This week ESMA released the long-awaited final guidelines for the upcoming SFTR regulation, due to come into force for most firms in April. Included in the final draft is a grace period of 12 months for the reporting of LEI codes – a reprieve that has been met with a collective sigh of relief from the industry.
The Legal Entity Identifier (LEI) code, a 20-character reference code to uniquely identify legally distinct entities that engage in financial transactions and associated reference data, was introduced by the G20 back in 2011 with the first codes issued from December 2012. ESMA has incorporated the use of LEIs across numerous pieces of legislation, including SFTR, where LEIs must be correctly indicated on all transaction reports, irrespective of the location of the counterparties, the issuers of securities or the rest of participants to an SFT and regardless of whether any of these entities are subject to LEI requirements in their own jurisdictions.
However, although the use of the LEI is required or is in the process of being implemented by other regulators, including those in the US, Canada and Asia-Pacific, overall global take-up has been patchy – leading to concerns over levels of LEI coverage, especially between the EU and third country jurisdictions. As of May 2019, 88% of instruments issued by EU issuers had an LEI code compared to a non-EU average of just 30% (according to FSB data).
“Considering the still unsatisfactory level of LEI coverage on the global scale, ESMA acknowledges the potential reporting implementation issue with respect to SFTs entered into by EU investors with regards to third-country securities,” said the regulator in a statement on Monday.
In that context, and to support the smooth introduction of the LEI requirements under the SFTR reporting regime, ESMA has confirmed a period of up to twelve months starting from the entry into force of SFTR reporting requirements during which the reports without the LEI of third-country issuers (that do not have an LEI) of securities which are lent, borrowed or provided as collateral in an SFTR will be accepted. In addition, it has instructed competent authorities to “not prioritise their supervisory actions” in relation to third-country issuer LEI reporting. In other words, back off and hang fire.
“ESMA’s decision is one of common sense, based on the acknowledgement that a regulation should not disrupt the markets it aims to regulate. In this case, there were serious concerns around liquidity,” says Yann Bloch, Senior Pre-Sales and Product Expert at financial software provider NeoXam.
However, the move does not necessarily mean that ESMA is taking its foot off the gas, or that non-compliant firms are off the hook. The partial relaxation of the validation rules only applies to the LEIs of third-country issuers. It does not affect the mandatory LEI reporting the LEI in all other cases, including for the identification of third-country entities that take part in the transaction under SFTR.
The big challenge is going to be accelerating LEI coverage outside the EU, which remains a significant challenge, and should be targeted as a top priority for the securities finance industry in 2020. Over the next year, ESMA has made it clear that counterparties and other participating entities (such as agent lenders and tri-party agents) will be expected to liaise with their third-country issuers to ensure that they are aware of the LEI requirement under LEI and move to comply by April 2021.
“This decision should not be misinterpreted,” agrees Bloch. “SFTR will still come into force on the planned date, with all its reporting requirements, including LEI codes for all entities (EU and non-EU) in securities finance transactions. The only exception will apply to non-EU issuers of securities lent, borrowed or used as collateral. This indicates that there are no big concerns over the industry’s readiness to comply with the new regulation.”
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