Deadline imminent for European assets and OTC derivatives

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Despite a number of last-minute reprieves, applications of exemptive relief and extensions, the deadline for SMSFs to obtain a Legal Entity Identifier (LEI) is set in stone at 31 March 2019.

A LEI is a 20-digit, alpha-numeric code that enables identification of legal entities participating in financial transactions.

All SMSFs that trade European assets and over-the-counter derivatives (OTC) will need a LEI code from 1 April.

Indeed, a range of Australian financial services entities – including funds, brokers/traders as well as trustees of self-managed superannuation funds – may be unable to transact these investments from this date if they don’t have a LEI.

Considering there are some 600,000 SMSFs in Australian, 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 requirement forms part of the 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 following analysis of the cause of the global financial crisis. It has 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 does impact all financial services entitles globally – in a number of ways – if they trade or clear European assets, or even if they simply trade or clear via a local institution with a European head office.

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.

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, product identiifiers 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.

Product 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 being an integral part of the compliance and risk management framework.

 Breakout box: What is a LEI?

The legal entity identifier is a 20-character alpha numeric code that uniquely identifies legally distinct entities that engage in financial transactions. The technical specification for the LEI is OSO 17442.

The LEI code is association with certain reference date for each entity.

LEI codes have been issued to over 1 million entities in more than 200 countries and territories.

In November 2017, APIR and the London Stock Exchange announced a partnership to support the issuance and maintenance of LEIs and associated reference data in the Asia Pacific region and to help Australian financial services firms comply with new global compliance standards. Obtaining an LEI for Australian firms a relatively quick, easy and inexpensive process.

This complements APIR’s position as the industry standard for coding and identification of managed funds, superannuation funds and managed accounts in Australia.