditional on the LEI existing for the foreseeable future, until these lobbying efforts take full effect,鈥 he concludes.
The key question of course is whether an extension of the grace period will have any positive effect on recalcitrant markets at all.
Lee is pessimistic. 鈥淭he relationship with issuers of securities is very different from the relationship with market counterparties, where you can impose some conditions.鈥
Mackay says that due to the practical effects that not adopting LEIs will have on reporting, it makes sense to extend the period to allow institutions to become compliant.
鈥淗owever, there does need to be a concerted effort not just from the market participants and industry bodies, but also pressure from regulatory bodies like ESMA and potentially also the NCAs to encourage these firms to get the LEI.鈥
White is less optimistic. 鈥淚t鈥檚 difficult to argue that granting further extensions ever has the effect of encouraging those who, up until that point, have failed to take it seriously, to give it due attention from there onwards,鈥 she concludes.
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