Despite regulatory compliance being an industry hot topic, the number of entities failing to renew their LEIs is on the rise, which spells trouble for reported transaction data integrity
The legal entity identifier (LEIs) is a simple but essential feature of the modern transaction reporting ecosystem. In recent years the number of LEIs has surged in the US, the EU and globally as the last of the post-financial crisis regulatory frameworks came into play.
The cheap and easily accessible 20-character alphanumeric code was adopted as a mandatory requirement by market overseers as a tool to cut through the tangles of large group structures and pinpoint who, exactly, was trading with whom.
One characteristic of LEIs is that, like puppies, they aren’t just for Christmas, they’re for life. However, unlike puppies, LEIs only require attention once a year when they need to be renewed. But, even this is too much for some firms.
The number of neglected LEIs globally that are now ‘lapsed’ due to a lack of renewal is steadily increasing. As of August, more than half a million LEIs were out-of-date and this figure is trending upwards. Moreover, the monthly number of LEIs lapsing is now outstripping the number of new issues.
This spells trouble not just for the entity itself but for its counterparties which will fail its reporting requirements under the alphabet soup of new regulations without a valid code for all the relevant parties it interacts with.
Darragh Hayes, director of LEI Worldwide, explains that lapsed LEIs have maintained a steady rate in correlation to new LEIs over the past three years.
Between January and August, the volume of global LEIs that are lapsed rose from 30.5 percent to 31 percent, according to LEI Worldwide data. On average this year 17,403 LEIs have lapsed per month, compared to the 16,390 new LEIs issued on average per month.
These numbers sound big but how serious is the problem really? “It’s not ideal,” says Steve Waite, chief marketing officer at Ubisecure, an identity services technology company.
“LEIs need to be renewed in order to maintain an accurate record of the organisation,” he explains. “If an LEI lapses, no checks are being completed on what reference data may have changed. Improving the lapsed rate will ensure the global LEI database offers the most value to relying parties who are increasingly using the LEI database as a source of organisation credibility and know-your-customer.”
Where are the neglectful parties?
Currently, the US is home to most LEIs and has the largest amount of lapsed LEIs. There are 117,825 lapsed LEIs in the US compared to a total of 239,261 overall LEIs in the market.
When it comes to lapsed LEI rate it is worth noting the US not only has the most lapsed LEIs because they are the largest user of the LEI, but they have the highest percentage of lapsed LEIs compared to other countries. The US has also been using the LEI heavily since 2012 so many of the older entities would have had lapsed LEIs going back years
Meanwhile, the UK has 158,460 LEIs of which 78,640 of which have lapsed. This is among the worst scorecards in Europe. Inside the EU performance seems better. Germany is the third-largest user of the LEI with 141,536 LEIs, of which just 26,160 are lapsed (18.4 percent). Less than half that of the UK and USA.
When it comes to the UK lapsed rates, there are a couple of things that may indicate why the UK has a higher lapsed rating than its German and Italian counterparts Hayes explains. This can include lack of education and awareness of the renewal requirement, regulations that require an LEI, but not specifically an active LEI, many entities set up in the UK for short term purposes, a lot of trusts in the UK, the LEI service provider that an entity chooses to partner with for their LEI requirements has a large impact on whether they will renew their LEI or not.
Hayes explains that this could be because of tighter adherence to EU regulations that require LEIs, such as the Securities Financing Transactions Regulation (SFTR), the second Markets in Financial Instruments Directive (MiFID ii) and the European Market Infrastructure Regulation (EMIR). “I say this because Italy who is the fourth largest user and also an EU member has 129,348 LEIs and just 27 percent are lapsed (35,082)”.
In total, the EU has more than 10 reporting or transparency regimes that require an LEI and, as a result, at least two-thirds of the worldwide LEIs pertain to European Economic Area (EEA) entities.
What’s gone wrong?
As usual, when manual processes are involved, the source of the problem is human error. But, there is a legislative angle to the problem as well.
Interpreting why LEIs are allowed to lapse, Ubisecure’s Waite says: “Sometimes it’s because the ownership of the task to renew the LEI changes, people change roles or move on from companies frequently, especially right now in the middle of a pandemic.
“Sometimes it’s because the regulation that dictated the initial LEI registration required the LEI only once. Often, like many annual tasks, it’s just that people forget,” he concludes.
Moreover, Hayes highlights that management in larger organisations with large amounts of subsidiaries where each entity needs an LEI often there is no central point of management. That is why it is smart to outsource group management of LEIs to a registration agent. Often people change roles in companies, and the person who registered the LEI initially may have moved or not left details of where the LEI is registered, meaning it can “slip between the cracks”.
Who are the neglectful parties?
Hayes explains that hedge funds, funds and trusts are more likely to let their LEIs lapse as they would have applied in 2018 upon the introduction of MiFID II in order to become compliant and after that may not have needed to renew it, or are unaware that they needed to renew it. “Commonly we see entities apply for an LEI for a one-time transaction, for example, a special purpose vehicle that may now be dormant and so they do not feel the need to renew the LEI that it got last year,” he adds.
If that entity is buying or selling securities, they may only need the LEI for that transaction, and not necessarily keep the LEI active longer than 12 months. A mid-sized company such as an LLC or LTD would be engaging in regular transactions and have quarterly reporting duties so would be more invested in maintaining an active LEI due to various regulations and policies.
Darragh explains: “This is what we have seen from our own database of clients”. Hayes also notes that LEIs under these entity types tend to lapse because the LEI may be needed to begin trading, or conduct a single transaction. It then may not be necessary to keep it active.
What can be done?
The recurring themes seem to be a lack of knowledge or awareness of the LEI needing to be renewed, compliance misunderstanding and a lack of knowledge that they can outsource to a registration agent who will ensure the LEI does not lapse and focus on maintaining it.
Waite explains that this is the problem for many organisations, they should not be so disregarded and should fall under compliance controls, but the reality is that sometimes they do not.
“We see this across other industries where domains and digital certificates (also annual renewal items) often get forgotten about and left out of compliance controls only to then cause devastating consequences,” he says.
“Our advice is that organisations should take LEI renewal very seriously, as there are fines now happening, and they should be part of the organisation’s compliance controls. Of course, LOUs can make it easier for organisations to renew, such as multi-year options.”
Ubisecure has seen 250,000 new LEIs issued in the past 12 months and RapidLEI has issued a fair percentage of those, Waite explains, adding that he expects to see overall lapsed rates fall as the numbers of LEIs under its management increases.
Elsewhere, the Global Legal Entity Identifier Foundation is working to reduce the rate of lapsed LEIs. It has introduced the new concept of the conformity flag, which will act as an indicator of the accuracy of an LEI record and will highlight how well an entity’s LEI complies with overall conformity.
When the flag is active the LEI is in full conformity. This will encourage LEI owners to keep their LEI active and help indicate where one needs updating. In order to obtain a conformity flag, the LEI will undergo a series of checks against reporting criteria which will be published in the coming months. This is to be implemented during 2021, and in due course, it will be added to all LEI records.
Waite believes a big impact will be made when the LEI conformity flag comes into effect. “Maintaining an active LEI is required to achieve conformity, and you’ll see LEI Issuers like RapidLEI, and our partners, provide services that allow LEI conformity to be queried and asserted,” he states.
Another solution would be to make regulations require that the LEI be renewed in order to keep the entity reference data accurate and up to date. The obligation to renew will certainly help the LEI achieve more widespread use cases.
Why are they important?
According to the European Securities and Markets Authority (ESMA), the use of the LEI also generates tangible benefits for businesses including simplified regulatory reporting; database management free of charges; more accurate calculation of counterparty exposures; improved risk management; and increased operational efficiencies. In this context, the LEI will provide benefits in terms of costs and new business opportunities, as a reliable, open, standardised, and high-quality legal entity reference data shared across the marketplace.
ESMA applies the same approach across the European Markets Infrastructure Regulation (EMIR), Markets in Financial Instruments Regulation (MiFIR) and Securities Financing Transactions Regulation (SFTR). This means that the LEI is required to be renewed and up to date only for the entities that are directly subject to the reporting obligation. Therefore, if the LEI for any of these entities has lapsed, the report will be rejected.
Meanwhile, the UK’s Financial Conduct Authority (FCA) says it is seeking to identify investment firms failing to meet their obligation to report transactions and will take action, including enforcement action where appropriate.
To further this aim, the FCA has implemented a validation rule in its Market Data Processor to reject transaction reports submitted by investment firms with an LEI in lapsed status. This ensures that investment firms which execute transactions renew their LEI on an annual basis.
What is an LEI and why does it need renewing?
A legal entity identifier (LEI) is a 20-character code that is based on the ISO 17442 standard developed by the International Organization for Standardization (ISO). LEIs are used as a reference to important information that offers transparency when taking part in financial transactions such as trading with stocks, bonds or foreign exchange. LEIs, like other identifiers, are needed by firms to fulfil their reporting obligations under financial regulations and directives such as the European Markets Infrastructure Regulation, Alternative Investment Funds Directive Central Securities Depositories Regulation and Securities Financing Transactions Regulation, to name a few.
Once a legal entity obtains an LEI code, the code is assigned to that legal entity for its entire life.
The purpose of renewal is to ensure the data is current. If a company changes their address or trading name, it should be updated on the LEI immediately, but if not, it will be double-checked upon renewal by a firm such as LEI Worldwide. This is paramount to maintaining high quality, reliable data.
