By Ben Lis | August 2, 2017
“No LEI, No Trade” captures the essence of MiFID II’s legal entity identifier (LEI) requirements. You may have seen this phrase in a financial markets publication or blog post. Its use is invariably accompanied by a call for European market participants to apply for a legal entity identifier in advance of the January 3rd go-live.
Please heed this call. If your firm or fund doesn’t have an LEI by that date, you won’t be able to trade in European markets. If you don’t have an LEI yet, avoid the last-minute rush and apply for one today. Here are instructions how.
For many firms, MiFID II’s LEI requirements don’t end with having an LEI. Investments firms and trading venues are additionally obliged to ensure a client has a valid LEI before executing a trade with them or on their behalf. “No LEI, No Trade” originated as short-hand to refer to the specific article in the regulation that mandates this pre-trade check.
Although it hasn’t received the same attention as the more general “make sure your firm has an LEI” message, this check creates a significant data management challenge for those firms obliged to perform it. Relevant LEI data on clients and counterparties must be mapped, validated for accuracy, and added to existing data records. Just as importantly, this data must be proactively monitored to make sure it stays up-to-date.
MiFID II’s LEI requirements appear in various parts of the technical specifications on transaction reporting, order record keeping, and financial instrument reference data. This post is the first of a series which will provide easy-to-follow summaries of the key LEI-related points in these specifications, so you can ensure your firm meets its regulatory obligations with no hitches.
Before we dive into those specifications, below is basic background on both MiFID II and the LEI.
MiFID stands for the “Markets in Financial Instruments Directive”. It’s the European Union law that ensures harmonized regulation of investment services across the member states of the European Economic Area (EEA). The original legislation, now referred to as “MiFID I”, has been in effect since 2007.
MiFID II revised and expanded the scope of the original directive, incorporating lessons learned from MiFID I and the financial crisis. It applies to all asset classes and, as noted above, will become effective in January 2018. MiFID II seeks to achieve fairer, safer and more efficient markets by:
- preventing market abuse
- increasing trade transparency
- ensuring best execution
- requiring more execution on trading venues
- increasing non-discriminatory access to CCPs, benchmarks and trading venues
- lowering market data costs
MiFID II includes a regulation called “MiFIR”, or the “Markets in Financial Instruments Regulation”. The LEI requirements are contained in MiFIR. ESMA’s publications refer to the two as “MiFID II and MiFIR” or sometimes as “MiFID II/MiFIR”. Trade publications and industry discussions often use “MiFID II” to refer to both, and that’s the convention we adopt.
Legal Entity Identifier (LEI)
The legal entity identifier was introduced in response to a significant problem encountered during the financial crisis: the inability to fully understand the systemic and firm-specific risk posed by the failure of a company such as Lehman Brothers.
It is critical to recognize that large financial institutions are not single monolithic entities, but are composed of many legal entities with complex relationships. For example, Lehman Brothers had over 7000 legal entities in more than 40 countries.
The number of legal entities and their relationships are not inherently problematic, but became so due to three factors:
- no means to unambiguously and consistently identify parties to financial transactions across global markets and asset classes
- a lack of regulatory trade reporting systems in some asset classes and jurisdictions
- no way to determine the ownership relationships amongst these parties
The regulators and market participants who met in the aftermath of the crisis noted the fix to this problem could be succinctly described as the answers to these three questions:
Who is who?
Introduce a common, public, global identifier to identify parties to financial transactions called the legal entity identifier. Firms register LEIs providing associated reference data such as legal name, address and ownership information.
Who owns what?
Mandate use of LEIs in regulatory trade reporting systems across all financial instruments and jurisdictions.
Who owns whom?
Introduce a public database of hierarchical ownership relationships amongst LEIs.
The G20 endorsed this solution and its implementation has steadily progressed. The infrastructure for registering and renewing LEIs is fully operational, with over 530,000 LEIs registered to date. The database of ownership relationships is currently being introduced. MiFID II, as well as regulations already in effect such as EMIR and Dodd-Frank, are enabling the answer to who owns what by mandating transaction reporting which includes the LEI.
The LEI in MiFID II
Transaction reporting, order record keeping, and standardized financial reference data are all required by MiFID II. The reports and records generated because of these requirements include data elements that identify the parties to a trade, the submitters of orders, and security issuers. For these reports and records to be useful, MiFID II mandates that LEIs identify the entities in these roles.
We’re now ready to dive into the specifics. In the next post, we’ll take an in-depth look at the use of LEIs in transaction reporting.