The Australian Securities and Investment Commission (ASIC) has signalled its intention to harmonise regulations with internationally accepted standards. The Legal Entity Identifier (LEI) is one element of those standards and, although not currently mandatory in Australia, it is now highly recommended for any legal entity or fund that holds global derivative positions. Indeed they will be mandatory for certain transactions and compliance reporting from next year.
Until the LEI becomes mandatory in October 2024, ASIC allows the use of the SWIFT-related Bank Identification Code (BIC) or the ABN.
However the LEI is not a recent development. Most Australian banks, and banks worldwide, became early adopters of the LEI when mandatory OTC derivative reporting was introduced in 2012.
Since then, the LEI has been progressively implemented in OTC derivative reporting around the world and has also become a required identifier for many other global transactional and reporting activities.
When the LEI becomes the only identifier for Australian entities in OTC transaction processing and reporting in October next year Australia will be aligned with the UK, the EU, the USA, and other leading jurisdictions around the world.
The history of the LEI
As the G20 evaluated the origins of the global financial crisis, it realised one of the root causes was the difficulty in determining the counterparties in many of the very exotic derivative transactions. Risk management protocols that applied in other financial markets were not present in the OTC derivatives markets.
As part of its review, the G20 introduced the concept of a legal entity identifier (LEI) which would be used to identify counterparties in OTC derivative transactions and in a new global reporting framework. The LEI is a structured 20-digit alphanumerical code which works much like an ABN does domestically, but is recognised by jurisdictions around the world. ISIN codes are conceptually similar for financial products. Importantly, the LEI captures not only the entities participating in the transaction, but also the details of any parent entities and ultimate parent ownership. Who owns who, in other words.
The Global LEI Foundation (GLEIF) was then set up by the Financial Stability Board to implement the LEI system around the world. It controls the issuing and maintenance of the LEI codes through a global network of issuing organisations and it also facilitates searches of the stored, freely available LEI data, along with a number of data download and cross referencing (eg LEI & BIC codes) services. These searches can provide useful insights for businesses, governments, regulators, and others looking to confirm the accuracy of entity data and ownership relationships.
In the 15 years since the GFC, the occurrence of similar market disruptions has been minimal, indicating that LEIs and accompanying global reporting frameworks are doing a good job of reducing ambiguity, and minimising risk in global derivative markets.
As previously mentioned, the GLEIF has responsibility for developing and running the LEI regime. It does this through accredited issuers (Local Operating Units or LOUs) with jurisdictional client support and service provided by Registration Agents (RAs). RAs assist clients with the validation process that is necessary before an LOU can issue an LEI. APIR has a long history issuing APIR codes and ISINs in the Australian market, and it was a natural progression to extend its services and become a participant in the LEI system as many existing clients require an LEI as well as an APIR and ISIN. That process started in 2015 and today APIR supports close to 6000 LEIs.
Globally there are approximately 2,000,000 active LEIs, with the bulk of them operating in applications in Europe where the regime has been heavily embraced by the EU and the UK and in the United States where legislative reform initiated early uptake after the GFC.
The introduction of a mandatory LEI requirement in 2024 will likely impact smaller businesses and operators that are not financial services businesses, such as those that might only conduct derivative transactions infrequently. For example, a farmer purchasing a tractor from overseas would need a foreign exchange contract – which is a derivative contract – to lock in a price for the vehicle. They would need an LEI to facilitate that transaction but may not require the LEI again for some time.
Australia is probably situated in the middle of global LEI usage and application. Under the European regulations set out in Markets in Financial Instruments Directive 2014, commonly known as MiFID II, it is now required for any legal entity using exchange traded markets, like a stock exchange, to have a LEI. So that means any company that is buying or selling shares in Europe is required to have an LEI; this has contributed to the strong growth of LEIs in Europe (as well as legal entities in other jurisdictions that trade on European exchanges).
In Australia, in order to harmonise our regulations with international jurisdictions like the UK and the EU, ASIC may also need to clarify whether an entity’s LEI needs to be renewed every year. This is critical for ensuring data accuracy and currency just like it is for the APIR (and any) identification regime. And while many organisations consider an annual or multi year renewal of their LEIs to be best practice, renewal is not an explicit requirement in the current legislation. As the reach of the LEI continues to grow and impact smaller businesses, clarification in this area would be beneficial.
Extended use cases
Having proved useful in greatly assisting risk management in the derivative markets to date, the FSB is keen to explore the LEI useability case for all cross-border transactions.
The LEI could be used to accurately identify counter parties in many types of cross-border transactions as it currently does with derivative transactions, the LEI could then be included in regulatory reporting to provide a wealth of compliance information for governments and regulators.
The GLEIF has been working on a number of cross-border transaction pilot projects and the LEI is a part of the FSB’s G20-endorsed Roadmap for Enhancing Cross-Border Payments*. The key use cases the GLEIF has been exploring include: corporate invoice reconciliation; KYC and customer onboarding; account-to-account owner validation; and screening efficiency for watch lists and sanctions.
In a recent article, GLEIF head of business operations, Clare Rowley, outlined a proof-of-concept pilot with a Japanese consortium program that is working on developing entity-level trust services recognised by Japanese and European organisations. This pilot integrates the LEI into the eSeals used to verify the authenticity of e-invoices exchanged between Japanese and European organisations.
Rowley said the pilot enabled the authenticity of both the e-invoice document (via the eSeal) and the sending organisation (via their LEI, embedded in the eSeal credential), and the time of the document’s sealing to be confirmed simultaneously.
The FSB is currently working on promoting standardisation in the internationally recognised ISO 20022 messaging standards for financial industry messaging in the payments, securities, trade services, cards and foreign exchange business domains. The possible inclusion of the LEI as an identifier in the messaging is being considered. The process of reviewing ISO Standards take time, but it would make sense to include an existing internationally recognised identifier.
Website identification in the age of AI
As well, the GLEIF is exploring the use of LEIs in digital certificates, also known as identity certificates, which authenticate a company’s website’s digital identity. This would expand the use of LEIs exponentially, given the hundreds of millions of websites currently in existence. But it would be an increasingly useful tool in an age where misinformation and the line between what is real on the internet, and what is not, has become increasingly blurred.
The FSB and the GLEIF obviously see the LEI as a pillar for future identification across a myriad of international applications and transactions. As its use grows, we expect issuer competition to increase, and we fully support its use across the international payments system. Anything that makes this system safer, benefits us all.
By Chris Donohoe, CEO
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