Notwithstanding another extension of relief by the Australian Securities and Investments Commission (ASIC), the deadline for legal entities, including self-managed superannuation funds (SMSFs), to obtain a Legal Entity Identifier (LEI) is fast approaching.
A LEI is a 20-digit, alpha-numeric code that enables identification of legal entities participating in certain financial transactions.
Indeed, a range of Australian financial services entities - including funds, brokers/traders as well as trustees of SMSFs - may be unable to transact non-exchange trade instruments such as CFDs and FX from April 1, 2019 if they don’t have a LEI.
Considering there are some 600,000 SMSFs in Australia, and that perhaps 5-10 per cent of them trade OTC instruments such as CFDs, there are potentially between 30,000-60,000 funds that are impacted by the deadline.
So what is a LEI? Essentially, the LEI is a unique identifier that was conceived by the G20 post the Global Financial Crisis (GFC) to improve market transparency, particularly for complex derivative transactions; this data is maintained in various repositories for central bank and regulator access. The Financial Stability Board (FSB) oversees the data and also uses it to ‘take the temperature’ of global markets and risk conditions.
The impact of MiFID II
The LEI is a key component of European Markets in Financial Instruments Directive (MiFID II) reporting regime, that came into effect in Europe on 3 January 2018.
MiFID II reporting was introduced in Europe also following analysis of the cause of the GFC. It had the aim of providing greater transparency in transaction identification and, therefore, strengthening investor protection for those undertaking a range of transactions.
In line with this, LEIs are a global identification standard introduced in response to regulators’ requirements to identify counterparties in a range of cross border financial transactions.
With over 1 million LEIs issued in over 200 countries and territories, they are now the globally preferred identifier for entities entering into financial transactions, regardless of jurisdiction, although the application of the LEI does vary between jurisdictions.
For instance, under MiFID II in Europe, the LEI is required for both exchange and OTC transactions. In Australia, by contrast, it does depend on who you are transacting through, although ASIC has stated that regulations will require a LEI to be used for all OTC transactions from 31 March 2019.
Irrespective of the OTC requirement, many brokers in Australia still require clients and entities to provide LEIs regardless, particularly those that have a European based parent.
While the impact of MiFID II is well understood by the Australian institutional funds market, it is less well understood by trustees of SMSFs and their advisers.
The question asked by many of them is: How can a Eurozone requirement possibly impact financial transactions taking place in Australia? In fact, despite being a EU requirement it may impact all financial services entities globally as European based brokers may have satellite offices around the globe that adopt the parent’s compliance regime.
So, while the MiFID II reporting regime cannot directly regulate Australian entities - it can affect the way they are required to transact. It certainly impacts any Australian entities wanting to transact with certain European counterparties, including SMSFs.
LEIs are not utilised in a uniform way around the world, clearly Europe appears to be the leading the way as a result of MiFIDII, but other jurisdictions such as India and the United States are using them for different purposes.
Looking ahead, the Global Legal Entity Identifier Foundation (GLEIF) is working with digital certificate providers (a digital certificate is an attachment to an electronic message used for security purpose) to enhance the authentication characteristics of the certificate by including LEI information on the certificate. This is an extremely exciting non-financial utilisation of the LEI.
Although it sounds complicated and onerous, obtaining a LEI is a one-off exercise, and once a SMSF obtains a LEI, the identifier stays with it for the entirety of its existence.
While it will inevitably be seen by some as an increased layer of regulation and administration, there has in fact been a long-standing need for a globally uniform system of legal entity identification, and the LEI requirement goes a long way in addressing this.
At its core, identifiers such as the LEI are a ‘building’ block for facilitating a number of financial stability objectives. These include: supporting the aggregation of risk positions and financial data, assisting in the assessment of micro and macro prudential risks, facilitating order resolution, assisting in containing market abuse, and further facilitating straight through processing.
Identifiers are likely to play an increasing role in safeguarding the financial services ecosystem in the future, particularly in light of the findings of the Royal Commission.
Already in Australia, APIR and SPIN codes – which provide the identification standard for our managed funds and our superannuation funds – together with global identifiers such as International Securities Identification Numbers (ISINs) and LEIs – have shown they have a vital role to play. They assist in facilitating the continued growth of the Australian wealth management industry as well as ensuring the smooth integration of Australian financial products into the global industry and regulatory framework.
As the Australian financial system faces increased pressures of global regulatory harmonisation, product identifiers will continue to move beyond being a useful way to categorise and monitor financial products, to be an integral part of the compliance and risk management framework.
Chris Donohoe is the chief executive of APIR.