The European Market Infrastructure Regulation (EMIR) framework defines reporting, clearing and risk mitigation obligations for derivatives trading. Since February 2014, EMIR requires all European institutions involved in trading any type of derivatives, whether OTC or exchange-traded, to report trades in those derivatives to a Trade Repository (TR). Trade reports must identify all counterparties, brokers, clearing members and beneficiaries using their Legal Entity Identifiers (LEIs).
The LEI presents a range of challenges, especially for non-financial companies that have not previously had to comply with financial services regulation. However, we believe that the introduction of the LEI can provide substantial benefits to firms that go beyond mere compliance with regulation.
The LEI can serve as a “universal” identifier across all systems and parts of a given company (e.g. to identify counterparties, customers, suppliers, lenders, debt owners, syndicators etc.) for both internal and external uses. It reduces ambiguities as to the entities companies are dealing with and gives intra-firm clarity on exposures to any given counterparty across desks, regions, funds, etc. Furthermore, combining LEIs with company hierarchy and ownership data can greatly enhance risk exposure monitoring.
As part of their assignment of LEIs, Local Operating Units perform elements of due diligence, validating a company’s status against national company registries, filings held by regulators and central banks, and stock exchanges. Once LEIs are fully rolled out and ingrained, regional identifiers should no longer be needed, greatly simplifying the maintenance of entity databases.
Adopting the LEI does come at a cost. Companies with an existing counterparty database have to make adjustments to their systems to incorporate the LEI, incurring development, quality assurance and maintenance costs. The wider EMIR requirements also require the development or procurement of a trade reporting system, or the outsourcing of reporting processes altogether. Certain costs, however, can easily be avoided by applying a range of best practices:
- Storing LEIs centrally: Decentralising the storage and maintenance of the LEI could remove most of the benefits of breaking silos between geographical locations, systems and/or desks. Reconciling these at a later stage might prove to be more costly than implementing a centralised approach from the start.
- Favouring a strategic solution over a tactical one: The LEI will increasingly become a globally used identifier for all companies, irrespective of current EMIR or other regulatory requirements. Implementing only a tactical solution now to accommodate for EMIR reporting might lead to higher future development costs when new requirements are defined.
- Avoiding manual mapping of LEIs: Although LEIs are expected to remain fairly stable, corporate actions do have an effect on company LEIs. Manually mapping and maintaining the LEI in an in-house database could prove to be a labour-intensive and error-prone activity.
Although EMIR is currently the driving force behind the LEI integration in Europe, much as Dodd-Frank has been the driving force behind LEI integration in the US, the LEI is currently being considered for a wider array of regulatory requirements globally. Further regulatory reforms will push companies to combine tactical solutions to specific regulations with a more strategic approach in preparation for future requirements.